UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.  20549

FORM 10-K

x☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 20132015
 
or
 
o☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                    to

Commission file number 000-26422

DISCOVERY LABORATORIES, INC.
(Exact name of registrant as specified in its charter)

Delaware
94-3171943
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)

2600 Kelly Road, Suite 100
Warrington, Pennsylvania 18976-3622
(Address of principal executive offices)

(215) 488-9300
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class
Name of each exchange on which registered
 
Common Stock, $0.001 par valueThe Nasdaq Capital Market
Preferred Stock Purchase Rights

Securities registered pursuant to Section 12(g) of the Act:

None
 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES  o☐ NO x☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  YES o☐ NO x☒

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES x☒ NO o☐
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES x☒ NO o☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x☒

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer
o☐
Accelerated filer
x☐
Non-accelerated filer
o☐
Smaller reporting company
o☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o☐ NO x☒

The aggregate market value of shares of voting and non-voting common equity held by non-affiliates of the registrant on June 30, 20132015 (based on the closing price for shares of the registrant’s common stock as reported on The Nasdaq Capital Market under the symbol DSCO on that datedate) was approximately $70$49.5 million.  In determining this amount, the registrant has assumed solely for this purpose that all of its directors, the executive officers named in Part III of thisits 2014 Annual Report on Form 10-K, and persons beneficially owning 10% or more of the outstanding shares of common stock of the registrant may be considered to be affiliates.  This assumption shall not be deemed conclusive as to affiliate status for this or any other purpose.

As of March 7, 2014, 84,696,91915, 2016, 8,191,289 shares of the registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

In accordance with General Instruction G(3) to the Annual Report on Form 10-K, portions of the registrant’s definitive Proxy Statement for its 20142016 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission no later than 120 days or April 30, 2014, after the registrant’s fiscal year ended December 31, 2013,2015, or April 29, 2016, and to be delivered to stockholders in connection with the 20142016 Annual Meeting of Stockholders, are herein incorporated by reference in Part III of this Form 10-K.

Unless the context otherwise requires, all references to “we,” “us,” “our,” and the “Company” include Discovery Laboratories, Inc., and its wholly-owned, presently inactive subsidiary, Acute Therapeutics, Inc.
 
FORWARD-LOOKING STATEMENTS
 
This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  The forward-looking statements are only predictions and provide our current expectations or forecasts of future events and financial performance and may be identified by the use of forward-looking terminology, including such terms as “believes,” “estimates,” “anticipates,” “expects,” “plans,” “intends,” “may,” “will” or “should” or, in each case, their negative, or other variations or comparable terminology, though the absence of these words does not necessarily mean that a statement is not forward-looking.  Forward-looking statements include all matters that are not historical facts and include, without limitation, statements concerning: our business strategy, outlook, objectives, future milestones, plans, intentions, goals, and future financial condition, including the period of time during which our existing resources will enable us to fund our operations.  Forward-looking statements also include our financial, clinical, manufacturing and distribution plans, and our expectations related to the commercialization of SURFAXIN® and our development and potential regulatory plans to secure marketing authorization for our products under development, starting with AEROSURF®, if approved;approved, and other potential future products that we may develop; our expectations, timing and anticipated outcomes of submitting regulatory filings for our products under development; our research and development programs, including planning for development activities, anticipated timing of clinical trials and potential development milestones, for our KL4 surfactant pipeline, our Aerosol Delivery System (ADS) based on our capillary aerosol generator (CAG)technology for delivery of aerosolized medications; plans for the manufacture of drug products, active pharmaceutical ingredients (APIs) and, materials and medical devices; and plans regarding potential strategic alliances and other collaborative arrangements to develop, manufacture and market our products.products, and other potential strategic transactions.
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We intend that all forward-looking statements be subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995.  Forward-looking statements are subject to many risks and uncertainties that could cause actual results to differ materially from any future results expressed or implied by the forward-looking statements.  We caution you therefore against relying on any of these forward-looking statements.  They are neither statements of historical fact nor guarantees or assurances of future performance.  Examples of the risks and uncertainties include, but are not limited to:

the risk that our AEROSURF phase 2b clinical program, which is our only development program at this time, may be interrupted, delayed, or generate inconclusive or non-compelling data, or present an unacceptable benefit / risk profile due to suboptimal efficacy and / or safety profile, which would have a material adverse impact on our business and our ability to continue as a going concern;

the risk that we will require in the near term, but may be unable to secure, significant additional capital to continue our operations, fund our debt service and support our research and development activities including expensive and time-consuming clinical trials, until such time, if ever, thatoperations and have sufficient cash resources to service and repay debt, but our revenues from all sources are sufficientability to offset our cash outflows. To the extent that we raise such capital throughmay be adversely impacted by: any delay or inability to complete our AEROSURF phase 2b clinical trial as planned, or if we obtain results from our clinical trial that are not sufficient to support a strategic transaction or equity financing; limitations on our ability to conduct primary offerings under our 2014 Universal Shelf, for our ATM Program or otherwise; the limited number of authorized shares available for issuance under our Amended and Restated Certificate of Incorporation, as amended, or failure to secure stockholder, if required, for a transaction involving greater than 20% of our outstanding common stock; any failure to comply with Nasdaq listing requirements, including with respect to the minimum bid price requirement, minimum market capitalization or minimum stockholders’ equity; and that unfavorable credit and financial markets may adversely affect our ability to fund our activities and that additional financings, such additionalequity financings could result in substantial equity dilution;

the risk that the initial and later phase of our AEROSURF phase 2 clinical program may be interrupted, delayed, or fail, which will harm our business;
the risk that, if we fail to successfully commercialize SURFAXIN as planned, and if we do not achieve revenues consistent with our expectations, it may be more difficult to secure the additional capital we will require when needed, if at all, whether from strategic alliances or other sources, to continue our commercial and medical affairs activities, as well as our research and development programs and our operations would be impaired, which ultimately could have a material adverse effect on our business, financial condition and results of operations;
risks relating to the ability of our sales and marketing organization to effectively introduce SURFAXIN in the United States (U.S.) and, if approved, our other product candidates, in a timely manner, if at all; and that we may not succeed in developing sufficient market awareness of our products or that our product candidates may not gain market acceptance by physicians, patients, healthcare payers and others in the medical community;
risks relating to the transfer of our manufacturing technology to contract manufacturing organizations (CMOs) and assemblers;
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the risk that we may be unable to enter into strategic alliances and/or collaboration agreements that would assist and support us in markets outside the U.S. with the development of our KL4 surfactant pipeline products, beginning with AEROSURF, including development of our lyophilized KL4 surfactant, and, if approved, commercialization of AEROSURF in markets outside the U.S.; support the commercialization of SURFAXIN in countries where regulatory approval is facilitated by the information contained in the SURFAXIN new drug application (NDA) approved by the U.S. Food and Drug Administration (FDA); and potentially support the development and, if approved, commercialization, of our other pipeline products;
risks relating to our plans potentially  to secure marketing and distribution capabilities in certain markets through third-party strategic alliances and/or marketing alliances and/or distribution arrangements, that could require us to give up rights to our drug products, drug product candidates and drug delivery technologies;
risks relating to our ability to manage growthour limited resources effectively and timely modify our business strategy as needed to respond to developments in our commercial operations and research and development activities, as well as in our business, our industry and other factors;

risks relating generally to our research and development activities, which among other things may involve time-consuming and expensive preclinical studies and potentially multiple clinical trials that may be subject to potentially significant delays or regulatory holds or fail;
risks related to our efforts to gain regulatory approval in the U.S. and elsewhere for our drug products, medical device and combination drug/device product candidates, including AEROSURF and our lyophilized KL4 surfactant, that we expect will bewhich is the drug component of AEROSURF and potentially could be developed as a life cycle extensionseparate surfactant drug product, including that changes in the national or international political and regulatory environment may make it more difficult to gain FDA or other regulatory approval of SURFAXIN under the name SURFAXIN LS™ ;
our drug products, medical device and combination drug/device product candidates;

risks relating to the rigorous regulatory approval processes, including pre-filing activities, required for approval of any drug, combination drug-device product or medical device that we may develop, whether independently, with strategic development partners or pursuant to collaboration arrangements;
the riskarrangements, including that the FDA or other regulatory authorities may not accept,file, or may withhold or delay consideration of, any applications that we may file,submit, the FDA or other regulatory authorities will not be able to agree on matters raised during the regulatory review process and other interactions, or that we may be required to conduct significant additional activities to potentially gain approval of our product candidates, if ever; or that the FDA or other regulatory authorities may not approve our applications or may limit approval of our products to particular indications or impose unanticipated label limitations;
 
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the risk that we may be unable to identify and the FDAenter into strategic alliances, collaboration agreements or other regulatory authorities will not be ablestrategic transactions that would provide capital to agree on matters raised duringsupport our AEROSURF development activities and resources and expertise to support the regulatory review process, or that we may be required to conduct significant additional activities toregistration and commercialization of AEROSURF in markets outside the U.S. and potentially gain approvalsupport the development and, if approved, commercialization, of our product candidates, if ever;other potential KL4 surfactant pipeline products;

risks relating to the transfer of our manufacturing technology to contract manufacturing organizations (CMOs) and assemblers, and our CMOs'CMOs’ ability to manufacture our lyophilized KL4 surfactant, in liquid and lyophilized dosage forms, which must be processed in an aseptic environment and tested using sophisticated and extensive analytical methodologies and quality control release and stability tests, for both commercial andour research and development activities;
activities and, if approved, commercial applications;

risks relating to our and our CMOs’ compliance status or ability to develop and manufacture combination drug/device products based on our CAG technology,ADS and related  components for preclinical and clinical studies of our combination drug/device product candidates and, if approved, for commercialization;commercial activities;

the risk that we, our CMOs or any of our third-party suppliers, many of which are single-source providers, may encounter problems in manufacturing our KL4surfactant drug products andproduct, the APIs used in the manufacture of our KL4drug products, CAG devicesproduct, ADS and related components, and other materials on a timely basis or in an amount sufficient to support our needs;

risks relating to our pledge of substantially all of our assets to secure our obligations under our loan facility (Deerfield Loan) with affiliates of Deerfield Management Company, L.P., which could make it more difficult for us to secure additional capital to satisfy our obligations and require us to dedicate cash flow to payments for debt service, which would reduce the availability of our cash flow to fund working capital, capital expenditures and other investment; moreover, we may be required to seek the consent of Deerfield to enter into certain strategic transactions;

risks that unfavorable credit and financial markets may adversely affect our ability to fund our activities, through our ATM Program or otherwise, and that our ATM Program may expire unutilized or be exhausted; and that additional equity financings could result in substantial equity dilution or result in a downward adjustment to the exercise price of five-year warrants that we issued in February 2011 (which contain price-based anti-dilution adjustments);
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risks that reimbursement and health care reform may adversely affect usour ability to secure appropriate funding an reimbursement; or that our products will not be accepted by physicians and others in the medical community;
or that market conditions, the risk that changes in the nationalcompetitive landscape or international political and regulatory environmentother factors may make it more difficult to gain FDA or other regulatory approval oflaunch and profitably sell our drug products and medical device candidates;products;

the risk that if we fail to maintain compliance with continued listing requirements of The Nasdaq Capital Market, our common stock may be delisted and the value of our common stock decrease;
the risks that we may be unable to maintain and protect the patents and licenses related to our products and that other companies may develop competing therapies and/or technologies;
the risks that we may become involved in securities, product liability and other litigation and that our insurance may be insufficient to cover costs of damages and defense;
the risk that we, our strategic partners or collaborators will be unable to attract and retain key employees, including qualified scientific, professional and other personnel, in a competitive market for skilled personnel, which could have a material adverse effect on our commercial and development activities and our operations;

the risks that we may be unable to maintain and protect the patents and licenses related to our products and that other companies may develop competing therapies and/or technologies;

the risks that we may become involved in securities, product liability and other litigation and that our insurance may be insufficient to cover costs of damages and defense; and

other risks and uncertainties detailed in “Risk Factors” and elsewhere in this Annual Report on Form 10-K, and in the documents incorporated by reference in this report.

Pharmaceutical, biotechnology and medical technology companies have suffered significant setbacks conducting clinical trials, even after obtaining promising earlier preclinical and clinical data.  Moreover, data obtained from clinical trials are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval.  After gaining approval of a drug product, pharmaceutical and biotechnology companies face considerable challenges in marketing and distributing their products, and may never become profitable.

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The forward-looking statements contained in this report or the documents incorporated by reference herein speak only as of their respective dates.  Factors or events that could cause our actual results to differ may emerge from time to time and it is not possible for us to predict them all.  Except to the extent required by applicable laws, rules or regulations, we do not undertake any obligation to publicly 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.

Trademark Notice
AEROSURF®,, AFECTAIR®,, DISCOVERYLABS®,, INSPIRED INNOVATION®, SURFAXIN®, andWARMING CRADLE SURFAXIN® are registeredand common law trademarks of Discovery Laboratories, Inc. (Warrington, PA).
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DISCOVERY LABORATORIES, INCINC.

Table of Contents to Annual Report on Form 10-K
For the Fiscal Year Ended December 31, 20132015
 
PART I
ITEM 1.
BUSINESS
1
ITEM 1A.
RISK FACTORS
2527
ITEM 1B.
UNRESOLVED STAFF COMMENTS
5756
ITEM 2.
PROPERTIES
5756
ITEM 3.
LEGAL PROCEEDINGS
5856
PART II
ITEM 5.
MARKET FOR REGISTRANT'SREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
58 56
ITEM 6.
SELECTED FINANCIAL DATA
5957
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
6057
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
8073
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
8073
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
8173
ITEM 9A.
CONTROLS AND PROCEDURES
8173
ITEM 9B.
OTHER INFORMATION
8374
PART III
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
8375
ITEM 11.EXECUTIVE COMPENSATION 
ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS 
ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE 
ITEM 14.PRINCIPAL ACCOUNTING FEES AND SERVICES 
PART IV
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
8375 
 
SIGNATURES
8476 
PART I

ITEM 1.BUSINESS.
 
COMPANY OVERVIEW

Discovery Laboratories, Inc. (referred to as “we,” “us,” or the “Company”) is a Delaware corporation, with our principal offices located at 2600 Kelly Road, Suite 100, Warrington, Pennsylvania.  We were incorporated as a Delaware corporation in 1992.  Our telephone number is 215-488-9300 and our corporate website address is www.discoverylabs.com.  Our common stock is listed on The Nasdaq Capital Market®, where our symbol is DSCO.1

We are a specialty biotechnology company focused on creating life-saving productsdeveloping novel KL4 surfactant therapies for critical-care patients with respiratory diseasediseases and improvingother potential applications.  Surfactants are produced naturally in the standard of care in pulmonary medicine.lung and are essential for normal respiratory function and survival.  Our proprietary drug technology producesplatform includes a synthetic, peptide-containing surfactant (KL4 surfactant) that is structurally similar to endogenous pulmonary surfactant, a substance produced naturally in the lung and essential for normal respiratory function and survival.  We are developing our KL4 surfactant in liquid, lyophilized and aerosolized dosage forms.  We are also developing novel drug delivery technologies potentiallybeing developed to enable efficient deliverynoninvasive administration of our aerosolized KL4 surfactant.  We believe that our proprietary technologiestechnology platform may make it possible for the first time, to develop a significant pipeline of surfactant products to address a variety of respiratory diseases for which there frequently are few or no approved therapies.

Initial Focus – Respiratory Distress Syndrome (RDS) in Premature Infants

We are initiallyOur core development program, AEROSURF® (lucinactant for inhalation), is focused on improving the management of respiratory distress syndrome (RDS) in premature infants.  RDS isinfants, a serious respiratory condition caused by insufficientthat can result in long-term respiratory problems, developmental delay and death.  Premature infants born prior to 37 weeks gestational age may not have fully developed natural lung surfactant production in underdeveloped lungsand therefore may need surfactant therapy to sustain life.  Higher incidence and severity of RDS are correlated with younger gestational ages; however, RDS can occur at any premature infants.gestational age.  RDS is the most prevalent respiratory disease in the Neonatal Intensive Care Unitneonatal intensive care unit (NICU) and can result in long-term respiratory problems, developmental delay and death.

Our first KL4 surfactant drug product, SURFAXIN® (lucinactant) Intratracheal Suspension for the prevention of RDS in.  We estimate that 120,000 to 150,000 premature infants at high risk for RDS, was approved by the United States Food and Drug Administration (FDA) in 2012.  SURFAXIN is our KL4 surfactant in liquid form and is the first synthetic, peptide-containing surfactant approved by the FDA and the only alternative to animal-derived surfactants currently usedare given respiratory support after birth each year in the United States (U.S.).  Since November 2013, SURFAXIN has been commerciallybecause they have or are at risk for RDS.

Surfactant therapy is a life-saving treatment for RDS and the primary therapy to address an underlying surfactant deficiency.  Surfactants currently available in the U.S.

Premature infants with severe RDS currently are treated with surfactants that can onlyanimal-derived and must be administered byusing invasive endotracheal intubation supported withand mechanical ventilation, both invasive procedures thateach of which may each result in serious respiratory conditions and other complications.  Intubation is associated with airway trauma and clinical instability that can extend beyond the respiratory system such as increased intracranial pressure and risk for brain injury.  Mechanical ventilation is associated with ventilator-associated lung injury, chronic lung disease and increased risk of infection.To avoid these risks, many premature infants are initially treated with noninvasive respiratory support, such complications, many neonatologists treat infants with less severe RDS by less invasive means, typicallyas nasal continuous positive airway pressure (nCPAP).  Unfortunately, a significant number ofsince nCPAP does not address the underlying surfactant deficiency, many premature infants onrespond poorly to nCPAP will not respond well(typically within the first 72 hours of life) and may require intubation and delayed surfactant therapy (an outcome referred to as nCPAP failure) and thereafter may require delayed surfactant therapy.  Since neonatologists currently cannot predict which infants will experience nCPAP failure, neonatologists are faced with difficult choices in treating.

In addition, many premature infants with less severe RDS.  This is because the medical outcomes for those infants who experience nCPAP failure and receive delayed surfactant therapy may be less favorable than the outcomes for infantsRDS who receive surfactant therapy inas initial therapy are capable of breathing without mechanical ventilation, but require surfactant therapy for RDS.  Because surfactant therapy requires intubation, these infants generally are supported with mechanical ventilation for either a limited or extended period of time.  If surfactant therapy could be administered noninvasively, neonatologists would be able to provide surfactant therapy to these premature infants without exposing them to the first hours of life.risks associated with intubation and mechanical ventilation.

AEROSURF® is an investigational combination drug/device product that combines our proprietary KL4 surfactant with our proprietarynovel aerosol delivery system (ADS), which is based primarily on our capillary aerosol generator (CAG).  Withtechnology.  We are developing AEROSURF neonatologists potentially will be able to administerenable administration of aerosolized KL4 surfactant to premature infants supported withreceiving nCPAP, without having to use invasive intubation and mechanical ventilation.  By enabling delivery of our KL4 surfactant using less invasive procedures, weWe believe that, if approved, AEROSURF will address a serious unmet medical need and potentially enablehave the potential to transform the treatment of a significantly greaterRDS, allow for earlier treatment of those premature infants who currently receive surfactants later in their course of treatment, decrease the morbidities and complications currently associated with surfactant administration, and reduce the number of premature infants with RDS who could benefit fromare subjected to invasive intubation and delayed surfactant therapy but are currently not treated.as a result of nCPAP failure.
1Information concerning the shares of our common stock and related share prices in this Annual Report on Form 10-K has been adjusted to reflect a 1-for-14 reverse split of our common stock and a change in the number of shares of common stock authorized for issuance under our Amended and Restated Certificate of Incorporation, as amended, that were made effective on January 22, 2016. 
We are also developing a lyophilized (freeze-dried) dosage form of our KL4 surfactant that is stored as a powder and reconstituted to liquid form prior to use with the objective of improving ease of use for healthcare practitioners, as well as potentially to prolong shelf life and eliminate the need for cold-chain storage.  We are initially developing this dosage form for use in our AEROSURF development program.  We are also planning to seek regulatory advice to determine if we could gain marketing authorization for a lyophilized dosage form of SURFAXIN under a development plan that would be both capital efficient and capable of implementation within a reasonable time.  If feasible, we would likely implement such a development plan and would plan to introduce it commercially as a life-cycle extension of SURFAXIN under the name SURFAXIN LS™, in the U.S. and potentially in other markets.

The current RDSsurfactant market for surfactantsRDS is estimated to be approximately $75 million annually in the U.S. and $250 to $300 million annually worldwide; however, we believe that this market has been constrained, in part, by the risks associated with surfactant administration and lack of medical innovation.  Treatment options for RDS have not improved significantly, nor have mortality and morbidity rates for RDS meaningfully improved over the last few decades.  We believe that the neonatal medical community would respond favorably to the introduction of a synthetic, peptide-containing (KL4) surfactant and a less-invasive method of surfactant administration.  By enabling delivery of our aerosolized KL4 surfactant using noninvasive methods, we believe that AEROSURF, if approved, will address a serious unmet medical need and potentially provide transformative clinical and pharmacoeconomic benefits.  We believe that AEROSURF has the potential to create a worldwide annual market opportunity of $600 million to a $1 billion per year.  See, “– Surfactant Therapy – The RDS Market.”

The drug product component of our AEROSURF product candidate is a lyophilized (freeze-dried) dosage form of our KL4 surfactant liquid instillate drug product that was approved by the U.S. Food and Drug Administration (FDA) in 2012 under the name SURFAXIN® (lucinactant) Intratracheal Suspension for the prevention of RDS programs, includingin premature infants at high risk for RDS.  In the second quarter of 2015, we determined to cease commercial and manufacturing activities for SURFAXIN to focus our limited resources on advancing the AEROSURF clinical development program and our aerosolized KL4 surfactant that potentially may be administered using less invasive means, collectively and over time, have the potential to greatly improve the management of RDS and to expand the current RDS estimated worldwide annual market to more than a $1 billion per year market opportunity.

To support the commercial introduction of SURFAXIN in the U.S. and our other KL4 surfactant pipeline products, if approved, we have established our own specialty respiratory critical care commercial and medical affairs team.  This team includes medical professionals with experience in neonatal/pediatric respiratory critical care, and has focused on products that address neonatal indications, beginning with SURFAXIN.pipeline.  We believe that this team will be positionedgaining the approval of SURFAXIN provided us valuable experience to efficiently introducesupport the further development of our other KL4 surfactant products under development, if approved, including AEROSURF and potentially SURFAXIN LS and future applications of our aerosolized KL4 surfactant.

In addition, we recognize that our commercial and medical affairs team could potentially support introductions of other synergistic pipeline products, including products owned or developed by third parties for the NICU/PICU.  To that end, we would consider potential transactions focused on securing commercial rights to such synergistic products, including in the form of product acquisitions, in-licensing agreements or distribution, marketing or co-marketing arrangements.candidates, beginning with AEROSURF.

Beyond RDS

In the future, we expectbelieve that we may be able to leverage the information, data and know-how that we gain from our development efforts with SURFAXINactivities for our KL4 surfactant, in liquid, lyophilized and AEROSURFaerosolized dosage forms, to support development of a potential product pipeline of KL4 surfactant products to address serious critical care respiratory and other conditions in larger children and adults in pediatric and adult intensive care units (PICUSunits.  While we remain focused on AEROSURF, we have supported and ICUs),plan in the future to support potential opportunities to explore the utility of our KL4 surfactant to address a variety of respiratory conditions.  Although there can be no assurance, we would consider supporting such efforts in the future if we are able to secure separate funding, including through potential government-supported and other grant programs that are dedicated to advancing research and development initiatives.

We believe that our aerosolized KL4 surfactant, alone or in combination with other pharmaceutical compounds, has the potential to be developed to address a range of serious respiratory conditions and may be an effective intervention for such conditions as acute lung injury (ALI), including acute radiation exposure to the lung (acute pneumonitis and delayed lung injury), chemical-induced ALI, and influenza-induced ALI.  In addition, although there can be no assurance, we may explore opportunities to apply KL4 surfactant therapies to treat conditions such as chronic rhinosinusitis, complications of certain major surgeries, mechanical ventilator-induced lung injury (often referred to as VILI), pneumonia, diseases involving mucociliary clearance disorders, such as chronic obstructive pulmonary disease (COPD) and cystic fibrosis (CF).  AtThere can be no assurance, however, that we will secure the present time, however,additional capital needed to undertake such explorations, that we are focusing our resources primarily on the commercial introduction of SURFAXIN and development of AEROSURF through phase 2 clinical trials.  Oncewill undertake such explorations or that, even if we have achieved these objectives,do, that we believe we wouldwill be in a better position to assess the potential of other development programs to address the critical care needs of patients in the PICU and ICU.

We also have developed a disposable aerosol-conducting airway connector for infants that is intended to simplify the delivery of aerosolized medications (including our aerosolized KL4 surfactant) and other inhaled therapies to critical-care patients requiring ventilatory support.  This device introduces aerosolized medications directly at the patient interface and minimizes the number of connections in the ventilator circuit.  We have registered this device as a Class I, exempt medical device in the U.S. under the name AFECTAIR® and it is currently commercially available in the U.S.successful.
 
BUSINESS STRATEGY

We continue to focus our drug research and development activities on the management of RDS in premature infants.  We believe thatare currently conducting a clinical development program for AEROSURF for the RDS market represents a significant opportunity from both a medical and a business perspective.  See, “– Surfactant Replacement Therapy for Respiratory Medicine – Respiratory Distress Syndrome in Premature Infants (RDS).”treatment of RDS.  Our immediate goal is to successfully introduce SURFAXIN in the U.S. and advance development of our AEROSURF program.  Key elements of our strategy to achieve theseour goals include:includes:

·WithWe are focusing our efforts on advancing the introduction of SURFAXIN, the first synthetic, peptide-containing surfactant approved by the FDA, we believe that hospitals in the U.S., over time, will replace animal-derived surfactants, which are derived from pig and cow lungs using a chemical extraction process, with SURFAXINAEROSURF clinical development program and our other clinically differentiated syntheticaerosolized KL4 surfactant products.pipeline candidates.  We opened an investigational new drug application (IND) with the FDA and initiated a phase 2 clinical program for AEROSURF for the treatment of RDS in premature infants in November 2013.
oTo supportIn May 2015, we announced the commercial introduction of SURFAXIN, we have established our own specialty respiratory critical care commercial and medical affairs organization that has experience in respiratory critical care and is focused on neonatal / pediatric indications, beginning with SURFAXIN and, in the future, AEROSURF and our other KL4 surfactant products under development, if approved.
oWe also will seek to identify other synergistic products that may be of benefit in the NICU/PICU and could be marketed through our team.  To gain access to synergistic products, we would consider potential transactions focused on securing commercial rights in the U.S., including through product acquisitions or in-licensing, distribution, marketing or co-marketing arrangements.  We believe that this strategy provides us direct control over our U.S. sales and marketing activities, permits us to establish a strong presence in NICUs and PICUs nationwide, and potentially optimizes the economicsresults of our business.

·To advance ourinitial AEROSURF development program in the U.S., we are conducting a phase 2 clinical program, having opened an investigational new drug (IND) application with the FDA in the fourth quarter of 2013.
oThe first part of our clinical program, phase 2a is designedopen label clinical trial conducted in 48 premature infants 29 to 34 week gestational age who were receiving nCPAP for RDS.  The primary goal of this trial was to evaluate the safety and tolerability of a single exposure of aerosolized KL4 surfactant administered in three escalating inhaled doses (15, 30 and 45 minutes) to premature infants with RDS, compared to infants receiving nCPAP alone.  In addition, a key objective of this trial was to establish proof of concept for our proprietary technology platform with (1) physiological data indicating that aerosolized KL4 surfactant is being delivered into the lung of premature infants, and (2) acceptable performance of the novel ADS in the NICU.  Physiological data from this clinical trial suggest that, with AEROSURF, in an escalatingKL4 surfactant is being delivered to the lungs of premature infants with RDS and potentially improves gas exchange.  In addition, parameters related to timing and frequency of the need for invasive surfactant therapy suggest that a single dose of AEROSURF may delay the time to invasive surfactant therapy due to nCPAP failure.  Based on these encouraging results, we initiated a study evaluating threeto explore whether multiple or increased doses of increasing amounts of AEROSURF.  The comparator is nCPAP only.  We anticipate results inAEROSURF may potentially reduce the second half of 2014.need for invasive surfactant therapy.
 
oThe nextIn October 2015, we completed enrollment in an AEROSURF phase 2a clinical expansion study in 32 premature infants 29 to 34 week gestational age who were receiving nCPAP for RDS.  This trial was designed to evaluate safety and tolerability of aerosolized KL4 surfactant administered in higher (60 and 90 minutes) doses compared to infants receiving nCPAP alone.  In November 2015, we announced top line data from our overall phase 2a clinical program in premature infants 29 to 34 week gestational age, including the previously announced data from the initial phase 2b, will have2a clinical trial.  The data suggestthat aerosolized KL4 surfactant delivered to premature infants with RDS is generally safe and well tolerated and may be reducing the incidence of nCPAP failure.  The reported adverse events and serious adverse events were those that are common and expected among premature infants with RDS and comparable to the control group.  Through 72 hours after the start of treatment, AEROSURF treated patients, predominantly receiving a primary objectivesingle dose, had lower rates of nCPAP failure compared to determinecontrol in each of the optimallast three dose and define the expected efficacy margin.  The results of this phase will inform the design of a potential phase 3 clinical trial focused on safety and efficacy.  We currently plan to initiate phase 2bgroups studied.  nCPAP failure rates were 53% in the second half of 2014control group (n=40) compared to 38% (n=8), 14% (n=7, excluding one patient who was inappropriately enrolled) and expect to complete it 38% (n=8) in the second half of 2015.45, 60 and 90 minute AEROSURF dose groups, respectively.
 
oSince June 2012,We also are enrolling a phase 2a multicenter, randomized, open-label, controlled clinical study in 32 premature infants 26 to 28 week gestational age receiving nCPAP for RDS that is designed to evaluate safety and tolerability of aerosolized KL4 surfactant administered in two escalating (30 and 45 minutes) doses, with potential repeat doses, compared to infants receiving nCPAP alone.  We anticipate completing enrollment in the second quarter of 2016 and releasing top-line results in the third quarter of 2016.  As with the previous phase 2a clinical trials, the primary objective of this 2a clinical trial is to evaluate safety and tolerability and we have beenare also assessing performance of the ADS in the NICU and available physiological data for information that indicates that aerosolized KL4 surfactant is being delivered to the lungs and potentially reducing or delaying the time to invasive surfactant therapy due to nCPAP failure.
oBased on the safety and tolerability profile observed in the phase 2a clinical program, we initiated the AEROSURF phase 2b clinical trial in premature infants 26 to 32 weeks gestational age receiving nCPAP for RDS.  The trial is a multicenter, randomized, controlled study with masked treatment assignment in approximately 240 premature infants and is designed to evaluate the safety and tolerability of aerosolized KL4 surfactant (including with potential repeat doses) administered in two dose groups (25 and 50 minutes), compared to infants receiving nCPAP alone.  We plan to evaluate the following endpoints: time to nCPAP failure (defined as the need for intubation and delayed surfactant therapy), incidence of nCPAP failure and physiological parameters indicating the effectiveness of lung function.  The trial is expected to be conducted in up to 60 clinical sites in the U.S., Canada, Europe and Latin America.  Enrollment is beginning with premature infants 29 to 32 week gestational age, and will include premature infants 26 to 28 weeks gestational age after completion of the ongoing phase 2a clinical trial in this age group.  We anticipate completing enrollment for this clinical trial by the end of 2016 and releasing top-line results in the first quarter of 2017.
·We are also planning for the manufacture of a sufficient number of ADSs to support the AEROSURF phase 2b clinical trial.  We are working with Battelle Memorial Institute (Battelle), which supportedassisted us in a multi-phasethe development program that culminated in theand manufacture of clinic-ready CAG devices and disposable AEROSURF Delivery Packs (ADPs) for our phase 2a clinical trial.  Battelle has agreedclinic-ready ADS to manufacture a sufficient number of CAG devices and ADPsADSs to support our plannedcontinuing development activities and our phase 2b clinical trialtrial. The ADS has been demonstrated to produce consistent and controlled output rates, particle size, and other aerosol characteristics throughout extended KL4 surfactant dosing periods.  We believe the ADS represents a robust platform to support reliable and reproducible clinical development, activities.potential commercialization of our AEROSURF combination drug / device product, if approved, and, in the future, further life-cycle product development.

·We are developing a lyophilized (freeze-dried) dosage form of our KL4 surfactant that can be stored as a dry substance and reconstituted to liquid form just prior to use and is being developed potentially to improve ease of use for healthcare providers, prolong shelf life and reduce the need for cold-chain storage.  We are developing lyophilized KL4 surfactant initially for our AEROSURF development program.  In the first quarter of 2015, we completed a technology transfer of our lyophilized surfactant manufacturing process to our contract manufacturing organization (CMO), Patheon Manufacturing Services LLC (Patheon), which manufactured a sufficient supply of clinical drug product to support our AEROSURF phase 2 clinical program.  We are currently engaged in a second technology transfer to a new facility at Patheon.  We also have entered into a manufacturing development agreement with Patheon for the further development of this lyophilized KL4 surfactant, potentially for our AEROSURF phase 3 program and, if approved, commercial supply.

·To achieve our business objectives over time, we will require significant additional capital and resources to support our operations, advance our development programs, manufacture our drug product and medical devices, and support the commercialization of our approved products in markets around the world.  We continue to assess potential opportunities that could provide capital resources and strengthen our capabilities.
oIn October 2014, we entered into a Collaboration Agreement with Battelle providing for further development of our ADS for use in our planned AEROSURF phase 3 clinical program and, if AEROSURF is approved, initial commercial supply.  The collaboration involves a sharing of development expense and provides us the continued benefit of Battelle’s expertise in developing and integrating aerosol devices using innovative and advanced technologies.  See, “– Business Operations – Strategic Alliances and Collaboration Arrangements – Battelle Collaboration Agreement.”
 
oWe plan to use our lyophilized KL4 surfactant in our AEROSURF program.  Our contract manufacturing organization (CMO), DSM Pharmaceuticals, Inc. (DSM) has manufactured sufficient lyophilized KL4 surfactant drug product to support our phase 2a clinical trial and we expect DSM will manufacture additional product supply to support our planned phase 2b and, potentially, phase 3 clinical trials.
oTo advance our AEROSURF program in the European Union (EU) and potentiallyfuture to seek opportunities to enter into a significant strategic alliance, collaboration or other markets outside the U.S., we plan to retain regulatory consultants to assist us in engaging international regulatory authorities regarding a potential AEROSURF development plan.

·While we currently intend to retain all rights and commercialize our approved products in the U.S., an important priority for us is to secure strategic resources to support the continued development and commercial introduction of our RDS products in markets outside the U.S.
oTo advance andtransaction that would support our AEROSURF development activities, we seek a significant strategic alliance that potentially could provideby providing development, regulatory and commercial market expertise as well as financial resources, for our AEROSURF development program, and, if approved, support the commercial introduction of AEROSURF in the EU and other selected markets outside the U.S.  Financial resources provided by such alliances typicallyan alliance could take the form of upfront payments, milestone payments, commercialization royalties and a sharing of research and development expenses.
 
oTo potentially advance the introduction of SURFAXIN in markets outside the U.S. where regulatory marketing authorization is facilitated by the information contained in our new drug application (NDA) approved by the FDA, we would consider various financing or collaboration arrangements that could provide regulatory expertise and support the commercial introduction of SURFAXIN, and potentially our other FDA-approved KL4 surfactant products, in other countries.  Such countries could potentially include those in Latin America, North Africa and the Middle East.
·An important priority for us is to strengthen our long-term financial position.  We will require significant additional capital over time to advance our development programs, support the introduction of our approved products, support our operations and maximize stockholder value.  See, “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”
oWe will require additional capital to fund our operations and development activities until such time as revenues from the sale of SURFAXIN and AEROSURF are sufficient, if ever, to fund our development activities and operations.  In February 2013, we entered into a loan agreement (Deerfield Loan) with affiliates of Deerfield Management Company, L.P. (Deerfield) and have received advances totaling $30 million, secured by a security interest in substantially all of our assets.  The proceeds of these loans are being used to meet our working capital requirements.  We also entered into an At-the-Market Equity Offering Sales Agreement with Stifel, Nicolaus & Company, Incorporated (Stifel), under which Stifel, as our exclusive agent, may sell through an “at-the-market” program (ATM Program), at such times that we may elect in our sole discretion, during a three-year term, up to a maximum of $25,000,000 of shares of our common stock.  At December 31, 2013, $23.0 million was available under the ATM Program.  We plan to use any proceeds from the ATM Program to meet our working capital requirements.  During 2013, we raised aggregate gross proceeds of $75.8 million through public offerings of our common stock, including under our ATM Program.  We plan to continue to carefully managingclosely manage our cash resources and will seek additional capital, including potentially from strategic transactions and through future debt and equity financings, as we deem necessary to maintain and strengthen our financial position.  However, with our current market capitalization, we may be constrained in our efforts by several factors, including: (i) our ability to conduct primary offerings, including under the ATM Program, is constrained by a restriction under our universal shelf registration statement on Form S-3 (File No. 333-196420), which was declared effective on June 13, 2014 (2014 Universal Shelf), that limits the value of primary securities offerings we may conduct in any 12-month period to no more than one-third of our public float; (ii) the number of authorized shares currently available for issuance under our Amended and Restated Certificate of Incorporation, as amended, likely would be insufficient to fund our activities through equity offerings; (iii) if in a financing, we seek to issue more than 20% of our outstanding shares of common stock, we may be required to first seek approval of our stockholders, a time-consuming and expensive process; (iv) if we fail to maintain compliance with Nasdaq listing requirements, including without limitation the minimum bid price, minimum market capitalization or minimum stockholders’ equity requirements, our common stock may be subject to delisting, which could affect the liquidity and value of our common stock.
 
oIn addition, as noted above, we expect that strategic alliances will play an important role in strengthening our financial position as well as our capabilities as we advance our KL4 surfactant development programs.

·We have invested, and will continue to invest, in improving our potential competitive position by protecting our exclusive rights in our KL4 surfactant technology, pipeline products and drug delivery technologies, including our CAG and aerosol-conducting airway connector, through patents, patent term restoration, trademarks and trade secrets.  We believe that our development programs will provide opportunities to extend our exclusivities into the future through new patents and other intellectual property.  We also hold, and will continue to seek, regulatory designations that provide post-approval market exclusivity for our pipeline products that would allow us to build our market share.  See, “– Licensing, Patents and Other Proprietary Rights and Regulatory Designations.”

·We continue to invest in quality systems and manufacturing capabilities.   We are planning for long-term continuity of supply and continued integrity and reliability of our manufacturing and quality assurance processes.  We seek to build a foundation to support our anticipated long-term needs, and intend to make appropriate capital investmentspursue non-dilutive funding opportunities, including in the near-term, balancing the useform of our available resources while maintaining flexibility in planning our long-term manufacturing activities and goals.

·While we are currently focused on RDS, we also believe that our KL4 surfactant technology could be developed into a broad product pipeline to address a variety of debilitating respiratory conditions and diseases, including pediatric and adult indications that could represent potentially significant market opportunities.  From time to time, we have participated in investigator-initiated research programs and government fundedU.S. Government-funded research and preclinical development initiatives that explore the use of our KL4 surfactant in the treatment of a range of respiratory diseases.  Since 2012, we have received $4.1 million in funding, including approximately $1.9 million to fund our AEROSURF phase 2a clinical program.
o
In July 2015, we completed a registered public offering of 1,791,667 Series A units and 3,000,000  Series B units each at a price per unit of $8.40, resulting in gross proceeds of $40.25 million ($37.6 million net after underwriting discount and expenses).  The proceeds included $5.0 million in non-cash consideration from affiliates of Deerfield Management, L.P. (Deerfield) in the form of a reduction in future interest payments due under the Deerfield Loan (discussed below).  Each Series A unit consists of one share of common stock and a Series A warrant to purchase one share of common stock at an exercise price of $9.80 per share.  Each Series B unit consists of a fully paid pre-funded Series B warrant to purchase one share of common stock at an exercise price of  $8.40 per share, and a Series B warrant to purchase one share of common stock at an exercise price of $9.80 per share.  See, Item 7 – Management Discussion and Analysis – Liquidity and Capital Resources – Financings Pursuant to Common Stock Offerings – Registered Public Offerings.”
oIn February 2013, we entered into an At-the-Market Equity Offering Sales Agreement (Sales Agreement) with Stifel, Nicolaus & Company, Incorporated (Stifel), pursuant to which Stifel, as our exclusive agent, may sell through an “at-the-market” program (ATM Program), at such times that we may elect during a three-year term, up to a maximum of $25,000,000 of shares of our common stock.  In February 2016, we entered into an amendment to the Sales Agreement to extend the term three years to February 11, 2019.  As of December 31, 2015, approximately $23.0 million remains available under the ATM Program.
o
In February 2013, we entered into a secured loan agreement with Deerfield, under which we secured long-term debt of $30 million (Deerfield Loan).  In July 2015, we entered into two amendments to the loan agreement, pursuant to which we prepaid $5 million of the outstanding principal amount, eliminated the initial principal payment due in February 2017; increased each of the remaining principal payments due in February 2018 (which may be deferred one year if we achieve a market capitalization milestone) and February 2019 to $12.5 million; agreed to pay $5 million in satisfaction of future interest obligations through issuance to Deerfield of $5 million securities in the July 2015 public offering; and reduced the rate of any remaining interest accruing under the Deerfield Loan from 8.75% to 8.25%.  The loan agreement also includes certain negative covenants that may require us to seek Deerfield’s consent before entering into certain strategic transactions, which could impair our ability to enter into certain strategic transactions.  See, “Item 7 – Management Discussion and Analysis – Liquidity and Capital Resources – Deerfield Loan.”
·We plan to continue prosecuting and protecting our rights in our KL4 surfactant drug products and drug delivery technologies through patents, patent term restoration, trademarks and trade secrets.  We expect that, as we advance our development programs, we may identify opportunities to extend the duration of our market exclusivities, through new patents and other intellectual property.  We also plan to utilize and seek regulatory designations that may provide post-approval market exclusivity for our approved products.  See, “– Licensing, Patents and Other Proprietary Rights and Regulatory Designations.”
·We believe that our KL4 surfactant technology may potentially support a product pipeline to address a variety of debilitating respiratory conditions and diseases including CFthat could represent potentially significant market opportunities.  While we remain focused on RDS, we have participated in investigator-initiated research programs and ALI.government-funded research and preclinical development initiatives that explore the use of our KL4 surfactant in the treatment of a range of respiratory diseases.  For example, since 2012, we have participated in a U.S. Government-funded study to assess whether aerosolized KL4 surfactant may mitigate radiation-induced lung injury in an animal model.  Although there can be no assurance, we may in the future support development activities to establish a proof-of-concept and, if successful, thereafter determine whether to seek strategic alliances or collaboration arrangements or pursue other financial alternatives to fund further development and/or worldwideand, if approved, commercialization of additional indications, if approved.KL4 surfactant indications.

Although we currently believe that we will be successful in completing our ongoing AEROSURF clinical trials within the time frames set forth above and that the results will support our planned AEROSURF phase 3 clinical program and registration of AEROSURF in the U.S.; that we will be able to manufacture a sufficient supply of lyophilized KL4 surfactant and ADSs and related components to support our AEROSURF clinical program; and that we will be able to secure the additional capital that we will require to achieve our business objectives, including through a strategic alliance or other strategic transaction, there can be no assurance that we will be successful.  Our activities involve significant risks and uncertainties that could cause the results of our efforts to differ from our expectations.  See, “Item 1A – Risk Factors.”
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Our estimates of market size and business opportunities included in this Item 1 – Business Section and elsewhere in this Annual Report on Form 10-K are based in part on our analysis of data derived from the following sources, among others: third-party market research conducted for us by Deerfield Institute, Defined Health and Compass Consulting with U.S. and EU based neonatologists in 2014; Annual Summary of Vital Statistics: 2010, Pediatrics, Martin et. al.; CDC National Vital Statistics, 2005;2013; IMS Midas Data MAT, December 2011;2013; HCUP Hospital Discharge data, 2008;2013; Obstetric and Neonatal Care Practices for Infants 501 to 1500 g From 2000 to 2009; Pediatrics, July 2013, Soll; Hospital Insurance Claim Database, 2009; Management and Outcomes of Very Low Birth Weight, New England Journal of Medicine (NEJM), 2008, Eichenwald, Stark; Cost of hospitalization for preterm and low birth weight infants in the United States, Pediatrics 2007, Russell RB; Market Intelligence Report on Number of ICU Beds in EU5 Countries; The Cystic Fibrosis Foundation website; Vermont Oxford Network Data, 2006; estimates from other companies with information on surfactant sales in countries where IMS data reporting is often incomplete or non-existent; and Discovery Labs Primary Market Research, December 2010 and May 2011; as well as our analysis of the SELECT and STAR trials described below.  Although we believe that the information contained in these sources are reliable as of the date of this Annual Report on Form 10-K, we have not independently verified such data and do not guarantee the accuracy or completeness of such information.  In addition, our analysis and assumptions take into account estimated patient populations, expected adoption rates of our products, current pricing, and economics and anticipated potential pharmacoeconomic benefits of our drug products, if approved.  We provide estimates and projections to give the reader an understanding of our strategic priorities, but we caution that the reader should not rely on our estimates and projections.  These estimates and projections are forward-looking statements, which we intend to be subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995.  For a discussion of forward-looking statements, see, “Forward-Looking Statements” on page iiiii of this Annual Report on Form 10-K, and “Item 1A – Risk Factors.”
SURFACTANT THERAPY

The RDS Market

Prior to the FDA’s approval of SURFAXIN, the only pulmonary surfactants commercially available in the U.S. were introduced in the 1990’s.  All of the available pulmonary surfactants were animal-derived and approved for RDS in premature infants.  SURFAXIN was the first synthetic, peptide-containing surfactant approved for use in neonatal medicine in the U.S.

We estimate that approximately 300,000 to 350,000 low birth weight premature infants are born annually in the U.S. (and approximately 500,000 to 600,000 in the major U.S., European and Japanese medical markets).  In addition, our current market data suggests that the number of low birth weight premature infants born annually in the Latin America, Asia and the Pacific markets may represent opportunities similar to Europe and Japan and we plan to conduct further market research on this topic.  In the U.S., we estimate that approximately 120,000 to 150,000 premature infants are given respiratory support because they have or are at risk for RDS.  Approximately 40% (50,000 to 60,000) of these infants currently are treated with surfactant as the initial therapy for RDS, usually within the first hours of life, generally because the perceived benefits of surfactant therapy for these very fragile infants outweigh the increased risks associated with invasive intubation and mechanical ventilation.  The remaining infants are usually initially supported with nCPAP alone.  As discussed above, a large percentage of these patients (approximately 25%) experience nCPAP failure and require delayed surfactant therapy administered via intubation and mechanical ventilation.  We estimate that approximately 20,000 to 25,000 infants will receive delayed surfactant therapy (post-nCPAP failure), bringing the total number of premature infants in the U.S. who are treated with surfactants for RDS to approximately 70,000 to 85,000.

Market research conducted with clinicians for us by third parties suggests that, if AEROSURF were approved, a significant number of the 120,000 to 150,000 premature infants given respiratory support because they have or are at risk for RDS would receive aerosolized KL4 surfactant as the initial treatment for RDS.
We estimate the surfactant market to be approximately $75 million annually in the U.S. and $250 to $300 million annually worldwide; however, we believe that this market has been constrained, in part, by the risks associated with surfactant administration and lack of medical innovation.  By enabling delivery of aerosolized KL4 surfactant using noninvasive means, we believe that, over time, AEROSURF has the potential to expand the current RDS estimated worldwide annual market to a $600 million to a $1 billion per year market opportunity.  See, “– Potential Pharmacoeconomic Benefits of AEROSURF.”)

Potential Pharmacoeconomic Benefits of AEROSURF

In addition to the potential clinical benefits of aerosolized KL4 surfactant, AEROSURF has the potential to provide significant pharmacoeconomic benefits for hospitals, payers and healthcare systems.  In the U.S., for example, the cost to support a mechanically ventilated premature infant (an estimated $55,000 per patient), is much greater than the cost to manage a premature infant who does not need mechanical ventilation (an estimated $8,500 per patient).  These costs increase even more if complications associated with intubation and mechanical ventilation should develop, including bronchopulmonary dysplasia.  Other healthcare system costs include the need to transport RDS patients who require intubation and mechanical ventilation to tertiary care neonatal intensive care units as well as family relocation costs.  Accordingly, by providing clinical and pharmacoeconomic benefits through the reduction or elimination of the need for intubation and mechanical ventilation to treat RDS, we estimate that AEROSURF may, over time, expand the size of the global surfactant market.

Serious Respiratory Indications Associated with Inflammation of the Lungs

Many respiratory diseases are associated with an inflammatory event that causes surfactant dysfunction and a loss of patency of the conducting airways.  Scientific data support the premise that the therapeutic use of surfactants in aerosol form has the ability to reestablish airway patency, improve pulmonary mechanics and act as an anti-inflammatory.  For this reason, we believe that AEROSURF is a highly promising program and that, with the knowledge that we gain from developing AEROSURF, we may be able to apply our technology platform to potentially address serious respiratory conditions affecting pediatric and adult patient populations.  We believe that our proprietary aerosolized KL4 surfactant technology potentially may be effective as a preventive measure to treat patients at risk for ALI and, possibly in the future, other conditions, such as COPD and CF.

Acute lung injury (ALI) is associated with conditions that either directly or indirectly injure the air sacs of the lung.  ALI is a syndrome of inflammation and increased permeability of the lungs with an associated breakdown of the lungs’ surfactant layer.  Among the causes of ALI are complications typically associated with certain major surgeries, mechanical ventilator-induced lung injury (often referred to as VILI), smoke inhalation, pneumonia and sepsis.  There are a significant number of patients at risk in the U.S. for ALI annually and there are no currently approved therapies other than supportive respiratory care.

We have collaborated in a number of preclinical studies funded through various U.S. government-sponsored, biodefense-related initiatives, including without limitation: (i) University of Pennsylvania, funded by the NIH’s National Institute of Allergy and Infectious Diseases (NIAID) to assess the ability of KL4 surfactant to mitigate effects of acute radiation exposure to the lung (award number R44AI102308); (ii) University of Rochester, to evaluate the use of KL4 surfactant to protect the lung in a radiation-induced multi-organ dysfunction animal model; (iii) a facility’s contract with the U.S. Department of Defense through the NIH Office of the Director and the Countermeasures Against Chemical Threats (CounterACT) program, to assess the utility of KL4 surfactant for the treatment of chemical-induced ALI;  (iv) a program funded by NIAID, to investigate the use of KL4 surfactant as a treatment for influenza-induced ALI.  We received additional awards of $1.0 million each from NIAID to support continued work with University of Pennsylvania to study (i) in 2014, how KL4 surfactant may mitigate radiation-induced lung injury, and in 2015, to support continued development of our aerosolized KL4 surfactant as a potential medical countermeasure to mitigate acute and chronic/late-phase radiation-induced lung injury.  We recently received from NIAID $225,000 fixed-price contract (contract HHSN272201500027C) to study KL4 surfactant aerosol to reduce influenza lung injury.  The foregoing content concerning these initiatives is solely the responsibility of Discovery Labs and does not necessarily represent the official views of the NIH.
We may in the future invest in or support third-party studies of these and other indications.  If a proof-of-concept should be established, we would then determine whether to seek strategic alliances or collaboration arrangements or utilize other financial alternatives to fund their further development.  There can be no assurance that we will invest or support studies in these indications, that we will secure the necessary capital, whether through government-sponsored grants or otherwise, that any such efforts will be successful, or that we will be able to conclude any such strategic alliance, collaboration arrangement or secure any financial alternative.
 
PROPRIETARY PLATFORM – KL4 SURFACTANT AND AEROSOL TECHNOLOGIES

Our KL4 Surfactant Technology

Pulmonary surfactants are protein and phospholipid compositions that form naturally in the human lung and are critical to survival and normal respiratory function.  They spread in a thin mono-layer to cover the entire alveolar surface orof the air sacs, or alveoli, of the lungs and the terminal conducting airways that lead to the air sacs.  Theyalveoli.  Surfactants facilitate breathing by continually modifying the surface tension of the fluid that lines the inside of the lungs.  If the lungs have a surfactant deficiency, as frequently occurs in premature infants, or experience surfactant degradation, generally due to disease, lung insult or trauma, the air sacsalveoli in the lungs will tend to collapse and will not absorb enough oxygen, resulting in severe respiratory diseases and disorders.  In addition to lowering alveolar surface tension, surfactants contribute in other important ways to respiration including, for example, by lowering the surface tension of the conducting airways and maintaining airflow and airway patency (keeping the airways open and expanded).  Many respiratory disorders are associated with surfactant deficiency or surfactant degradation.  However, the use of surfactant therapy presently has limited application and is currently approved by the FDA only to manage RDS in premature infants.

Our proprietary KL4 surfactant technology produces a synthetic surfactant that is structurally similar to human pulmonary surfactant and contains a proprietary synthetic peptide, KL4 (sinapultide), a 21-amino acid peptide that closely mimicsis designed to imitate the essential attributes of the human surfactant protein B (SP-B), one of four known surfactant proteins and the most important for proper functioning of the respiratory system.  Our synthetic surfactant is manufactured to approvedrigorous specifications, with minimal lot-to-lot variability, is currently approved by the FDA in liquid instillate form, and is being developed in liquid instillate, lyophilized (freeze-dried) and aerosolized dosage forms.  We have licensedhold an exclusive worldwide rightslicense and sublicense to this technology, which was invented at The Scripps Research Institute and exclusively licensed to Johnson & Johnson, Inc. (J&J) and further developed by an affiliate of Johnson & Johnson, Inc. (J&J).

We havepreviously demonstrated in preclinical studies that our KL4 surfactant may possess certain beneficial properties, including modulation of the inflammatory process, antimicrobial properties and non-immunogenicity.  (Wolfson, M.R., Wu, J., Hubert, T.L., Gregory, T.J., Mazela, J., & Shaffer, T.H. (2012), “Lucinactant attenuates pulmonary inflammatory response, preserves lung structure, and improves physiologic outcomes in a preterm lamb model of RDS.” Pediatr Res, 72(4), 375-383; Black C, Leon C, Pluim J. Bactericidal properties of the novel, peptide-containing surfactant - Surfaxin®. Pediatric Academic Societies, Honolulu, HI, May, 2008.  E‑PAS2008:633756.11; and Clayton RG, Cochrane CG, Gregory TJ. Surfaxin® (lucinactant) does not induce an immune response in a standardized preclinical model. Pediatric Academic Societies, Honolulu, HI, May, 2008.  E‑PAS2008:633756.12.)  We believe these properties may be important attributes as we seek to develop our KL4 surfactant technology pipeline potentially to address a broad range of respiratory conditions beyond RDS that represent significant unmet medical needs.  However, the clinical relevance of such attributes has not been adequately established and, accordingly, warrants further study.
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KL4 Surfactant Dosage Form FlexibilityForms

SURFAXIN is our first KL4 surfactant approved for sale in the U.S. and is a liquid instillate that is administered using the same method of administration required for animal-derived surfactants, endotracheal intubation and mechanical ventilation.  As with the animal-derived surfactantsSurfactants currently marketed in the U.S., it are liquid instillate and must be stored in refrigerated conditions, and warmed prior to use.

In addition to liquid instillate, ouruse, and administered using endotracheal intubation and mechanical ventilation.  Our KL4 surfactant technology also can be produced in a lyophilized (freeze-dried) dosage form that isand reconstituted to a liquid formjust prior to administration.  In several experiments, weWe have demonstrated in laboratory experiments that our lyophilized KL4 surfactant retains many of the key attributes and characteristics of our liquid instillate andinstillate.  We believe that it may provide additional benefits in a clinical setting, including potentially:
 
·improved ease of use for healthcare practitioners, including potential elimination of the drug warming process allowing for shortened preparation time; and potential elimination or reduction of continuous cold chain storage and refrigeration requirements;
 
·potential improved product stability andfor extended shelf life; and
 
·relatively lower viscosity than that of a liquid instillate, which may aid and/or improve the distribution of KL4 surfactant throughout the lung and potentially may reduce the frequency of transient peri-dosing events typically observed during administration of surfactants.

We have also demonstrated that we can aerosolize both the liquid instillate and lyophilized dosage forms of our KL4surfactant and that our aerosolized KL4 surfactant product candidate has the following important characteristics:
 
·full retention of the surface-tension lowering properties of a functioning surfactant necessary to restore lung function and maintain patency of the conducting airways;
 
·full retention of the surfactant composition upon aerosolization; and
 
·drug particle size believed to be suitable for deposition into the lung.

We initially planare using lyophilized KL4 surfactant to develop our aerosolized KL4 surfactant in our AEROSURF development program to treat RDS in premature infants and thereafterinfants.  Thereafter, we potentially will be able to address a range of indications in neonatal, pediatric and adult critical care patient populations.  We believe our KL4 surfactant in liquid, lyophilized and aerosolized dosage forms, may be developed to expand the therapeutic options available to treat previously unaddressed respiratory problems in patients of all ages.

Our Aerosolization Delivery Technologies

Capillary Aerosol Generator (CAG) Technology

We have worldwide exclusive rights to our CAG technology for use with pulmonary surfactants (alone or in combination with any other pharmaceutical compound(s)) for all respiratory diseasesThe Safety and conditions.  In addition, we hold in the U.S. exclusive rights to the CAG technology for use with certain non-surfactant drugs to treat a wide rangeEfficacy Profile of pediatric and adult respiratory indications in hospitals and other health care institutions.

Our proprietary CAG technology is designed to produce a high-quality aerosol capable of delivering our KL4 surfactant to the lung.  An aerosol is created by pumping our KL4 surfactant through a heated capillary.  Upon exiting the capillary, the aerosol cools and slows in velocity, yielding a dense aerosol with a defined particle size.  In studies conducted with our initial CAG device and our KL4 surfactant, we have generated an aerosolized KL4 surfactant at consistent and reproducible volumes suitable to deliver therapeutic dosages in a reasonable period of time.  Preclinical studies presented in 2007 at the Pediatric Academic Societies Annual Congress (PAS) comparing our CAG technology to commercially available aerosol devices indicated that our CAG device generated as much as a 10-fold higher aerosol output rate compared with the other devices studied.  We believe that our CAG technology is capable of effectively delivering our KL4 surfactant to the lung of premature infants with RDS without having to resort to invasive procedures that are currently required to administer surfactants.
AFECTAIR Aerosol-Conducting Airway Connector

We have also developed a novel, disposable aerosol-conducting airway connector that is intended to simplify the delivery of aerosolized medications, including our aerosolized KL4 surfactant, and inhaled therapies to infants requiring ventilatory support in the NICU and PICU.  This device introduces the aerosolized medication directly at the patient interface and minimizes the number of connections in the ventilator circuit, simplifying the delivery of aerosolized medications and other inhaled therapies.

We registered this device in the U.S. under the name AFECTAIR as a Class I, exempt medical device and we have completed the European conformity (CE) marking process in the EU.  Based on in vitro studies demonstrating that AFECTAIR improves the delivery of inhaled therapies to infants requiring ventilatory support, we believe that it has the potential to greatly improve the delivery of aerosolized medications and inhaled therapies to critical-care patients. We currently are focused on gaining information and learning from the introduction of AFECTAIR in the U.S.  Thereafter, we may consider introducing AFECTAIR in markets outside the U.S.
SURFACTANT REPLACEMENT THERAPY FOR RESPIRATORY MEDICINE

Prior to the FDA’s approval of SURFAXIN, the only pulmonary surfactants commercially available in the U.S. were introduced in the 1990’s.  All of the available pulmonary surfactants were animal-derived and approved for RDS in premature infants.  SURFAXIN is the first synthetic, peptide-containing surfactant approved for use in neonatal medicine and provides healthcare practitioners in the U.S. with an alternative to the animal-derived surfactants that today are the standard of care to manage RDS in premature infants.  We believe that our proprietary KL4 surfactant technology makes it possible, for the first time, to develop a significant pipeline of surfactant products targeted to treat a wide range of respiratory problems, including those for which there are currently few or no approved therapies.  Our potential programs include:

Respiratory Distress Syndrome in Premature Infants (RDS)

We are currently focused primarily on addressing RDS in premature infants, one of the most common serious respiratory problems facing premature infants in the NICU.  RDS is a condition in which premature infants are born with a lack of natural lung surfactant and are unable to absorb sufficient oxygen.  Premature infants born prior to 37 weeks gestation have not fully developed their own natural lung surfactant and therefore may need surfactant treatment to sustain life.  RDS is experienced in approximately half of the babies born between 26 and 32 weeks gestational age.  The incidence of RDS approaches 100% in babies born less than 26 weeks gestational age.  RDS can result in long-term respiratory problems and death.

Premature infants with severe RDS currently are treated with surfactants (usually within the first hours of birth) that can only be administered by endotracheal intubation supported with mechanical ventilation, both invasive procedures that may each result in serious respiratory conditions and other complications.  Neonatologists generally try to avoid mechanically ventilating infants due to the perceived risks associated with intubation, such as the risk of trauma and the need for paralytic agents and sedation.  To avoid these complications, many neonatologists will administer surfactants as an initial therapy only to premature infants with severe RDS, where the potential benefits of invasive surfactant therapy more clearly outweigh the associated risks.  Unfortunately, many infants with server RDS will relapse following initial surfactant therapy and require reintubation and prolonged mechanical ventilation as well as supplemental oxygen, increasing their risk of developing further serious respiratory complications.

A common ventilatory support treatment alternative to intubation and mechanical ventilation is nCPAP, which is generally used to support all but the very low birth weight infants with severe RDS.  Unfortunately, a significant number of infants do not respond adequately to nCPAP, an outcome referred to as nCPAP failure, and thereafter may require delayed surfactant therapy administered by intubation and mechanical ventilation.  Several published studies point toward a high rate of nCPAP failure in the neonatal population (Finer et al, “Early CPAP versus surfactant in extremely preterm infants,” N Engl J Med 2010;362(21):1970-9 (Finer, et al, NEJM 2010); Morely et al, “Nasal CPAP or Intubation at Birth for Very Preterm Infants,” N Engl J Med 2008;358:700-8 (Morely et al, NEJM 2008)).  Since it currently is not possible to predict which patients will experience nCPAP failure, neonatologists are faced with difficult choices in deciding how best to treat premature infants with less severe RDS. This is because the medical outcomes for those infants who experience nCPAP failure and receive delayed surfactant therapy may be less favorable than the outcomes for those infants who receive surfactant therapy in the first hours of life.
We estimate that approximately 360,000 low birth weight premature infants are born annually in the U.S. and at risk for RDS (approximately 600,000 in the U.S., major European medical markets, and Japan).  In the U.S., we estimate that approximately 160,000 premature infants could benefit from surfactant therapy.  However, due to the risks associated with intubation and mechanical ventilation, only approximately 45,000 of these infants currently are treated with surfactants as the initial therapy for severe RDS.  The remainder primarily receive nCPAP for less severe RDS.  As discussed above, a large percentage of these patients will fail nCPAP therapy and require delayed surfactant therapy administered via intubation and mechanical ventilation.  We estimate this delayed surfactant therapy (post-nCPAP failure) population to be another approximately 45,000 infants, bringing the total number of premature infants in the U.S who are treated with surfactants for RDS to approximately 90,000.

Neonatologists’ treatment options have not improved significantly, nor have mortality and morbidity rates for RDS meaningfully improved over the last decade.  We believe that the neonatal medical community would respond favorably to the introduction of a synthetic, peptide-containing surfactant and a less-invasive method of administration.

SURFAXIN for the Prevention of RDS in Premature Infants at High Risk for RDS

SURFAXIN is the first synthetic, peptide-containing surfactant that is structurally similar to pulmonary surfactant and mimics the surface-active properties of human surfactant.  SURFAXIN is a liquid instillate and is administered (usually within the first hours of birth) via endotracheal tube supported by mechanical ventilation.  SURFAXIN represents the first synthetic, peptide-containing surfactant approved for the prevention of RDS in premature infants at high risk for RDS.

Our NDAnew drug application (NDA) for SURFAXIN was supported by a phase 3 pivotal trial (SELECT) to evaluate the safety and efficacy of SURFAXIN for the prevention of RDS in premature infants.  Co-primary endpoints were the incidence of RDS at 24 hours and RDS-related mortality at 14 days.  The primary comparator was Exosurf® (colfosceril palmitate) with the intent of demonstrating superiority.  SURFAXIN demonstrated a statistically significant improvement in both RDS at 24 hours and RDS-related mortality through day 14.  Survanta® Survanta® (beractant) served as an additional active comparator.  SURFAXIN demonstrated a statistically significant reduction in RDS-related mortality through day 14 versus Survanta.  We also conducted a supportive, multicenter, double-blind, active-controlled, phase 3 clinical trial (STAR) which was designed as a non-inferiority trial comparing SURFAXIN to Curosurf®Curosurf® (poractant alfa), a surfactant derived from pig lung.lung, and was used to support the safety of SURFAXIN.

The SELECT and STAR trials, as well as a pooled phase 3 analysis, have been presented at several international medical meetings and the results from the two studies were published in Pediatrics, the Official Journal of the American Academy of Pediatrics and a premier medical journal for pediatric healthcare practitioners.  Post-hoc analysis of data from our SELECT and STAR phase 3 clinical trials indicates that premature infants with RDS who were extubated after treatment with surfactant and who later required reintubation had a significantly higher rate of mortality than those infants who did not require reintubation.  The data also indicate that premature infants treated with SURFAXIN requiredmay require less reintubation compared to those treated with Survanta and Curosurf.  The clinical relevance of this finding has not been adequately established and, accordingly, warrants further study.  However,than currently approved animal-derived surfactants.  Moreover, pharmacoeconomic analysis suggests that lower reintubation rates may result in significant hospital cost savings associated with reduction in time spent on mechanical ventilation and reduced rates of bronchopulmonary dysplasia (BPD), air leak, sepsis, necrotizing enterocolitis (NEC), or intraventricular hemorrhage (IVH).

TheSURFAXIN was approved by the FDA granted marketing approval for SURFAXIN on March 6,in 2012.  In the thirdsecond quarter of 2012, following a routine review,2015, we determined that one ofdecided to cease our analytical chemistry methods used to assesscommercial and manufacturing activities for SURFAXIN drug product conformance to specifications required improvement and that an update to product specifications was needed.  We subsequently improvedfocus our capital resources on advancing the AEROSURF clinical development program and validated the analytical chemistry method and submitted updated product specifications to the FDA.  In November 2013, the FDA approved our submission and we initiated the commercial introduction of SURFAXIN.
To facilitate proper administration of SURFAXIN, we are making available to hospitals a WARMING CRADLE® dry-block heating device that is designed to warm drug vials at the same temperature that is designated in the SURFAXIN prescribing information.  WARMING CRADLE dry-block heater is registered with the FDA as a Class I, exempt laboratory medical device.

AEROSURF for the Treatment of RDS in Premature Infants

AEROSURF is an investigational drug-device combination product that produces our KL4 surfactant in aerosolized form using our lyophilized KL4 surfactant with our CAG.  We are developing AEROSURF to potentially reduce or eliminate the need for intubation and mechanical ventilation in the treatment of RDS.  With AEROSURF, neonatologists may potentially administer our aerosolized KL4 surfactant to premature infants supported by nCPAP, without subjecting them to invasive intubation and mechanical ventilation, which are currently required to administer surfactant therapy to premature infants.  With the risk of intubation reduced or eliminated, we believe that AEROSURF could enable the treatment of a significantly greater number of premature infants with RDS who could benefit from surfactant therapy but who are currently not treated.pipeline.

By enabling delivery of our aerosolized KL4 surfactant using less invasive procedures, we believe that AEROSURF will address a serious unmet medical need, provide potentially transformative clinical and pharmacoeconomic benefits, and potentially enable the treatment of a significantly greater number of premature infants with RDS who could benefit from surfactant therapy but are currently not treated.  As noted above, of the 160,000 infants that could likely benefit from surfactant therapy, approximately 115,000 currently receive nCPAP therapy as the initial therapy for RDS.  We believe, and market research with clinicians suggests, that, if AEROSURF is approved, a large majority of infants who currently receive nCPAP only will instead receive aerosolized KL4 surfactant as the initial treatment for RDS.  In addition, if AEROSURF is approved, of the 45,000 remaining premature infants who currently receive liquid surfactant administered using intubation and mechanical ventilation as the initial treatment, a significant number of these infants could potentially also receive aerosolized KL4 surfactant therapy as the initial treatment.Our Aerosolization Delivery Technologies

In addition to the potential clinical benefits of aerosolized KL4 surfactant, this therapy has the potential to provide significant pharmacoeconomic benefits for hospitals, payers and healthcare systems.  The  cost to support a mechanically ventilated RDS patient (an estimated $55,000 per patient),  is much greater than the cost to manage a patient on nCPAP (an estimated $8,000 per patient).  These costs increase even more when treating complications associated with intubation and mechanical ventilation such as bronchopulmonary dysplasia.  By providing clinical and pharmacoeconomic benefits and enabling the treatment of a significantly greater number of premature infants with RDS who could benefit from surfactant therapy but are currently not treated, we estimate that AEROSURF may, over time, expand the size of the U.S. surfactant market from a current estimated $250-$300 million per year to a range of $600 million to over $1 billion per year.Aerosol Delivery System (ADS)

We are developing AEROSURFhave worldwide exclusive rights to deliver our aerosolized KL4 surfactant using the CAG.  To develop our CAG technology,ADS, which consists of a capillary aerosol generator and related components, for use with pulmonary surfactants (alone or in June 2012, we entered into a Researchcombination with any other pharmaceutical compound(s)) for all respiratory diseases and Development Services Agreement with Battelle, which has a particular expertise in developing and integrating aerosol devices using innovative and advanced technologies.  Battelle assisted us with technical support and expertise and, together with our medical device engineering team, conducted a multi-phased program to finalize the design, test, and manufacture clinic-ready CAGs for our AEROSURF phase 2a clinical trial.conditions.  In addition, Battelle has agreed to manufacture a sufficient number of additional CAG devices and ADPs to support our AEROSURF phase 2b clinical trial, which we anticipate could initiatehold in the second halfU.S. exclusive rights to this technology for use with non-surfactant drugs to treat certain other pediatric and adult respiratory indications in hospitals and other health care institutions.  Our ADS is protected by a portfolio of 2014.  In addition topatents covering the CAG, we are developing a lyophilized KL4 surfactant dosage form that we intend to use initially for AEROSURF.  See, “– Lyophilized KL4 Surfactant for RDS in Premature Infants.”  We plan to develop AEROSURF usingcore components of the lyophilized dosage form of our KL4 surfactant.system.

To prepare for our AEROSURF development activities, we previously conducted preliminary meetings with the FDA to discuss the AEROSURF development plan.  We also engaged regulatory consultants to assist us in refining and submitting our IND to implement our phase 2a clinical program.  We filed with the FDA in October 2013 and opened our IND in November 2013.  We currently plan to retain regulatory consultants to assist us in engaging international regulatory authorities regarding an AEROSURF development plan outside the U.S.
Our phase 2a program is currently ongoing.  This initial phase of our phase 2 clinical programproprietary ADS is designed to evaluateaerosolize our KL4 surfactant.  An aerosol is created by pumping our KL4 surfactant through a heated capillary, after which the safetyaerosol cools and tolerability ofslows in velocity, yielding a single exposure of AEROSURF in an escalating dose study evaluating three doses of increasing amounts of AEROSURF.  The comparator is nCPAP only.  We plan to conduct this trial in up to four medical centers in the U.S.,dense aerosol with a defined particle size suitable for respiration.  In studies conducted with our initial capillary aerosol generator and anticipate results in the second half of 2014.

The next phase, phase 2b, of our clinical program is expected to begin in the second half of 2014KL4 surfactant, we generated aerosolized KL4 surfactant at consistent and conclude in the second half of 2015.  The primary objective of this phase will be to determine the optimal dose and define the expected efficacy margin.  The design of this phase will be informed by the results of the phase 2a trial.  This phase is expected to be a multicenter trial conducted in the U.S., with results to be available in the second half of 2015.  The potential phase 3 efficacy clinical will be defined based in part on the results of the phase 2 trial.

In December 2010, the National Institutes of Health (NIH) awarded us Phase I of a Fast Track Small Business InnovationResearch (SBIR) Grant to support up to $580,000 of AEROSURF development activities.  We also have filed for a Phase II SBIR Grantreproducible volumes that could provide up to an additional $1.88 million to support our AEROSURF clinical activities.  See, “–Surfactant Replacement Therapy for Respiratory Medicine - Serious Respiratory Indications Associated with Inflammationdelivery of the Lungs.”

Lyophilized KL4 Surfactant for RDStherapeutic doses in Premature Infants

We are developing a lyophilized (freeze-dried) dosage formreasonable periods of our KL4 surfactant that can be stored as a powder and reconstituted to liquid form prior to use, with the objective of improving ease of use for healthcare practitioners, as well as potentially prolonging shelf life and eliminating the need for cold-chain storage.  This lyophilized dosage form is intended initially to be used in our AEROSURF development program.  We have completed a technology transfer of our lyophilized surfactant manufacturing process to DSM, which has expertise in lyophilized products.  DSM has manufactured a supply of clinical drug product needed for the initial phase of our phase 2 program and will manufacture the clinical drug supply needed to complete our phase 2 clinical program.  We also have entered into a development agreement with DSM for the further development of this lyophilized KL4 surfactant, potentially fortime.  In our AEROSURF phase 32a clinical program, we assessed physiological data suggesting that AEROSURF may be delivering surfactant into the lung (where it needs to act) and if approved, commercial supply.

reducing the incidence of nCPAP failure.  We are focused initially on developing this dosage form for use inbelieve that our AEROSURF development program.  We are also planning to seek regulatory advice to determine if we could gain marketing authorization for a lyophilized dosage form of SURFAXIN under a development plan that would be both capital efficient andADS is capable of implementation within a reasonable time.  If feasible, we would likely implement such a development plan and would plandelivering our KL4 surfactant to introduce it commercially as a life-cycle extensionthe lung of SURFAXIN under the name SURFAXIN LS, in the U.S. and potentially in other markets.

Serious Respiratory Indications Associated with Inflammation of the Lungs

Many respiratory diseases are associated with an inflammatory event that causes surfactant dysfunction and a loss of patency of the conducting airways.  Scientific data support the premise that the therapeutic use of surfactants in aerosol form has the ability to reestablish airway patency, improve pulmonary mechanics and act as an anti-inflammatory.  For this reason, we believe that AEROSURF is a highly promising program and that, with the knowledge that we gain from our efforts to develop AEROSURF for the treatment of RDS in premature infants with RDS we may be ablewithout having to leverageresort to invasive intubation and mechanical ventilation, procedures that are currently required to administer surfactants.

AFECTAIR® Aerosol-Conducting Airway Connector

We also developed AFECTAIR, a novel disposable aerosol-conducting airway connector for infants that is intended to simplify the delivery of aerosolized medications (including our technology platform to potentially address serious respiratory conditions affecting pediatric and adult patient populations.  We believe that our proprietary aerosolized KL4 surfactant technology potentially may be effective as a preventive measuresurfactant) and other inhaled therapies to treat patientscritical-care infants requiring ventilatory support.  This device introduces aerosolized medications directly at risk for ALIthe patient interface and possiblyminimizes the number of connections in the future COPD andventilator circuit.  In vitro studies have demonstrated that investment in these indications could potentially address significant unmet medical needs.

Acute lung injury (ALI):  ALI is associated with conditions that either directly or indirectly injurethis connector improves the air sacsdelivery of the lung.  ALI is a syndrome of inflammation and increased permeability of the lungs with an associated breakdown of the lungs’ surfactant layer.  Among the causes of ALI are complications typically associated with certain major surgeries, mechanical ventilator-induced lung injury (often referredinhaled therapies to as VILI), smoke inhalation, pneumonia and sepsis.  There are a significant number of patients at risk in the U.S. for ALI annually and there are no currently approved therapies other than supportive respiratory care.
Chronic obstructive pulmonary disease (COPD):  COPD is an incurable, chronic respiratory disorder that includes both emphysema and chronic bronchitis and is characterized by obstruction to airflow that interferes with normal breathing, inflammation, mucus plugs formation, infection, and disruption of the normal lung architecture.infants requiring ventilatory support. We therefore believe that using our KL4 surfactant has unique attributes, including potential modulation ofAFECTAIR device with our ADS will improve the inflammatory process and anti-microbial properties, that, when combined with a potential ability to enhance mucus clearance may be an effective treatment for COPD, potentially improving outcomes for these very ill patients.

We have collaborated in research and preclinical studies to assess the usedelivery of our KL4 surfactant to potentially address ALIpremature infants.  Although we initially implemented a plan in an animal model.  In September 2012,2013 to separately market AFECTAIR, we announced four collaborations in a series of preclinical studies funded through various U.S. government-sponsored, biodefense-related initiatives, including collaborations with: (i) University of Pennsylvania, funded by the NIH’s National Institute of Allergy and Infectious Diseases (NIAID) to assess the ability of KL4 surfactant to mitigate effects of acute radiation exposure to the lung; (ii) University of Rochester, to evaluate the use of KL4 surfactant to protect the lung in a radiation-induced multi-organ dysfunction animal model; (iii) a facility of the U.S. Department of Defense through the NIH Office of the Director and the Countermeasures Against Chemical Threats (CounterACT) program, to assess the utility of KL4 surfactant for the treatment of chemical-induced ALI; and  (iv) a program funded by NIAID, to investigate the use of KL4 surfactant as a treatment for influenza-induced ALI.

Welater concluded that it may in the future invest in or support third-party studies of these indications.  If a proof-of-concept should be established, we will then determine whether to seek strategic alliances or collaboration arrangements or utilize other financial alternatives to fund their further development.  There can be no assurance that we will invest or support studies in these indications, that any such efforts will be successful, or that we will be able to conclude any such strategic alliance, collaboration arrangement or secure any financial alternative.

Cystic Fibrosis (CF)

CF is a life-threatening genetic disease affecting the respiratory and other body systems.  CF is characterized by a genetic mutation that results in the production of thick, viscous mucus that is difficult to clear from the airways of the lung and typically leads to life-threatening respiratory infections.  CF is the most common, life-threatening genetic disorder in the U.S.  CF occurs in approximately one in every 3,500 Caucasian live births and affects approximately 30,000 patients in the U.S. and nearly 70,000 worldwide.  Life expectancy for CF has more than doubled in the past 25 years to the mid-forties, due to significant advances in research and care.

We believe that our KL4 surfactant has unique attributes, potentially including anti-microbial properties, modulation of the inflammatory process, and lack of immunogenicity, that when combined withprovide a potential abilitycompetitive advantage and decided to enhance mucociliary clearance, may serve as a complementary therapy to advance the treatment of CF and improve treatment outcomesreserve AFECTAIR for these very ill patients.  In 2009,use with our aerosolized KL4 surfactant was evaluatedADS in an investigator-initiated phase 2a clinical trial in CF patients conducted at The University of North Carolina with the support of the Cystic Fibrosis Foundation.  In addition, we have received an orphan drug designation for CF from the FDA and the European Medicines Agency (EMA).our AEROSURF development program.

BUSINESS OPERATIONS

Research and Development

Our research and development activities are focused on developing our proprietary KL4 surfactant, CAG,ADS, and aerosol delivery technologies into a series of KL4 surfactant pipeline programs that potentially could support a significant respiratory critical care franchise.  We are initially focused on the management of RDS in premature infants.  We continually evaluatereassess our research and development priorities in light of a number of factors, including the results obtained in our clinical trials, preclinical research and related activities, advances in technology and progress in our device development programs, and relationship of a project to our near-term objectives; our cash flow requirements, financial liquidity and our ability to secure the necessary capital; and the potential for development partnerships, collaboration agreements and collaboration agreements.  In connection withother strategic transactions.  As part of our evaluations,assessments, we expect to modify and adapt our research and development plans from time to time and anticipate that we will continue to do so.so in the future.
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We plan to focus ourOur research and development resources are focused in the near term primarily on our RDS programs, primarily AEROSURF.AEROSURF development program to address RDS.  We are presently engaged in a phase 2a2 clinical trial for AEROSURFprograms and are preparing to initiate ahave initiated our phase 2b trial, potentially in the second half of 2014.clinical trial.  Battelle has assisted us in the development of a phase 2 clinic-ready ADS and has manufactured for usand will continue to manufacture a supply of clinic-ready CAG devicesADS to support our preclinical activities and our phase 2a2 clinical trial.program.  We also are working with Battelle under a collaboration agreement to manufacture additional CAG devicesdevelop a phase 3 clinic-ready ADS to support additional research and development activities, and our phase 2b3 clinical trial.program and potential commercial supply.  We are also working with DSMPatheon to manufacture a supply of lyophilized KL4 surfactant in mid-2014 to support theour phase 2b trial2 activities and conduct further manufacturing development work for the planned phase 3 clinical trial.

In addition to developing our lyophilized KL4 surfactant for AEROSURF, we plan to seek regulatory advice to determine if we could gain marketing authorization for a lyophilized dosage form of SURFAXIN under a development plan that would be both capital efficient and capable of implementation within a reasonable time.  If feasible, we would likely implement such a development plan and would plan to introduce it commercially as a life-cycle extension of SURFAXIN under the name SURFAXIN LS, in the U.S. and potentially in other markets.

In markets outside the U.S., for AEROSURF, we plan to engageseek regulatory advice and discuss with international regulatory authorities regarding a potential AEROSURF development plan to advance AEROSURF in selected major markets around the EU and potentially other markets.world.  We also would invest in research and development activities to support a significant strategic alliance focused on the EU and/or other selected markets outside the U.S. for the development and, if approved, commercial introduction of AEROSURF.  For SURFAXIN, we would consider various financing or collaboration arrangements that could provide regulatory expertise and support the commercial introduction of SURFAXIN, and potentially our other FDA-approved KL4 surfactant products, in other countries.

To support our research and development activities, we have:
 
·physicians and scientists withon staff and available under consulting arrangements who have expertise in pediatric and pulmonary medicine and extensive contacts in the neonatal medical community;
 
·expertise in the design and execution of preclinical experiments and studies to support drug development.  We conduct certain development-related experiments and bench studies in-house and also engage professional research laboratories as well asand collaborate with academic and educationscientific centers to conduct animal studies and experiments requiring specialized equipment and expertise;
 
·expertise in the design, development and management of clinical trials.  We have our own scientific, medical, biostatistics, and trial and data management capabilities.  For the initial phase of the AEROSURF program, we plan to analyze and report onhave managed our clinical trial data, supported by third-party technology systems and independent consultants, and will monitormonitored all clinical activities using our clinical operations capabilities.  We rely on scientific advisory committees and other medical and consulting experts to assist in the design and monitoring of clinical trials.  We also plan to rely on CROshave retained contract research organizations (CROs) to support operations of our plannedongoing multi-center AEROSURF trials, including potentially for locations outsidein the U.S.;, EU, Latin America and Canada;
 
·regulatory personnel with expertise in FDA regulatory matters.  We also consult extensively with independent FDA and international regulatory experts, including former senior scientific staff of the FDA;
 
·engineering expertise to support development of our CAGADS and aerosol delivery technologies.  In addition to our own engineering team, we are engaged in a development programcollaboration with Battelle, to bring itswhich has significant expertise in developing and integrating aerosol device technologies, to optimizewe have our CAG device and manufacture clinic-ready CAG devices forown engineering team that is focused on further optimizing our phase 2 AEROSURF clinical trials;ADS;
 
·quality operations capabilities to assure compliance of our drug and device development activities with applicable regulations;
 
·
manufacturing capabilities to manufacture our KL4 surfactant for use in preclinical studies.  Wewe rely on CMOs to produce our lyophilized KL4 surfactant, APIs and to manufacture and assembleother materials for our AFECTAIR devices.drug product.  We plan to rely on third-party manufacturers to manufacture and assemble our CAG systemsADS and related components; and
 
·our own analytical and testing laboratories,laboratory and research and medical device development laboratory.  We also rely on a number of third-party analytical and testing laboratories to support our research activities and provide certain laboratory services.services in support of our manufacturing activities.
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Research and development costs are charged to operations as incurred.  During the yearyears ended December 31, 2013,2015, and  December 31, 2014, we invested approximately $27.7$28.9 million and 26.7 million, respectively, for research and development expense, which includes (i) product development and manufacturing, (ii) medical and regulatory operations, and (iii) direct preclinical and clinical programs.

Manufacturing and Distribution

In 2005, we acquired manufacturing operations located in a leased facility in Totowa NJ (Totowa Facility) toWe use third parties for the manufacture SURFAXIN,of our liquid instillatelyophilized KL4 surfactant.surfactant, ADS and related components, AFECTAIR aerosol-conducting airway connector and related components, certain analytical and laboratory services in support of our manufacturing activities, clinical supply labeling, packaging warehousing and distribution.  To support our manufacturing operations, in 2007, we establishedmaintain our own analytical and technical support laboratory at our headquarters in Warrington, Pennsylvania (Warrington Laboratory).

KL4 Surfactant

We use third parties for the manufacture ofbelieve that our lyophilized KL4 surfactant and medical devices and related components, certain analytical and laboratory services in support of our manufacturing activities, packaging and labeling, warehousing, third-party logistics services and distribution.

KL4 Surfactant

Our KL4 surfactant products, including SURFAXIN, must beproduct is manufactured in compliance with current good manufacturing practices (cGMP) established by the FDA and other international regulatory authorities, as applicable.  Our KL4 surfactant is a complex drug product comprised of four active pharmaceutical ingredients (APIs).  It must be aseptically manufactured as a sterile, liquid suspension andthat requires ongoing monitoring of drug product stability and conformance to specifications.  Like some other surfactants, it is stored and shipped in a refrigerated, cold-chain environment.  We currently rely on single source suppliers under separate product supply agreements for KL4 and POPG, two of our APIs, and source ourthe other two APIs from a single source supplierssupplier under purchase orders that we issue from time to time.  To mitigate our risk, we plan to qualify secondary suppliers for our APIs over the next 18 to 36 months.several years.  Our risk of losing a source of supply is currently somewhat mitigated by our decision to enlarge our safety stock of all APIs when we began the commercial introduction of SURFAXIN.  While we generally purchase our primary packaging components and excipients from single-sources, these items are generally readily available from multiple manufacturers.APIs.

We conductmanufacture our lyophilized KL4 surfactant at Patheon under a development agreement that expires October 24, 2016.  We completed development work for the technology transfer of our lyophilized KL4 surfactant manufacturing activitiesprocess to Patheon in 2013.  We have since manufactured a sufficient clinical supply of KL4 surfactant to support our phase 2 clinical program and other development activities.  During the fourth quarter of 2014, we began a technology transfer of our lyophilized KL4 surfactant manufacturing process to another facility at Patheon, where we expect to manufacture our lyophilized KL4 surfactant for SURFAXINuse in our Totowa FacilityAEROSURF phase 3 clinical program.  Under our arrangement with Patheon, we provide the APIs and Patheon purchases excipients and other materials required to manufacture our analytical and technical support laboratory in our Warrington Laboratory.  We have a third-party agreement for packaging and vial labeling services for our SURFAXIN drug product.  Our Totowa facility consistslyophilized KL4 surfactant.
In our Warrington Laboratory, we conduct certain analytical development and quality control activities, including release testing of all APIs as well asand release and stability testing of SURFAXINour lyophilized KL4 surfactant clinical and commercial drug product supply.product.  Our Warrington Laboratory also provides analytical testing and quality system support for our efforts to identify and protect our intellectual property, and for our lyophilized and aerosolized KL4 surfactant dosage forms, as well asour research to identify and protect our intellectual property, including studying other potential formulations of our KL4 surfactant in support of AEROSURF and our other potential KL4 surfactant product candidates.

We also work with a number of third-party institutions and laboratories that perform various studies as well as quality control release and stability testing and other activities related to our KL4 surfactant development and manufacturing activities, including  our biological activity test (BAT) release and stability testing.activities.  At the present time, several of these laboratories are single-source providers.  We are implementing a plan to potentially qualify over the next 12- 24 months additional sources to meet our key release testing and stability requirements.

Importantly, as we undertake the commercial introduction of SURFAXIN and the development of AEROSURF, we are planning for long-term continuity of supply and continued integrity and reliability ofWe previously manufactured our manufacturing and quality assurance processes.  We seek to build a foundation to support our anticipated long-term needs, and intend to make appropriate capital investments in the near-term, balancing the use of our available resources while maintaining flexibility in planning our manufacturing goals.

·The lease for our Totowa Facility currently expires on June 30, 2015.  We continue to explore possible alternatives that could enable longer-term utilization of that facility for the manufacture of SURFAXIN and potentially lyophilized KL4 surfactant.
·We completed the technology transfer of our lyophilized KL4 surfactant manufacturing process to DSM in 2013 and have manufactured a sufficient clinical supply of KL4 surfactant to support the phase 2a AEROSURF clinical trial.  We plan to manufacture additional clinical supply in mid-2014 to support our phase 2b clinical trial.  We also have entered into a development agreement with DSM for the potential further development and  manufacture of lyophilized KL4 surfactant for our AEROSURF phase 3 clinical program, as well as other potential pipeline development programs.
·To secure an additional source of SURFAXIN commercial drug product, in 2012 we initiated a technology transfer of our liquid KL4 surfactant manufacturing process to DSM and in August 2013 entered into a supply agreement with DSM that provides for the manufacture of commercial supply of SURFAXIN, drug product through December 31, 2015, with such further extensions at that time as the parties may agree.
·We also have initiated a project to identify a second CMO that would manufacture clinical and commercial supply and assure a continuous and back up supply of SURFAXIN drug product.  We currently are working through potential development plans with a few CMOs and thereafter plan to initiate a technology transfer of our liquid KL4 manufacturing process.

We also believe that our in-house manufacturing capabilities, including our executive management, in-house manufacturing and quality operations managers and employees, are important to our long-term success.  Our management team includes executives experienced in pharmaceutical and biopharmaceutical drug product manufacturing, with extensive experience in manufacturing both small and large molecules, biological and sterile drug/device combination products in both domestic and overseas operations, and supply chain; as well as in worldwide quality operations to assure consistent and continued quality and cGMP compliance for our products, whether manufactured on our own or with a CMO.  Our manufacturing operations are lead by seasoned professionals with broad technical and managerial skills in all facets of our KL4 surfactant manufacturing process, expertise built on many years of accumulated knowledge in biopharmaceutical manufacturing, facility management, process and cleaning validation, sterility assurance and microbiological analyses, clean room operation and direction of formulation and aseptic filling of our drug product.  Although there can be no assurance, we believe that we can leverage the extensive experience that we have gained from having managed our own manufacturing operations since 2005 to flexibly respond over time and provide for the continued manufacture of our KL4 surfactant drug product, onin liquid instillate form, at our own ormanufacturing operations located in a leased facility in Totowa New Jersey (Totowa Facility).  In connection with our CMOs.decision to cease commercialization activities for SURFAXIN, we allowed our lease for this facility to expire in June 2015.  Our Totowa facility consisted of pharmaceutical manufacturing space that was designed for the manufacture and filling of sterile liquid pharmaceuticals in compliance with cGMP.  To support our manufacturing activities, we also operated a microbiology laboratory at our Totowa Facility.

CAG Device and Related ComponentryAerosol Delivery System (ADS)

AEROSURF is aan investigational combination drug-devicedrug/device product that producingproduces aerosolized KL4 surfactant by combining our lyophilized KL4 surfactant with our CAG device and aerosol delivery technologies.  We are developing and, if approved, willplan to commercialize AEROSURF in the U.S. for the treatment of premature infants with RDS.  We also believe that in the future our aerosolized KL4 surfactant may be used to address a broad range of serious respiratory conditions in the NICU as well as in children and adults in the PICU and ICU.

The CAG deviceADS includes ana durable, reusable aerosol control unit and a disposable AEROSURF delivery pack (ADP).  The ADP includes the critical drug product-contact components that are either cleaned or manufactured in an environmentally-controlled, clean area. The control unit and ADPs are assembled and packaged in a clean area.  Each of the ADP devicesADPs is tested for conformance to designated product specifications during assembly and each of the assembled control units must bemeet quality control testedstandards prior to release and monitored for conformanceconform to designated product specifications.

In JuneBeginning in 2012, we entered into an agreement with Battelle under which Battelle assisted us in a multi-phase development program focused on design and testing of clinic-ready CAG devicesADS for use in our AEROSURF phase 2a2 clinical trials, and then manufactured CAG devicesa sufficient number of ADSs for the phase2aphase 2a clinical trial that is currently underway.  In addition, we recently entered into an agreement with in premature infants 29 to 34 week gestational age.  Battelle for the also agreed to manufacture and assembly ofassemble a sufficient numbersupply of control units, ADPs and related components to support our plannedongoing phase 2a clinical trial in premature infants 26 to 28 week gestational age, our phase 2b clinical trial in premature infants 26 to 32 week gestational age and development activities.  In the future, weWe expect to rely on CMOs to manufacture and assemble the CAG devicearrange for additional control units, ADPs and related components from Battelle, as needed needed to support.  For our development activities, planned phase 3 clinical studiesprogram, we and Battelle are collaborating to further develop the phase 2 ADS.  Under our Collaboration Agreement, we and Battelle have agreed to negotiate in good faith for the manufacture of phase 3 control units, ADPs and related components.  We are also assessing other potential partners to assure continued availability of ADS for our clinical and development activities through our phase 3 clinical program, and, if approved, potential commercialization of AEROSURF.
AFECTAIR Aerosol-Conducting Airway Connectorinitial commercial distribution.  See, “– Business Operations – Strategic Alliances and Collaboration Arrangements – Battelle Collaboration Agreement.”

In 2012 we entered into a supply agreement (Agreement) withOur AFECTAIR aerosol-conducting airway connector has been manufactured by Lacey Manufacturing Company, a division of Precision Products, LLC (Lacey), which also provided labeling and packaging services.  We hold sufficient quantities of this device to manufacture AFECTAIR devices through October 2015.  Lacey operates a cGMP-compliant manufacturing facility and has significant experience with the mold injection process required to manufacture AFECTAIR devices.  In addition to providing manufacturing support Lacey has agreed to label, package, and prepare AFECTAIR devices for shipment.our AEROSURF phase 2b clinical trial.

Distribution

ToWe currently receive labeling, packaging and distribution services to support our AEROSURF clinical activities in the commercial introductionU.S., European Union and Latin America from Almac Group Limited under an agreement that expires October 15, 2016.
We received warehousing, distribution and related services for SURFAXIN we have established arrangements withfrom ASD Specialty Healthcare Inc. (ASD) and Integrated Commercialization Solutions, Inc. (ICS), affiliates of AmerisourceBergen Specialty Group, for warehousing, distribution and related services.Group.  ICS is ourprovided third-party logistics provider and assistsassisted us with inventory tracking, customer service, order management, distribution, returned goods, contract and accounts receivable management, certain financial management services and other similar services.

In 2012, we amendedservices for SURFAXIN and updated our agreement withAFECTAIR.  ASD which agreed to actacted as our exclusive specialty distributor for SURFAXIN WARMING CRADLE dry-block heaters and AFECTAIR devices in the U.S. and provideprovided related services.  Lacey will shipFollowing the finished productcessation of commercial activities for SURFAXIN, we terminated the arrangement with ASD.  ICS continues to ICS who has agreed to warehouse and provide third-party logisticlimited inventory services for us.  ASD has agreed to act as distributor for AFECTAIR devices.in support of our clinical activities under an agreement that will expire in October 2016.

Our collaboration with Laboratorios del Dr. Esteve, S.A. (Esteve) provides that Esteve has responsibility for distribution of specified KL4 surfactant products in Andorra, Greece, Italy, Portugal and Spain.  See, “– Strategic Alliances and Collaboration Arrangements – Laboratorios del Dr. Esteve, S.A.”  In other parts of the world, we planexpect to evaluatecontract for third-party distribution capabilitiesservices prior to commercializing in those regions.

GeneralStrategic Alliances and AdministrativeCollaboration Arrangements

We have made significant investmentsBattelle Collaboration Agreement

On October 10, 2014, we entered into the Collaboration Agreement with Battelle providing for the further development of our ADS for potential use in our salesplanned phase 3 clinical program for AEROSURF for the treatment of RDS in premature infants and, marketing capabilitiesif AEROSURF is approved for commercial sale by the FDA or other regulatory authority, initial commercial supply.  In August 2015, we agreed to amend the Collaboration Agreement to adjust the anticipated Project Plan Cost (as defined in the Agreement) and intendchange the date for completion of Stage 3 (“Milestone Date”) as defined in the Collaboration Agreement from May 31, 2016 to continue investingJuly 15, 2016.  As of December 31, 2015, if this development project is successfully completed, we expect to fund development activities of approximately $6.6 million through 2016, subject to certain rights of termination outlined in generalthe Collaboration Agreement.

Pursuant to the Collaboration Agreement, we and administrative resources primarilyBattelle (i) have defined the requirements of the phase 3 ADS and agreed upon a detailed project plan for the next two stages of the project (Stage 1), (ii) are developing the ADS in accordance with the project plan (Stage 2), and (iii) plan to complete all required testing, verification and documentation to be in a position to manufacture a sufficient supply of ADSs (Stage 3) to support our intellectual property portfolios (including buildingphase 3 clinical program.  Upon completion of the three-stage project plan, we and enforcing our patentBattelle intend to negotiate in good faith potentially to enter into an agreement for the manufacture of a sufficient number of ADS to support the planned AEROSURF phase 3 clinical program, and, trademark positions), our business development initiatives, financial systems and controls, legal and corporate and healthcare compliance requirements, management information technologies, and general management capabilities.if AEROSURF is approved, to negotiate in good faith potentially to enter into a supply agreement providing for an initial commercial supply of ADSs.

Strategic AlliancesA Steering Committee, comprised of an equal number of members appointed by each party, oversee the work of the project.  The foregoing notwithstanding, we will retain final decision-making authority on all matters related to the design, registration, manufacture, packaging, marketing, distribution and sale of ADSs.  We and Battelle shared equally in the costs of Stage 1 activities.  Following completion of Stage 1, we and Battelle agreed on a detailed project plan, including projected costs, for Stages 2 and 3.  The parties will share equally in the costs of the project plan for Stages 2 and 3 as set forth in the project plan.  Battelle will bear the entire cost of any cost overruns associated with execution of the project plan and we will bear the entire cost of any increase in the agreed upon project plan costs resulting from changes in the scope of the product requirements as agreed in Stage 1 and set forth in the project plan.

In connection with the Collaboration Agreement, we issued to Battelle two warrants to purchase shares of our common stock, each having an exercise price of  $70 per share and a term of 10 years, subject to earlier termination under certain circumstances set forth therein, including (i) a warrant to purchase up to 71,429 shares of our common stock, exercisable upon successful completion by Battelle of the Stage 3 activities (Initial Warrant), and (ii) a warrant to purchase up to 35,714 shares of our common stock (Additional Warrant; and together with the Initial Warrant, the Battelle Warrants), exercisable if and only if Battelle successfully completes the Stage 3 activities no later than July 15, 2016 (Milestone Date), which date may be adjusted as provided in the Collaboration Agreement.  We and Battelle have agreed to execute a registration rights agreement providing for the registration of the resale of shares underlying the Battelle Warrants.  The Battelle Warrants may be exercised for cash only, except that, in the event a registration statement is not effective at the time of exercise and if an exemption from registration is otherwise available at that time, the Battelle Warrants may be exercised on a cashless basis.
In addition, if Battelle successfully completes the Stage 3 activities, we have agreed to pay Battelle royalties equal to a low single-digit percentage of the worldwide net sales and license royalties on sales of AEROSURF for the treatment of RDS in premature infants, up to an aggregate limit of $25 million.

The term of the Collaboration Agreement will end at the time we fulfill our payment obligations to Battelle, unless sooner terminated by a party as provided in the Collaboration Agreement, including for a “failure of purpose” (as defined therein) or a material breach by either party.

Laboratorios del Dr. Esteve, S.A.

We have a strategic alliance with Laboratorios del Dr. Esteve, S.A. (Esteve) for the development, marketing and sales of a broad portfolio of potential KL4 surfactant products in Andorra, Greece, Italy, Portugal, and Spain (collectively, the territory).  Antonio Esteve, Ph.D., a principal of Esteve, served as a member of our Board of Directors from May 2002 until January 2013.  Under the alliance, Esteve will pay us a transfer price on sales of our KL4 surfactant products.  We will be responsible for the manufacture and supply of all of the covered products and Esteve will be responsible for all sales and marketing in the territory.  Esteve is obligated to make stipulated cash payments to us upon our achievement of certain milestones, primarily upon receipt of marketing regulatory approvals for the covered products.  In addition, Esteve has agreed to contribute to phase 3 clinical trials for the covered products by conducting and funding development performed in the territory.  As part of a 2004 restructuring in which Esteve returned certain rights to us in certain territories (Former Esteve Territories), we agreed to pay Esteve 10% of any cash up front and milestone fees (up to a maximum aggregate of $20 million) that we receive in connection with any strategic collaborations for the development and/or commercialization of certain of our KL4 surfactant products in the Former Esteve Territories.  The alliance will terminate as to each covered product, on a country-by-country basis, upon the latest to occur of: the expiration of the last patent claim related to a covered product in such country; the first commercial sale in such country of the first-to-appear generic formulation of the covered product, and the tenth anniversary of the first sale of the covered product in such country.  In addition to customary termination provisions for breach of the agreement by a party, the alliance agreement may be terminated by Esteve on 60 days’ prior written notice, up to the date of receipt of the first marketing regulatory approval, or, on up to six months’ written notice, if the first marketing regulatory approval has issued.  We may terminate the alliance agreement in the event that Esteve acquires a competitive product (as defined in the agreement).
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Potential Alliances and Collaboration Arrangements

While we currently intendWe continue to retain all rights and commercialize our approved products in the U.S.,  we seekenter into discussions with entities with a view to enter into strategic alliances, collaboration arrangements and other collaboration arrangements foropportunities to support our AEROSURF development activities and resources and expertise to support the registration and commercialization of AEROSURF and potentially support the development and/orand, if approved, commercialization of our other KL4 surfactant product candidates in markets outside the U.S.
 
LICENSING, PATENTS AND OTHER PROPRIETARY RIGHTS AND REGULATORY DESIGNATIONS

We continue to invest in maintaining and enforcing our potential competitive position through a number of means: (i) by protecting our exclusive rights in our KL4 surfactant, CAGADS and aerosol-conducting airway connector technologies through patents and patent extensions,term restorations, (ii) by seeking regulatory exclusivities, including potential orphan drug and new drug product exclusivities, and (iii) through protecting our trade secrets and proprietary methodologies that support our manufacturing and analytical processes.

Patents and Proprietary Rights

Johnson & Johnson, Ortho Pharmaceutical Corporation and The Scripps Research Institute

Our precision-engineered KL4 surfactant technology, including SURFAXIN, is based on the proprietary synthetic peptide KL4 (sinapultide), a 21 amino acid protein-like substance that closely mimics the essential human lung protein SP-B.  This technology was invented at The Scripps Research Institute (Scripps) and was exclusively licensed to and further developed by J&J.  We have received an exclusive, worldwide license and sublicense from J&J and its wholly-owned subsidiary, Ortho Pharmaceutical Corporation for, with rights to, a series of over 30 patents and patent filings (worldwide) which are important, either individually or collectively, to our strategy for commercializing our KL4 surfactant product candidates.  The license and sublicense give us the exclusive rights to such patents for the life of the patents.  Under the license agreement, we are obligated to pay the licensors fees of up to $2.5 million in the aggregate upon our achievement of certain milestones, primarily upon receipt of marketing regulatory approvals for certain designated products.  In addition, we have paid $950,000 to date for milestones that have been achieved.  In addition, we are required to make royalty payments at different rates, depending upon type of revenue and country, in amounts in the range of a high single-digit percent of net sales (as defined in the agreement) of licensed products sold by us or sublicensees, or, if greater, a percentage of royalty income from sublicensees in the low double digits.  The license agreement provides that the license will expire, on a country-by-country basis, upon the payment of royalties for all licensed products for ten years beginning on the date of the first commercial sale of the first licensed product in such country and thereaftercountry. Thereafter, royalties shall be paid in respect of a given licensed product until the expiration of the last licensed patent containing a valid claim covering the licensed product in such country; or forcountry. For countries in the EU in which royalties are paid only by virtue of licensed know-how, uponroyalties shall  be payable commencing from the paymentdate of royaltiesfirst commercial sale of the first licensed product in such country and ending on the earlier of (i) the date on which the licensed know-how becomes public or (ii) the tenth anniversary of the first commercial sale of the first licensed product in any such country.country of the EU.  In addition to customary termination provisions for breach of the agreement by a party, we may terminate the agreement, as to countries other than the U.S. and Western Europe territories (as defined in the agreement), on a country-by-country basis, on six months’ prior written notice; and as to the entire agreement, on 60 days’ prior written notice.

Patents covering our proprietary precision-engineered surfactant technology that have been issued worldwide include composition of matter, formulation, and uses and include the following issued United StatesU.S. patents: U.S. Patent No. 5,407,914; U.S. Patent No. 5,952,303; U.S. Patent No. 6,013,619; and U.S. Patent No. 6, 613,764 (along with certain corresponding issued foreign counterparts).  These patents relate to precision-engineered pulmonary surfactants (including SURFAXIN), certain related peptides (amino acid protein-like substances) and compositions, methods of treating respiratory distress syndromes with these surfactants and compositions, and a pulmonary lavage method of treating RDS with these surfactants.  Our licensed patent estate also includes the U.S. and foreign patents that relate to methods of manufacturing SURFAXIN and certain peptides that may be used in the manufacture of SURFAXIN, and other aspects of our precision-engineered surfactant technology.  These patents include U.S. Patent No. 5,741,891; U.S. Patent No. 5,952,303; U.S. Patent No. 6,013,764; U.S. Patent No. 6,120,795; U.S. Patent No. 6,492,490; and U.S. Patent No. 8,217,142 (along with certain corresponding issued foreign counterparts).
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The patent term of U.S. Patent No. 5,407,914 has beenwas previously extended until November 17, 2014.2014 and is now expired.  U.S. Patent No. 5,952,303 will expire on March 29, 2017.  U.S. Patent No. 5,741,891 will expire on October 22, 2016.  U.S. Patent No. 6,013,764 will expire on June 25, 2017.  U.S. Patent No. 6,120,795 will expire on March 4, 2017.  U.S. Patent No. 6,013,764, U.S. Patent No. 6,492,490 and U.S. Patent No. 8,217,142 will expire on June 25, 2017.  U.S. Patent No. 6,013,619 will expire on April 28, 2017.

We also have licensed or optioned for license certain patents and pending patent applications from Scripps that relate to combination therapies of pulmonary surfactant and other drugs, and methods of use.  Some of these patent applications have issued and some are still pending in the U.S. and a number of foreign jurisdictions, including Australia, Canada, EuropeIsrael, Japan, New Zealand, South Africa, South Korea, and Japan.  For example,Singapore.  In the U.S., selected compositions of pulmonary surfactants and protease inhibitors and methods of administering these compositions are claimed in the U.S. Patent No. 7,863,241 titled “Compositions for treatment and prevention of pulmonary conditions” which issued on January 4, 2011 and will expire on February 17, 2025.August 21, 2023.

Our KL4-Related Patents and Patent Rights

We have been active in seeking patent protection for our innovations relating to new dosage forms, formulations and methods of manufacturing and delivering synthetic peptide containing pulmonary surfactants.  Our patent activities have focused particularly on improved dosage forms and delivery of aerosolized pulmonary surfactant.

In November 2005, we filed U.S. and International patent applications (US 11/274,701 which is now U.S. Patent No. 7,582,312 issued on September 1, 2009 and PCT US/2005/041281, now entered national phase), directed to lyophilized formulations of synthetic peptide containing pulmonary surfactants and methods of manufacture.  U.S. Patent No. 7,582,312 will expire on November 15, 2025.

In December 2005, we filed U.S. and International patent applications (US 11/316,308 which is now U.S. Patent No. 8,337,815 issued on December 25, 2012 and PCT US/2005/046862, now entered national phase), directed to synthetic peptide containing pulmonary surfactant formulations having improved viscosity characteristics, aerosolization capacity and storage stability.  U.S. Patent No. 8,337,815 will expire on December 12, 2028.

In January 2006, we filed U.S. and International patent applications (US 11/326,885 which is now U.S. Patent No 7,541,331 issued on June 2, 2009 and PCT/US06/000308, now entered national phase), directed to a surfactant treatment regimen for BPD.  U.S. Patent No 7,541,331 will expire on January 6, 2026.

In September 2007, we filed U.S. and International patent applications (US 11/901,866 which is now U.S. Patent No. 8,221,772 and PCT US/2007/020260, now entered national phase) directed to surfactant compositions and methods of promoting mucus clearance and treating pulmonary disorders such as cystic fibrosis.  U.S. Patent No. 8,221,772 will expire on September 19, 2027.

In March 2013, we filed International patent applications (PCT/US13/34364 and PCT/US13/34464, now entered national phase and commenced expedited examination in USU.S. and EU) directed to lyophilized pulmonary surfactant and methods of manufacture.  In this patent family, two U.S. Patents Nos. 8,748,396 and 8,748,397 were issued on June 10, 2014, European patent 2723323B1 issued on September 23, 2015 and another U.S. patent application (US 14/387707) along with multiple foreign counterparts are pending.  U.S. Patents Nos. 8,748,396 and 8,748,397 and European patent 2723323B1will expire on March 28, 2033.

Philip Morris USA Inc. and Philip Morris Products S.A.

In 2008, to restructure a December 2005 strategic alliance, we entered into an Amended and Restated License Agreement with Philip Morris USA, Inc. (PMUSA) with respect to the U.S. (U.S. License Agreement), and, as PMUSA had assigned its ex-U.S. rights to Philip Morris Products S.A. (PMPSA) all, we entered into a license agreement with PMPSA with respect to rights in and to the CAG technology outside of the U.S. (International Rights), effective on the same date we entered into a License Agreement with PMPSA with respect to the International Rights (International License Agreement)and on substantially the same terms and conditions as the U.S. License Agreement.  These agreements licensed to us all rights in and to PMUSA and PMPSA proprietary aerosol technology.  In addition to customary termination provisions for breach of the agreements, we may terminate the License Agreements, in whole or in part, upon advance written notice to the licensor.  In addition, either party to each License Agreement may terminate upon a material breach by the other party (subject to a specified cure period).  Our license under each License Agreement, unless terminated earlier, will expire as to each licensed product, on a country-by-country basis, upon the latest to occur of: the date on which the sale of such licensed product ceases to be covered by a valid patent claim in such country; the date a generic form of the product is introduced in such country; or the tenth anniversary of the first commercial sale of such licensed product.
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Under the License Agreements, we are obligated to pay royalties at a rate equal to a low single-digit percent of sales of products sold in the Exclusive Field (as defined below)(see, “– Aerosol Technology Patents and Patent Rights.”) in the territories.  In connection with exclusive undertakings of PMUSA and PMPSA not to exploit the CAGaerosol technology for all licensed uses, we are obligated to pay royalties on all product sales, including sales of certain aerosol devices that are not based on the CAGlicensed aerosol technology; provided, however, that no royalties are payable to the extent that we exercise our right to terminate the license with respect to a specific indication.  We also arehave been required to pay minimum royalties quarterly beginning in 2014, but are entitled to a reduction ofreduce future quarterly royalties above the quarterly minimums in the amount of anythe true-up payments we make to satisfy minimum royalties paid.for prior quarters.  Our license rights extend to innovations to the CAGaerosol technology that are made under the License Agreements.  We believe that our AEROSURF aerosolized KL4 surfactant can be developed to potentially address a broad range of serious respiratory conditions.  We are developing AEROSURF to treat premature infants with or at risk for RDS using the CAGproprietary aerosol technology.

Capillary AerosolizationAerosol Technology Patents and Patent Rights

We currently hold exclusive licenses to the CAGaerosol technology, which is the core technology in our ADS.  This technology is based on a capillary aerosol generator and is licensed both in and outside of the U.S. for use with pulmonary surfactants (alone or in combination with any other pharmaceutical compound(s)) for all respiratory diseases and conditions.  In addition, under the U.S. License Agreement, our license to use the CAGaerosol technology includes certain non-surfactant drugs to treat a wide range ofcertain designated pediatric and adult respiratory indications in hospitals and other health care institutions.  The aerosolizationaerosol technology patents expire on various dates beginning in May 2016 and ending in 2031, or, in some cases, possibly later.

Aerosol-Conducting Airway Connector Technology Patents and Patent Rights

In March 2009, we filed International patent application (PCT US/2009/037409)037409, now entered national phase) directed to aerosol-conducting airway connectors that we plan to market under the trademark AFECTAIR and improvements of an aerosol delivery system using AFECTAIR. The International patent application is an interim phase in the prosecution of patents and is now concluded.  Beginning on September 16, 2010, this application entered national phase in US, Europe and Japan, among other countries and is currently pending.  The claims of this application are directed to a novel ventilation circuit adaptor (an aerosol-conducting airway connector) and related aerosol circuitry that are intended to increase the efficiency of aerosol delivery to the patient by allowing more efficient delivery of aerosols to the patient, reduce drug compound dilution and wastage and result in more precise aerosol dosing.  In this patent family, U.S. Patent No. 8,701,658 was issued on April 22, 2014, European patent No. 2265309 was issued on December 16, 2015 and several foreign patents have issued during 2011 through 2015.  U.S. Patent No. 8,701,658 will expire on March 17, 2029.

See, “Item 1A – Risk Factors – If we cannot protect our intellectual property, other companies could use our technology in competitive products.  Even if we obtain patents to protect our products, those patents may not be sufficiently broad or they may expire and others could then compete with us;” “– Intellectual property rights of third parties could limit our ability to develop and market our products;” and “– If we cannot meet requirements under our license agreements, we could lose the rights to our products.”

Trademarks

AEROSURF®, AFECTAIR®, AFECTAIR® DUO, DISCOVERYLABS®, SURFAXIN®, SURFAXIN LS™, and WARMING CRADLE® are our registered and common law trademarks.

Trade Secrets

In addition to our patent exclusivities, we rely on trade secrets to protect and maintain our competitive position.  We take measures to protect and maintain our trade secrets and know-how licensed to us or developed by us by entering in confidentiality agreements with third parties.  Our trade secrets and know-how include information related to manufacturing processes for our drug products and devices, analytical methods and procedures, research and development activities, provisional patent applications, as well as certain information provided to FDA that was not made public which relates to our regulatory activities and clinical trials.
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Other Regulatory Designations

New Drug Product Exclusivity

SURFAXIN is expected to receive  at least three years of marketing exclusivity as a new drug product based on the data from the SELECT and STAR clinical trials.  In addition, the FDA has indicated that our SURFAXIN drug product also qualifies as a “new molecular entity,” which we expect may provide extended marketing exclusivity of five years.  However, the FDA has not made its final determination as to the length of the exclusivity period for SURFAXIN.

Orphan Drug and Orphan Medicinal Product Designations

“Orphan Drugs” are pharmaceutical products that are intended to address diseases affecting fewer than 200,000 patients in the U.S.  The Office of Orphan ProductProducts Development of the FDA grantsdetermines whether to designate a drug as an Orphan Drug.  If a drug is designated as an Orphan Drug, it is eligible to obtain certain advantages to the sponsors of Orphan Drugsbenefits, including, but not limited to, seven years of market exclusivity upon approval of the drug for the orphan indication, certain tax incentives for clinical research and grants to fund testing of the drug.  The FDA has granted Orphan Drug designation for our KL4 surfactant for the treatment of RDS in premature infants.  However, our indication is SURFAXIN is for the prevention, rather than treatment, of RDS, such that this designation does not apply to SURFAXIN.  If we develop AEROSURF or SURFAXIN LS for the treatment of RDS, this orphan drugOrphan Drug designation may apply for those indications.  We are currently seeking the confirmation from the FDA.  The FDA has also granted Orphan Drug designation to (i) our KL4 surfactant for the prevention and treatment of BPD in premature infants, (ii) our KL4 surfactant for the treatment of ARDSacute respiratory distress syndrome (ARDS) in adults, and (iii) our KL4 surfactant for the treatment of CF.

The European Commission grants “Orphan Medicinal Product” designation for pharmaceutical products for the diagnosis, prevention or treatment of a life-threatening or chronically debilitating condition affecting no more than 5 in 10,000 people which provides for exclusive marketing rights for indications in Europe for 10 years (subject to revision after six years) following marketing approval by the EMA.European Medicines Agency (EMA).  In addition, the designation would enable us to receive regulatory assistance in the further development process, and to access reduced regulatory fees throughout its marketing life.  We have received Orphan Medicinal Product designation for (i) our KL4 surfactant for the prevention of RDS in premature infants of less than 32 weeks gestational age, (ii) our KL4 surfactant for the treatment of RDS in premature infants of less than 37 weeks gestational age, (iii) our KL4 surfactant for the treatment of ALI in adults (which in this circumstance encompasses ARDS), and (iv) our KL4 surfactant for the treatment of CF.  In submitting our request to the EMA for Orphan Medicinal Product designations, instead of listing the drug product under the USAN name (lucinactant) as we have in the U.S., we were required to submit our request under the names of the four APIs in our KL4 surfactant (lucinactant) as follows: sinapultide (KL4), dipalmitoylphosphatidylcholine, palmitoyl-oleoyl phosphatidylglycerol and palmitic acid.

Fast Track Designations and Priority Review

Designation as a “Fast Track” product means that the FDA has determined that the drug is intended for the treatment of a serious or life-threatening condition and demonstrates the potential to address unmet medical needs, and that the FDA will facilitate and expedite the development and review of the application for the approval of the product.  The FDA generally willmay grant priority review for an NDA for a drug granted Fast Track designation withinif relevant criteria are met, and rolling review, which means that the review goal for the NDA would be six months.

The FDA has granted “Fast Track” designation for (i) SURFAXIN for the prevention and treatment of BPD in premature infants, and (ii) our KL4 surfactant for the treatment of ARDS.ARDS in adults.  We believe that other of our products may qualify for Fast Track or other designations, including potentially breakthrough therapy, accelerated approval and priority review.  These designations and programs are intended to facilitate and expedite development and review of an NDA to address unmet medical needs in the treatment of serious or life-threatening conditions.

COMPETITION

We are engaged in the highly competitive fields of pharmaceutical research and development.  Competition from numerous existing companies and others entering the fields in which we operate is intense and expected to increase.  We compete with conventional pharmaceutical companies, among others.  Most of these companies have substantially greater research and development, manufacturing, marketing, financial, technological personnel and managerial resources than we do.  Acquisitions of competing companies by large pharmaceutical or health care companies could further enhance such competitors’ financial, marketing and other resources.  Moreover, competitors that are able to complete clinical trials, obtain required regulatory approvals and commence commercial sales of their products before we do may enjoy a significant competitive advantage over us.  There are also existing therapies that may compete with the products we are developing.  See, “Item 1A – Risk Factors – 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.”
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Currently, the FDA has approved surfactants as replacement therapy only for the prevention and/or treatment of RDS in premature infants.  Administration of these surfactants requires invasive intubation and mechanical ventilation.  The most commonly used of these approved surfactants are Curosurf (poractant(poractant alfa), which is derived from a chemical extraction process of porcine (pig) lung, and Survanta (beractant), which is derived from a chemical extraction process of bovine (cow) lung.  Curosurf is marketed in Europe by Chiesi Farmaceutici S.p.A. and in the U.S. by its wholly-owned subsidiary, Cornerstone TherapeuticsChiesi USA, Inc.  In addition, Chiesi has published the results of a preclinical study in an early-stage effort to develop a synthetic surfactant (Sato A, Ikegami M (2012) SP-B and SP-C Containing New Synthetic Surfactant for Treatment of Extremely Immature Lamb Lung. PLoS ONE 7(7): e39392.doi:10.1371/journal.pone.0039392).  Chiesi has also initiatedcompleted a first-in-human phase 2 clinical trial to study the safety and tolerability of intratracheal administration of two different single doses of its investigational synthetic surfactant in preterm neonatesinfants with RDS (clinicaltrials.gov).  Survanta historically has beenis marketed internationally by Abbott Nutritionals, Inc. (Abbott).  However, in December 2012, Abbott distributed to its shareholder a wholly-owned subsidiary, AbbVie, Inc. (AbbVie), which separated Abbott’s research-based pharmaceuticals business, including Survanta, from the remainder of its businesses.  ONY, Inc. markets Infasurf®Infasurf®, a surfactant derived from calf lung surfactant lavage, in the U.S.

With respect to our aerosolized surfactant drug delivery technologies, we believe that efforts to aerosolize animal-derived surfactants have not been very successful.satisfactory due to limitations with conventional technologies.  Recent studies suggest that to aerosolize a surfactant for delivery to premature infants, it is necessary to optimize the aerosol to a particular particle size range, use an aerosol generator with characteristics that are compatible with the patient’s breathing, and employ a delivery system that delivers sufficient drug product to the patient (Mazela, et. al., Aerosolized Surfactants, Current Opinion in Pediatrics 2007, 19:155–162; Finer, et. al., An Open Label, Pilot Study of AEROSURF Combined with nCPAP to Prevent RDS in Preterm Neonate, Journal of Aerosol, Medicine and Pulmonary Drug Delivery, Volume 23, Number 5, 2010).  In addition, aerosol particle size and output consistency is important throughout the aerosolized surfactant dosing period.  In particular, for clinical registration trials, a surfactant aerosol delivery system needs to deliver a consistent dose to the patient throughout the individual dosing period as well as consistent dose from device to device.  There are a number of device manufacturers with aerosolization expertise, including PariPARI and Aerogen.Aerogen, Inc.  These companies manufacture aerosol devices such as nebulizers, aerosol masks, and compressors.  Pari, for example, has provided nebulizers for use in clinical research and in commercial productproducts for several companies. Chiesi has recently investigated the use of nebulized Curosurf using a PariPARI eFlow® Neonatal Nebulizer System (CureNeb study; PAS 2013 abstract  - http://www.abstracts2view.com/pas/view.php?nu=PAS13L1_3500.7)abstract).   Aerogen manufactures a number of aerosolization devices, including a disposable, single patient nebulizer and a reusable, multi-patient nebulizer.  Our AFECTAIR device is an aerosol-conducting airway connector that is intended to replace standard connectorsAerogen nebulizers have also been used in surfactant aerosolization clinical trials including, see Finer, et al, JAMP, Volume 23, Number 5, 2010 and in the ventilatory circuit.  AFECTAIR has been shown in various studiesongoing study by Sood, et al (https://clinicaltrials.gov/ct2/show/NCT02294630?term=sood+surfactant&rank=1).  Another potential competitor to potentially increase theour aerosolized surfactant drug technology may be other minimally invasive surfactant therapies (MIST).  MIST is delivery of aerosolized medications.  Although we are not awareexogenous surfactant to the lung via brief catheterization of any effortsthe trachea with an instillation catheter in a preterm infant, followed by reinstitution of CPAP.  Currently, a phase 4 clinical trial is being conducted to assess the efficacy of this therapy versus CPAP alone (ClinicalTrials.gov Identifier: NCT02140580).  Unlike AEROSURF, these approaches would still require invasion of the vocal cords with a surfactant administration apparatus.  A further potential competitor to develop an alternative to AFECTAIR, itour aerosolized surfactant drug technology may be viewed as competing with companies that are developing aerosol generators with the intentadministration of improving the delivery of aerosols to infants.surfactant via laryngeal mask airway (LMA).
 
GOVERNMENT REGULATION

The development, manufacture, distribution, marketingIn the U.S., drug products, medical devices, and advertising of drug, device, anddrug-device combination drug-device products are subject to extensive regulation by federal, state and local governmental authorities in the U.S., including Food and Drug Administration, or the FDA.  The Federal Food, Drug, and Cosmetic Act, or the FDC Act, and other federal and state statutes and regulations, govern, among other things, the research, development, testing, manufacture, storage, recordkeeping, approval, clearance, labeling, promotion, advertising and marketing, distribution, post-approval monitoring and reporting, sampling, and import and export of drug products, medical devices, and drug-device combination products.  Failure to comply with applicable U.S. requirements may subject a company to a variety of administrative or judicial sanctions, such as FDA refusal to approve or clear pending new submissions to market drugs or devices warning or untitled letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, civil penalties, and by similar agencies in other countries.  Any product that we developcriminal prosecution.  Drug products, medical devices, and drug-device combination products must receive all relevant regulatory approvals or clearances before it may be marketed in the U.S.  Drug products, medical devices, and drug-device combination products are subject to extensive regulation, including premarket review and marketing authorization, by similar agencies in other countries.

Drug Products

Pharmaceutical product development for a new product or certain changes to an approved product in the U.S. typically involves preclinical laboratory and animal tests, the submission to the FDA of an investigational new drug application, or IND, which must become effective before clinical testing may commence, and adequate and well-controlled clinical trials to establish the safety and effectiveness of the drug for each indication for which FDA approval is sought.  Satisfaction of FDA pre-market approval requirements typically takes many years and the actual time required may vary substantially based upon the type, complexity, and novelty of the product or disease.
Preclinical tests include laboratory evaluation of product chemistry, formulation, and toxicity, as well as animal trials to assess the characteristics and potential safety and efficacy of the product.  The conduct of the preclinical tests must comply with federal regulations and requirements, including good laboratory practices.  The results of preclinical testing are submitted to the FDA as part of an IND along with other information, including information about product chemistry, manufacturing and controls, and a proposed clinical trial protocol.  Long term preclinical tests, such as animal tests of reproductive toxicity and carcinogenicity, may continue after the IND is submitted.
A 30-day waiting period after the submission of each IND is required prior to the commencement of clinical testing in humans.  If the FDA has neither commented on nor questioned the IND within this 30-day period, the clinical trial proposed in the IND may begin.
Clinical trials involve the administration of the investigational new drug to healthy volunteers or patients under the supervision of a qualified investigator.  Clinical trials must be conducted: (i) in compliance with federal regulations; (ii) in compliance with good clinical practice, or GCP, an international standard meant to protect the rights and health of patients and to define the roles of clinical trial sponsors, administrators, and monitors; as well as (iii) under protocols detailing the objectives of the trial, the parameters to be used in monitoring safety, and the effectiveness criteria to be evaluated.  Each protocol involving testing on U.S. patients and subsequent protocol amendments must be submitted to the FDA as part of the IND.
The FDA may order the temporary, or permanent, discontinuation of a clinical trial at any time, or impose other sanctions, if it believes that the clinical trial either is not being conducted in accordance with FDA requirements or presents an unacceptable risk to the clinical trial patients.  The study protocol and informed consent information for patients in clinical trials must also be submitted to an institutional review board, or IRB, for approval.  An IRB may also require the clinical trial at the site to be halted, either temporarily or permanently, for failure to comply with the IRB’s requirements, or may impose other conditions.
Clinical trials to support NDAs for marketing approval are typically conducted in three sequential phases, but the phases may overlap.  In Phase 1, the initial introduction of the drug into healthy human subjects or patients, the drug is tested to assess metabolism, pharmacokinetics, pharmacological actions, side effects associated with increasing doses, and, if possible, early evidence on effectiveness.  Phase 2 usually involves trials in a limited patient population to determine the effectiveness of the drug for a particular country.  Gainingindication, dosage tolerance, and optimum dosage, and to identify common adverse effects and safety risks.  If a compound demonstrates evidence of effectiveness and an acceptable safety profile in Phase 2 evaluations, Phase 3 trials are undertaken to obtain the additional information about clinical efficacy and safety in a larger number of patients, typically at geographically dispersed clinical trial sites, to permit FDA to evaluate the overall benefit-risk relationship of the drug and to provide adequate information for the labeling of the drug.  In most cases FDA requires two adequate and well‑controlled Phase 3 clinical trials to demonstrate the efficacy of the drug.  A single Phase 3 trial with other confirmatory evidence may be sufficient in rare instances where the study is a large multicenter trial demonstrating internal consistency and a statistically very persuasive finding of a clinically meaningful effect on mortality, irreversible morbidity or prevention of a disease with a potentially serious outcome and confirmation of the result in a second trial would be practically or ethically impossible.
After completion of the required clinical testing, an NDA is prepared and submitted to the FDA.  FDA approval of the NDA is required before marketing of the product may begin in the U.S.  The NDA must include the results of all preclinical, clinical, and other testing and a compilation of data relating to the product’s pharmacology, chemistry, manufacture, and controls.  The cost of preparing and submitting an NDA is substantial.  The submission of most NDAs is additionally subject to a substantial application user fee, currently exceeding $2,374,000 for fiscal year 2016, and the manufacturer and/or sponsor under an approved new drug application are also subject to annual product and establishment user fees, currently exceeding $114,000 per product and $585,000 per establishment for fiscal year 2016.  These fees are typically increased annually.
The FDA has 60 days from its receipt of an NDA to determine whether the application will be filed based on the agency’s threshold determination that it is sufficiently complete to permit substantive review.  If the NDA submission is filed, the FDA reviews the NDA to determine, among other things, whether the proposed product is safe and effective for its intended use.  The FDA has agreed to certain performance goals in the review of new drug applications.  Most such applications for standard review drug products are reviewed within ten to twelve months; most applications for priority review drugs are reviewed in six to eight months.  Priority review can be applied to drugs that the FDA determines offer major advances in treatment, or provide a treatment where no adequate therapy exists.  The review process for both standard and priority review may be extended by FDA for three additional months to consider certain late-submitted information, or information intended to clarify information already provided in the submission.
The FDA may also refer applications for novel drug products, or drug products that present difficult questions of safety or efficacy, to an advisory committee—typically a panel that includes clinicians and other experts—for review, evaluation, and a recommendation as to whether the application should be approved.  The FDA is not bound by the recommendation of an advisory committee, but it generally follows such recommendations.  Before approving an NDA, the FDA will typically inspect one or more clinical sites to assure compliance with GCP.  Additionally, the FDA will inspect the facility or the facilities at which the drug is manufactured.  FDA will not approve the product unless compliance with current good manufacturing practices, or cGMPs, is satisfactory and the NDA contains data that provide substantial evidence that the drug is safe and effective in the indication studied.
After FDA evaluates the NDA and the manufacturing facilities, it issues either an approval letter or a complete response letter.  A complete response letter generally outlines the deficiencies in the submission and may require substantial additional testing, or information, in order for the FDA to reconsider the application.  If, or when, those deficiencies have been addressed to the FDA’s satisfaction in a resubmission of the NDA, the FDA will issue an approval letter.  FDA has committed to reviewing such resubmissions in two or six months depending on the type of information included.
An approval letter authorizes commercial marketing of the drug with specific prescribing information for specific indications.  As a condition of NDA approval, the FDA may require a risk evaluation and mitigation strategy, or REMS, to help ensure that the benefits of the drug outweigh the potential risks.  REMS can include medication guides, communication plans for healthcare professionals, and elements to assure safe use, or ETASU.  ETASU can include, but are not limited to, special training or certification for prescribing or dispensing, dispensing only under certain circumstances, special monitoring, and the use of patient registries.  The requirement for a REMS can materially affect the potential market and profitability of the drug.  Moreover, product approval may require substantial post-approval testing and surveillance to monitor the drug’s safety or efficacy.  Once granted, product approvals may be withdrawn if compliance with regulatory standards is not maintained or problems are identified following initial marketing.
Changes to some of the conditions established in an approved application, including changes in indications, labeling, or manufacturing processes or facilities, require submission and FDA approval of a new NDA or NDA supplement before the change can be implemented.  An NDA supplement for a new indication typically requires clinical data similar to that in the original application, and the FDA uses the same procedures and actions in reviewing NDA supplements as it does in reviewing NDAs.
Orphan Drugs
Under the Orphan Drug Act, the FDA may grant orphan drug designation to drugs intended to treat a rare disease or condition – generally a disease or condition that affects fewer than 200,000 individuals in the U.S.  Orphan drug designation must be requested before submitting an NDA.  After the FDA grants orphan drug designation, the generic identity of the drug and its potential orphan use are disclosed publicly by the FDA.  Orphan drug designation does not convey any advantage in, or shorten the duration of, the regulatory review and approval process.  The first NDA applicant to receive FDA approval for a particular active moiety to treat a particular disease with FDA orphan drug designation is entitled to a seven-year exclusive marketing period in the U.S. for that product, for that indication.  During the seven-year exclusivity period, the FDA may not approve any other applications to market the same drug for the same disease, except in limited circumstances, such as a showing of clinical superiority to the product with orphan drug exclusivity by means of greater effectiveness, greater safety, or providing a major contribution to patient care.  Orphan drug exclusivity does not prevent FDA from approving a different drug for the same disease or condition, or the same drug for a different disease or condition.  Among the other benefits of orphan drug designation are tax credits for certain research and a waiver of the NDA application user fee.
Fast Track Designation
FDA is required to facilitate the development, and expedite the review, of drugs that are intended for the treatment of a serious or life-threatening disease and which demonstrate the potential to address unmet medical needs for the condition.  Under the fast track program, the sponsor of a new drug candidate may request that FDA designate the drug candidate for a specific indication as a fast track drug concurrent with, or after, the filing of the IND for the drug candidate.  FDA must determine if the drug candidate qualifies for fast track designation within 60 days of receipt of the sponsor’s request.
Under the fast track program, sponsors have the opportunity to engage in more frequent interactions with FDA. In addition, FDA may initiate review of sections of a fast track drug’s NDA before the application is complete.  This rolling review is available if the applicant provides, and FDA approves, a schedule for the submission of the remaining information and the applicant pays applicable user fees.  However, FDA’s time period goal for reviewing an application does not begin until the last section of the NDA is submitted.  Additionally, the fast track designation may be withdrawn by FDA if FDA believes that the designation is no longer supported by data emerging in the clinical trial process.
The Hatch-Waxman Act
Orange Book Listing: In seeking approval for a drug through an NDA, applicants are required to list with the FDA each patent with claims covering the applicant’s product or method of using the product.  Upon approval of a drug, device, or combination product candidate requireseach of the expenditurepatents listed in the application for the drug is then published in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, commonly known as the Orange Book.  Drugs listed in the Orange Book can, in turn, be cited by potential generic competitors in support of substantial resources over an extended period.  As a result, larger companies with greater financial resources will likely have a competitive advantage over us.

Drug Product Regulations

Development Activities:  To gain regulatory approval of our KL4 surfactant technology pipeline products, we must demonstrate, through experiments, preclinical studies and clinical trials that eachan abbreviated new drug application, or ANDA.  An ANDA provides for marketing of oura drug product candidates meetsthat has the same active ingredients in the same strengths and dosage form as the listed drug and has been shown to be bioequivalent to the listed drug.  Other than the requirement for bioequivalence testing, ANDA applicants are not required to conduct, or submit results of, pre-clinical or clinical tests to prove the safety or effectiveness of their drug product.  Drugs approved in this way are commonly referred to as “generic equivalents” to the listed drug, and efficacy standards establishedcan often be substituted by pharmacists under prescriptions written for the original listed drug.
The ANDA applicant is required to certify to the FDA concerning any patents listed for the approved product in the FDA’s Orange Book.  Specifically, the applicant must certify that: (i) the required patent information has not been filed; (ii) the listed patent has expired; (iii) the listed patent has not expired, but will expire on a particular date and approval is sought after patent expiration; or (iv) the listed patent is invalid or will not be infringed by the new product.  The ANDA applicant may also elect to submit a section viii statement certifying that its proposed ANDA labeling does not contain (or carves out) any language regarding the patented method-of-use rather than certify to a listed method-of-use patent.  If the applicant does not challenge the listed patents, the ANDA application will not be approved until all the listed patents claiming the referenced product have expired.
A certification that the new product will not infringe the already approved product’s listed patents, or that such patents are invalid, is called a Paragraph IV certification.  If the ANDA applicant has provided a Paragraph IV certification to the FDA, and other international regulatory authorities.  In addition, we and our suppliers and CMOsthe applicant must demonstrate that all development-related laboratory, clinical and manufacturing practices comply with regulationsalso send notice of the Paragraph IV certification to the NDA and patent holders once the ANDA has been received by the FDA.  The NDA and patent holders may then initiate a patent infringement lawsuit in response to the notice of the Paragraph IV certification.  The filing of a patent infringement lawsuit within 45 days of the receipt of a Paragraph IV certification automatically prevents the FDA other international regulatorsfrom approving the ANDA until the earlier of 30 months, expiration of the patent, settlement of the lawsuit, or a decision in the infringement case that is favorable to the ANDA applicant.
An applicant submitting an NDA under Section 505(b)(2) of the FDC Act, which permits the filing of an NDA where at least some of the information required from approval comes from studies not conducted by, or for, the applicant and local regulators.  Regulations establish standards for such things as drug substances, materials and excipients; medical device components, subassemblies and device manufacture; drug manufacturing operations and facilities, analytical laboratories and medical device development laboratories processes and environments;which the applicant has not obtained a right of reference, is required to certify to the FDA regarding any patents listed in each instance, in connection with research, development, testing, manufacture, quality control, labeling, storage, record keeping, approval, advertising and promotion, and distribution ofthe Orange Book for the approved product candidates, on a product-by-product basis.  See, “Item 1A – Risk Factors – The regulatory approval process for our products is expensive and time-consuming andit references to the outcome is uncertain.  We may not obtain required regulatory approvals to commercialize our products.”same extent that an ANDA applicant would.
Preclinical Studies and Clinical TrialsMarket Exclusivity: Development testing generally begins with laboratory testing and experiments, as well as research studies using animal modelsMarket exclusivity provisions under the FDC Act also can delay the submission or the approval of certain applications.  The FDC Act provides a five-year period of non-patent exclusivity within the U.S. to obtain preliminary information onthe first applicant to gain approval of an NDA for a product’s efficacy andnew chemical entity, or NCE.  A drug is entitled to identify any safety issues.  The resultsNCE exclusivity if it contains a drug substance no active moiety of these studies are compiled along with other information in an investigational new drug (IND) application, which is filed withhas been previously approved by the FDA.  After resolving any questions raisedDuring the exclusivity period, the FDA may not receive for review an ANDA or file a 505(b)(2) NDA submitted by another company for another version of such drug where the applicant does not own or have a legal right of reference to all the data required for approval.  However, an application may be submitted after four years if it contains a Paragraph IV certification.  The FDC Act also provides three years of market exclusivity for an NDA, 505(b)(2) NDA or supplement to an existing NDA if new clinical investigations, other than bioavailability studies, that were conducted or sponsored by the applicant are deemed by the FDA which may involve additional testingto be essential to the approval of the application, for example, for new indications, dosages or strengths of an existing drug.  This three-year exclusivity covers only the conditions for use associated with the new clinical investigations and animaldoes not prohibit the FDA from approving ANDAs for drugs for the original conditions of use, such as the originally approved indication.  Five-year and three-year exclusivity will not delay the submission or approval of a full NDA; however, an applicant submitting a full NDA would be required to conduct or obtain a right of reference to all the non-clinical studies and adequate and well-controlled clinical trials necessary to demonstrate safety and effectiveness.
Patent Term Extension: After NDA approval, the owner of a relevant drug patent may begin.  Regulatory agencies in other countries generally requireapply for up to a Clinical Trial Application (CTA)five-year patent extension.  Only one patent may be extended for each regulatory review period, which is composed of two parts: a testing phase, and an approval phase.  The allowable patent term extension is calculated as half of the drug’s testing phase - the time between the day the IND becomes effective and NDA submission – and all of the review phase – the time between NDA submission and approval – up to a maximum of five years.  The time can be submitted and approved before each trial can commence in each country.shortened if FDA determines that the applicant did not pursue approval with due diligence.  The total patent term after the extension may not exceed 14 years.

Clinical trials normally are conducted in three sequential phasesFor patents that might expire during the application phase, the patent owner may request an interim patent extension.  An interim patent extension increases the patent term by one year and may take a numberbe renewed up to four times.  For each interim patent extension granted, the post-approval patent extension is reduced by one year.  The director of years to complete.  phase 1 consiststhe U.S. Patent and Trademark Office must determine that approval of testing the drug covered by the patent for which a patent extension is being sought is likely.  Interim patent extensions are not available for a drug for which an NDA has not been submitted.
Post-Approval Requirements
Once an NDA is approved, a product will be subject to certain post-approval requirements.  For instance, FDA closely regulates the post-approval marketing and promotion of drugs, including standards and regulations for direct-to-consumer advertising, off-label promotion, industry-sponsored scientific and educational activities and promotional activities involving the internet.  Drugs may be marketed only for the approved indications and in accordance with the provisions of the approved labeling.
Adverse event reporting and submission of periodic reports is required following FDA approval of an NDA.  The FDA also may require post-marketing testing, known as Phase 4 testing, risk evaluation and mitigation strategies, or REMS, and surveillance to monitor the effects of an approved product, or the FDA may place conditions on an approval that could restrict the distribution or use of the product.  In addition, quality-control, drug manufacture, packaging, and labeling procedures must continue to conform to current good manufacturing practices, or cGMPs, after approval.  Drug manufacturers and certain of their subcontractors are required to register their establishments with FDA and certain state agencies.  Registration with the FDA subjects entities to periodic unannounced inspections by the FDA, during which the agency inspects manufacturing facilities to assess compliance with cGMPs.  Accordingly, manufacturers must continue to expend time, money, and effort in the areas of production and quality-control to maintain compliance with cGMPs.  Regulatory authorities may withdraw product approvals or request product recalls if a small numbercompany fails to comply with regulatory standards, if it encounters problems following initial marketing, or if previously unrecognized problems are subsequently discovered.  In addition, prescription drug manufacturers in the U.S. must comply with applicable provisions of humans, normally healthy volunteers,the Drug Supply Chain Security Act and provide and receive product tracing information, maintain appropriate licenses, ensure they only work with other properly licensed entities, and have procedures in place to determine preliminaryidentify and properly handle suspect and illegitimate products.
Pediatric Information
Under the Pediatric Research Equity Act, or PREA, NDAs or supplements to NDAs must contain data to assess the safety and tolerable dose range.  Phase 2 usually involves studies in a limited patient population to evaluate the effectiveness of the drug productfor the claimed indications in humans having the disease or medical conditionall relevant pediatric subpopulations and to support dosing and administration for each pediatric subpopulation for which the productdrug is indicated, determine dosage tolerancesafe and optimal dosage and identify possible common adverse effects and safety risks.  Phase 3 consists of additional controlled testing at multiple clinical sites to establish clinical safety and effectiveness in an expanded patient population of geographically dispersed clinical sites to evaluate the overall benefit-risk relationship for administering the product and to provide an adequate basis for product labeling.  Phase 4 clinical trials may be conducted after approval to gain additional experience from the treatment of patients in the intended therapeutic indication.

effective.  The conduct of clinical trials is subject to stringent medical and regulatory requirements.  The time and expense required to establish clinical sites, provide training and materials, establish communications channels and monitor a trial over a long period are substantial.  The conduct of clinical trials at institutions located around the world is subject to foreign regulatory requirements governing human clinical trials, which vary widely from country to country.  Delays or terminations of clinical trials could result from a number of factors, including stringent enrollment criteria, slow rate of enrollment, size of patient population, having to compete with other clinical trials for eligible patients, geographical considerations and others.  Clinical trials are monitored by the regulatory agencies as well as medical advisory and standards boards, which could determine at any time to reevaluate, alter, suspend, or terminate a trial based upon accumulated data, including data concerning the occurrence of adverse health events during or related to the treatment of patients enrolled in the trial, and the regulator’s or monitor’s risk/benefit assessment with respect to patients enrolled in the trial.  If they occur, such delays or suspensions could have a material impact on our KL4 surfactant technology development programs.  See, “Item 1A–Risk Factors – Our research and development programs, including for AEROSURF involve significant risks and uncertainties that are inherent in the clinical development and regulatory approval processes.”
Regulatory Review:  The results of preclinical and clinical trials for drug products are submitted to the FDA in an NDA, with comparable filings submitted to other international regulators.  After the initial submission, the FDA has a period of time in which it must determine if the NDA is complete.  If an NDA is accepted for filing, following the FDA’s review, the FDA may grant marketing approval, request additional information,full or deny the application if it determines that the applicationpartial waivers, or deferrals, for submission of data.  Unless otherwise required by regulation, PREA does not provideapply to any drug for an adequate basisindication for approval.  If the FDA grants approval, the approval may be conditioned upon the conduct of post-marketing clinical trials or other studies to confirm the product’s safety and efficacy for its intended use.  Until the FDAwhich orphan designation has issued its approval, no marketing activities can be conducted in the U.S.  Similar regulations apply in other countries.been granted.
After anThe Best Pharmaceuticals for Children Act, or BPCA, provides NDA is submitted, althoughholders a six-month extension of any exclusivity—patent or non-patent—for a drug if certain conditions are met.  Conditions for exclusivity include the FDA’s determination that information relating to the use of a new drug in the pediatric population may produce health benefits in that population, FDA making a written request for pediatric studies, and the applicant agreeing to perform, and reporting on, the requested studies within the statutory period provided fortimeframe.  Applications under the FDA’s standard review is approximately one year, dealingBPCA are treated as priority applications, with questions or concernsall of the agency and, taking into account the statutory timelines governing such communications, may result in review periodsbenefits that can take several years.  The FDA may decline to accept an NDA and may deliver what is referred to as a Complete Response Letter that describes the shortcomings of the application, including whether the applicant should consider additional clinical trials, which could have the effect of terminating a development program.designation confers.

Post-approval Regulation:  Following the grant of marketing approval, the FDA regulates the marketing and promotion of drug products.  Promotional claims are generally limited to the information provided in the product package insert for each drug product, which is negotiated with the FDA during the NDA review process.  In addition, the FDA enforces regulations designed to guard against conflicts of interest, misleading advertising and improper compensation of prescribing physicians.  The FDA will review, among other things, direct-to-consumer advertising, prescriber-directed advertising and promotional materials, sales representative communications to healthcare professionals, promotional programming and promotional activities on the Internet.  The FDA will also monitor scientific and educational activities.  If the FDA determines that a company has promoted a product for an unapproved (off-label) use, or engaged in other violations, it may issue a regulatory letter and may require corrective advertising or other corrective communications to healthcare professionals.  Enforcement actions may also potentially include product seizures, injunctions and civil or criminal penalties.  The consequences of such an action and the related adverse publicity could have a material adverse effect on a developer’s ability to market its drug and its business as a whole.  Regulation and enforcement of advertising and promotion by institutions other than FDA are discussed below.

Following approval, the FDA and other international regulators will continue to monitor data to assess the safety and efficacy of an approved drug.  A post-approval discovery of previously unknown problems or failure to comply with the applicable regulatory requirements may result in restrictions on the marketing of a product or a recall or withdrawal of the product from the market, as well as possible civil or criminal sanctions.  Similar oversight is provided by international regulators.

Medical Device Products

To varying degrees, eachA medical device is an instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including any component part, or accessory which is:  (i) recognized in the official National Formulary, or the U.S. Pharmacopoeia, or any supplement to them; (ii) intended for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease, in man or other animals; or (iii) intended to affect the structure or any function of the regulatory agencies having oversight overbody of man or other animals, and which does not achieve any of its primary intended purposes through chemical action within or on the body of man or other animals and which is not dependent upon being metabolized for the achievement of any of its primary intended purposes.
The FDC Act classifies medical devices including the FDA and comparable foreign regulators, has laws and regulations governing the development, testing, manufacturing, labeling, marketing, and distribution of medical devices.  In the U.S., medical device products are subject to regulation that is intended to calibrate regulatory requirements to the issues of safety and efficacy presented by specific devices.  Medical devices are classified into one of three classescategories based on the risks associated with the device and the level of control necessary to assure theprovide reasonable assurance of safety and effectiveness of the device.  The three classes and the requirements that apply to them are: (i) Class I General Controls, with exemptions and without exemptions, (ii) Class II General Controls and Special Controls, with exemptions and without exemptions, and (iii) Class III General Controls and Premarket Marketing authorization.  The class to which a device is assigned determines the process that applies for gaining marketing authorization.  Mosteffectiveness.  Class I devices are exempt from Premarketdeemed to be low risk and are subject to the fewest regulatory controls.  Class III devices are generally the highest risk devices and are subject to the highest level of regulatory control to provide reasonable assurance of the device’s safety and effectiveness.  Class III devices must typically be approved by FDA before they are marketed.
Generally, establishments that manufacture and/or distribute devices, including manufacturers, contract manufacturers,  sterilizers, repackagers and relabelers, specification developers, reprocessors of single-use devices, remanufacturers, initial importers, manufacturers of accessories and components sold directly to the end user, and U.S. manufacturers of export-only devices, are required to register their establishments with the FDA and provide FDA a list of the devices that they handle at their facilities.
Pre-market Authorization and Notification 510(k);
While most Class I and some Class II devices require Premarket Notificationcan be marketed without prior FDA authorization, most medical devices can be legally sold within the U.S. only if the FDA has:  (i) approved a premarket approval application, or PMA, prior to marketing, generally applicable to Class III devices; or (ii) cleared the device in response to a premarket notification, or 510(k); submission, generally applicable to Class I and mostII devices.  Some devices that have been classified as Class III are regulated pursuant to the 510(k) requirements because FDA has not yet called for PMAs for these devices.  Other less common regulatory pathways to market for Class III devices require Premarket Marketing authorization.include the humanitarian device exception, or HDE, or a product development protocol or PDP.

Combination Drug-Device ProductsExempt Devices

Combination drug products such as AEROSURF and potentially other aerosolized KL4 surfactant drug products are similarly subject to extensiveIf a manufacturer’s device falls into a generic category of Class I or Class II devices that FDA has exempted by regulation, by federal, state and local governmental authoritiesa premarket notification is not required before marketing the device in the U.S.  Manufacturers of such devices are required to register their establishments and list the generic category or classification name of their devices.  Some 510(k)-exempt devices are also exempt from Quality System Regulation, or QSR, requirements.
Postmarket Requirements
After a device is placed on the market, numerous regulatory requirements apply. These include:  the QSR, labeling regulations, the FDA’s general prohibition against promoting products for unapproved or “off‑label” uses, the Medical Device Reporting regulation (which requires that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in other countries.  Combination products involve reviewa way that would likely cause or contribute to a death or serious injury if it were to recur), and the Reports of two or more regulated components that might normally be reviewed by regulatory authorities having different expertiseCorrections and may involve more complicatedRemovals regulation (which requires manufacturers to report recalls and time-consuming regulatory coordination, approvals and clearances thanfield actions to the FDA if initiated to reduce a drug product alone.  The FDA has determined that our aerosolized KL4 surfactant combination drug-device product will be evaluated as a drug and, therefore, will be reviewedrisk to health posed by the Center for Drug Evaluation and Research (CDER)device or to remedy a violation of the FDA, with input from the Center for Devices and Radiological Health (CDRH)FDC Act).  Among other things, we will have to demonstrate compliance with both cGMP, to ensure that the drug possesses adequate strength, quality, identity and purity, and applicable Quality System Regulations (QSR), to ensure that the device is in compliance with applicable performance standards.  Although cGMP and QSR overlap in many respects, each is tailored to the particular characteristics of the types of products to which they apply, such that compliance with both cGMP and QSR may present unique problems and manufacturing challenges.
Manufacturing Standards

The FDA enforces these requirements by inspection and other international regulators establish requirementsmarket surveillance.  If the FDA finds a violation, it can institute a wide variety of enforcement actions, ranging from a public warning letter to more severe sanctions such as: fines, injunctions, and standards and routinely inspect the quality system, facilities,  equipment, processes, and analytical  laboratories  used in the manufacturing and monitoringcivil penalties; recall or seizure of products.  Prior to grantingproducts; operating restrictions, partial suspension or total shutdown of production; refusing requests for 510(k) clearance or PMA approval of new products; withdrawing 510(k) clearance or PMA approvals already granted; and criminal prosecution.
Combination Products
A combination product is a product comprised of (i) two or more regulated components, i.e., drug/device, biologic/device, drug/biologic, or drug/device/biologic, that are physically, chemically, or otherwise combined or mixed and produced as a single entity; (ii) two or more separate products packaged together in a single package or as a unit and comprised of drug and device products, device and biological products, or biological and drug products; (iii) a drug, device, or biological product packaged separately that according to its investigational plan or proposed labeling is intended for use only with an approved individually specified drug, device, or biological product where both are required to achieve the intended use, indication, or effect and where upon approval of the proposed product the labeling of the approved product would need to be changed, e.g., to reflect a change in intended use, dosage form, strength, route of administration, or significant change in dose; or (iv) any investigational drug, device, or biological product packaged separately that according to its proposed labeling is for use only with another individually specified investigational drug, device, or biological product where both are required to achieve the intended use, indication, or effect.
FDA is divided into various branches, or Centers, by product type.  Different Centers typically review drug, biologic, or device applications.  In order to review an application for a combination product, the FDA will conductmust decide which Center should be responsible for the review.  FDA regulations require that FDA determine the combination product’s primary mode of action, or PMOA, which is the single mode of a pre-approval inspectioncombination product that provides the most important therapeutic action of the manufacturing facilitiescombination product.  The Center that regulates that portion of the product that generates the PMOA becomes the lead evaluator.  If there are two independent modes of action, neither of which is subordinate to the other, the FDA makes a determination as to which Center to assign the product based on consistency with other combination products raising similar types of safety and effectiveness questions or to the facilitiesCenter with the most expertise in evaluating the most significant safety and effectiveness questions raised by the combination product.  When evaluating an application, a lead Center may consult other Centers but still retain complete reviewing authority, or it may collaborate with another Center, by which the Center assigns review of suppliersa specific section of the application to determineanother Center, delegating its review authority for that section.  Typically, the FDA requires a single marketing application submitted to the Center selected to be the lead evaluator, although the agency has the discretion to require separate applications to more than one Center.  One reason to submit multiple evaluations is if the applicant wishes to receive some benefit that accrues only from approval under a particular type of application, like new drug product is manufactured in accordance with cGMP regulations and product specifications.  Following approval, the FDA will conduct periodic inspections.exclusivity.  If in connection withmultiple applications are submitted, each may be evaluated by a facility inspection, the FDA determines that a manufacturer does not comply with cGMP, the FDA will issue an inspection report citing the potential violations and may seek a range of remedies, from administrative sanctions, including the suspension of our manufacturing operations, to seeking civil or criminal penalties.  The FDA may determine to conduct such inspections at any time and for any reason.  See, “Item 1A – Risk Factors – Manufacturing problems potentially could cause us to experience shortages of SURFAXIN and AFECTAIR product inventories, or delay our preclinical or clinical programs, which could have a material adverse effect on our business.”different lead Center.

International Approvals

In additionDrug products, medical devices, and drug-device combination products are subject to seeking regulatory approval to market our productsextensive regulation, including premarket review and marketing authorization, by similar agencies in the U.S., we also expect to apply for such approval with other international regulators.countries.  Regulatory requirements and approval processes are similar in approach to that of the U.S. but are not harmonized.  International regulators are independent and not bound by the findings of the FDA and there is a risk that foreign regulators will not accept clinical trial design/results or may require additional data or other information not requested by the FDA.  Therefore, we will have to comply with both cGMP and International Conference on Harmonization (ICH) guidelines.In addition, international regulators may require different manufacturing practices than the FDA’s cGMPs.
 
Anti-Kickback, False Claims Act, and Other Laws Regarding Advertising and Promotion

In addition to FDA’s ongoing post-approval regulationFDA restrictions on marketing of drugs,pharmaceutical products, medical devices, and combination products, discussed above, several other types of lawsstate and regulations, subject to differing enforcement regimes, govern advertising and promotion.   In recent years promotional activities of FDA-regulated products have come under intense scrutiny andfederal laws have been applied to restrict certain marketing practices in the subject of enforcement action brought by the Department of Justice (DOJ), state authorities,medical product industry in recent years.  These laws include anti-kickback statutes, false claims statutes, and even private individuals.

other statutes pertaining to health care fraud and abuse.  The federal Anti-Kickbackhealthcare program anti-kickback statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce, or in return for, purchasing, leasing, ordering or arranging for the purchase, lease or order of any healthcare item or service reimbursable under Medicare, Medicaid, or other federally financed healthcare programs.  The Patient Protection and Affordable Care Act, or PPACA, amended the intent element of the federal statute so that a person or entity no longer needs to have actual knowledge of the statute or specific intent to violate it.  This statute has been interpreted to apply to arrangements between pharmaceutical or device manufacturers on the one hand and prescribers, purchasers, and formulary managers on the other.  Violations of the anti-kickback statute are punishable by imprisonment, criminal fines, civil monetary penalties, and exclusion from participation in federal healthcare programs.  Any salesAlthough there are a number of statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution or marketingother regulatory sanctions, the exemptions and safe harbors are drawn narrowly, and practices that involve remuneration intended to induce prescribing, purchases, or recommendations may be subject to scrutiny under the Anti-Kickback statute.  Many states have likewise adopted state anti-kickback statutes, and enforcement has been significant.if they do not qualify for an exemption or safe harbor.
 
Another development affecting the healthcare industry is the increased use of the federal civil False Claims Act to impose liability onFederal false claims laws prohibit any person from knowingly presenting, or entity who, among other things, knowingly presents, or causescausing to be presented, a false or fraudulent claim for payment by a federal healthcare program.  If certain conditions are met, the False Claims Act allows a private individual called a “whistleblower” to bring a civil action on behalf of the federal government, or knowingly making, or causing to be made, a false statement to have a false claim paid.  This includes claims made to programs where the federal government reimburses, such as Medicaid, as well as programs where the federal government is a direct purchaser, such as when it purchases off the Federal Supply Schedule.  Recently, several pharmaceutical and other healthcare companies have been prosecuted under these laws for allegedly inflating drug prices they report to sharepricing services, which in any monetary recovery.  In recent years,turn were used by the number or suits brought by private individuals has increased dramatically.government to set Medicare and Medicaid reimbursement rates, and for allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product.  In addition, manycertain marketing practices, including off-label promotion, may also violate false claims laws.  Additionally, PPACA amended the healthcare program anti-kickback statute such that a violation can serve as a basis for liability under the federal false claims law.  The majority of states also have enacted false claim lawsstatutes or regulations similar to the federal False Claims Act.
A host ofanti-kickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other laws and regulations govern the advertising and promotion of drugs and devices.  The federal “Open Payments” law (previously referred to as “Sunshine Law”), which is partstate programs, or, in several states, apply regardless of the Patient Protectionpayor.
Other federal statutes pertaining to healthcare fraud and Affordable Care Act, as amended byabuse include the Health Care and Education Reconciliation Act, each enacted in March 2010, imposes federal transparency provisions, requiring annual reportingcivil monetary penalties statute, which prohibits the offer or payment of various types of paymentsremuneration to physicians and teaching hospitals.   Implementation ofa Medicaid or Medicare beneficiary that the Open Payments provisions has been subjectofferor/payor knows or should know is likely to delay byinfluence the U.S. Centers for Medicare and Medicaid Services (CMS).  Under the current regime, applicable manufacturers werebeneficiary to begin tracking relevant transfer-of-value data in August 2013, and must report data collected between August 1order a receive a reimbursable item or service from a particular supplier, and the endhealthcare fraud statute, which prohibits knowingly and willfully executing or attempting to execute a scheme to defraud any healthcare benefit program or obtain by means of 2013 to CMSfalse or fraudulent pretenses, representations, or promises any money or property owned by or under the control of any healthcare benefit program in a two-phased approach by March 31, and May 31, 2014, respectively.  CMS will publishconnection with the data on a public website later in the year.  Inaccuratedelivery of or incomplete reports may be subject to enforcement.   Like the federal Open Payments law, several states have existing laws that require manufacturers to report transfers of value to selectpayment for healthcare providers licensed within the state.   Additionally, other laws such as the federal Lanham Act and similar state laws allow competitors and others to initiate litigation relating to advertising claims.  Additionally, the U.S. Foreign Corrupt Practices Act and local laws of other countries potentially implicate the sale and marketing of drugs and devices internationally.  This complex patchwork of laws can change rapidly with relatively short notice.

SURFAXIN is our first approved drug product in the U.S. and AFECTAIR is our first registered medical device in the U.S.  None of our other products under development has been approved for marketing in the U.S.benefits, items, or elsewhere.  We may not be able to obtain regulatory approval for any of these products.  If we do not obtain the requisite governmental approvals or if we fail to obtain approvals of the scope we request, we or our licensees or strategic alliance or marketing partners may be delayed or precluded entirely from marketing our products, or the commercial use of our products may be limited.  Such events would have a material adverse effect on our business, financial condition and results of operations.  See, “Item 1A – Risk Factors – Our technology platform is based solely on our proprietary KL4 surfactant technology, our novel CAG technology, and our novel aerosol-conducting airway connector;” “– Our research and development programs, including for AEROSURF involve significant risks and uncertainties that are inherent in the clinical development and regulatory approval processes,” “– The regulatory approval process for our products is expensive and time-consuming and the outcome is uncertain.  We may not obtain required regulatory approvals to commercialize our products,” and “– Even if we succeed in gaining regulatory approval to market our drugs, if the FDA and foreign regulators later withdraw their approval or otherwise restrict marketing, our business would be materially harmed.”

Certain of our product candidates may qualify for Fast Track designation, Orphan Drug designation, or other potential expedited regulatory pathway options.  Each potential expedited regulatory pathway could provide for expedited FDA communication or approval, as well as additional potential benefits, such as additional market exclusivity or tax incentives.  See, “– Licensing, Patents and Other Proprietary Rights and Regulatory Designations – Patents and Proprietary Rights – Other Regulatory Designations,” and “Item 1A – Risk Factors – Even though some of our product candidates have qualified for expedited review, the FDA may not approve them at all or any sooner than other product candidates that do not qualify for expedited review.”services.
 
EMPLOYEES

As of March 7, 2014,11, 2016, we have 12658 employees, including 5 part-time employees.  Of this total, 14 (approximately 11%All of our total labor force)employees are employed at our Totowa Facility, and are subject to a collective bargaining agreement that expires on December 3, 2015.  All are employedbased in the U.S.  See, “Item 1A – Risk Factors – We depend upon key employees and consultants in a competitive market for skilled personnel.  If we or our strategic partners or collaborators are unable to attract and retain key personnel, it could adversely affect our ability to develop and market our products.”
 
AVAILABLE INFORMATION

We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (SEC).  You may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549.  You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  Many of ourIn addition, the SEC filings aremaintains an Internet site that contains reports, proxy and information statements, certain and other information that we may file electronically with the SEC (http://www.sec.gov).  We also available to the public from the SEC’s website at “http://www.sec.gov.”  We make available for download free of charge through our website our Annual Report on Form 10-K, our quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we have filed it electronically with, or furnished it to, the SEC.
We maintain websitesour corporate website at http://www.DiscoveryLabs.com, www.SURFAXIN.com, and www.AFECTAIR.com.  Our websiteswebsite and the information contained therein or connected thereto are not incorporated into this Annual Report on Form 10-K.
 
ITEM 1A.
RISK FACTORS.

You should carefully consider the following risks and any of the other information set forth in this Annual Report on Form 10-K and in the documents incorporated herein by reference, before deciding to invest in shares of our common stock.  The risks described below are not the only ones that we face.  Additional risks that are not presently known to us or that we currently deem immaterial may also impair our business operations.  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.  If any of the following risks actually occurs, our business prospects, financial condition or results of operations could be materially harmed.  In such case, the market price of our common stock would likely decline due to the occurrence of any of these risks, and you could lose all or part of your investment.

Note:  Information concerning the shares of our common stock and related share prices in these risk factors has been adjusted to reflect a 1-for-14 reverse split of our common stock and a change in the number of shares of common stock authorized for issuance under our Amended and Restated Certificate of Incorporation, as amended (Certificate of Incorporation), that were made effective on January 22, 2016.
WeTo be able to secure the additional capital that we will require, we are substantially dependent upon our ability to successfully complete enrollment in our ongoing phase 2b clinical trial before the end of 2016 and release top line data in the near term, butfirst quarter of 2017, in accordance with our plan.  If we are unable to successfully complete enrollment and release top line data in accordance with our plan, or if the results of our clinical trial are inconclusive, or present an unacceptable benefit / risk profile due to suboptimal efficacy and / or safety profile, we may be unable to secure whenthe additional capital that we will require to support our research and development activities and operations and have sufficient cash resources to service and repay debt, which could have a material adverse effect on our business and our ability to continue as a going concern.

Our business and our ability to secure the significant additional capital that we will require to support our research and development activities and operations and have sufficient cash resources to service and repay debt, is highly dependent upon our ability to successfully develop, manufacture, secure regulatory approval for, and commercialize our AEROSURF combination drug/device product candidate for the treatment of respiratory distress syndrome (RDS) in premature infants.  At the present time, we are conducting a phase 2b clinical trial, the enrollment for which is expected to be completed before the end of 2016, with top line results expected in the first quarter of 2017. At December 31, 2015, we had cash and cash equivalents of approximately $38.7 million, which we expect to be sufficient to fund our phase 2b clinical trial and our operations through the first quarter of 2017.  If for any reason, we should experience delays in successfully completing this clinical trial, whether due to slower rates of enrollment or of initiation of clinical sites, or failure to timely supply aerosol delivery system (ADS) and disposable AEROSURF delivery packs as needed, or otherwise, and any such delay extends beyond the period for which we have sufficient funding, we may have difficulty securing the additional capital that we require to complete the trial and continue our development program on acceptable terms, if at all.  Moreover, even if we are able to complete our phase 2b clinical trial on time, but obtain results that are inconclusive, fail to achieve our stated endpoints, or otherwise present an inappropriate benefit / risk profile, or if we suffer regulatory setbacks or delays that jeopardize or ability to successfully commercialize our product, if approved, we may be unable to secure the additional capital that we require before we exhaust our cash resources.  Accordingly, failure to obtain acceptable and promising results within the required time could have a material adverse effect on our ability to secure the additional capital that we will require, through strategic transactions or otherwise, and likely adversely affect our ability to continue as a going concern.

We will require significant additional capital to support our operations, pay our debt service, commercialize our approved products and develop our products under development, including AEROSURF®, and to continue our other research and development programs.activities and operations and have sufficient cash resources to service and repay debt, but our ability to raise such capital may be adversely impacted by a number of factors may represent significant challenges to accessing the capital markets at a time when we would like or require, and at an increased cost of capital.  Moreover, any financings could result in substantial dilution to our stockholders, cause our stock price to fall and adversely affect our ability to raise capital.

Our operations have consumed substantial amounts of cash since inception.  As of December 31, 2013, we have an accumulated deficit of approximately $480 million and we expect to continue to incur significant, increasing operating losses over the next several years.  As of December 31, 2013,2015, we had cash and cash equivalents of approximately $86.3$38.7 million, current accounts payable and accrued expenses of $10.8 million, and $30$25 million ($18.4 million net of discount) of long-term debt under a secured loan (Deerfield Loan)(Deerfield Loan) with affiliates of Deerfield Management, L.P.(Deerfield).  During 2013, we raised aggregate gross proceedsThe principal portion of $75.8 million through public offerings of our common stock, including net proceeds of approximately $1.8 million that we raised under our ATM Program.  On November 8, 2013, we announced the commercial launch of SURFAXIN®. debt is payable in two equal installments in February 2018 (subject to potential deferral in certain circumstances) and February 2019.  Before any additional financings, including under our ATM Program, we anticipate that we will have sufficient cash available to support our operations and debt service obligations through the thirdfirst quarter of 2017.
Our operations have consumed substantial amounts of cash since inception.  As of December 31, 2015, we have an accumulated deficit of approximately $579 million and we expect to continue to incur significant, increasing operating losses over the next several years.  Following the approval of SURFAXIN® in 2012, we initiated commercial activities in late 2013.  However, with revenue growth slower than expected and more of our capital and resources being allocated to SURFAXIN than expected, we reassessed and initiated a plan to focus our limited capital and resources to the development of AEROSURF.  Our plan was to (i) enter into a strategic alliance or collaboration arrangement to support the manufacture and commercialization of SURFAXIN, or (ii) cease our manufacturing and commercial activities for SURFAXIN.  After considering potential alternatives, we began winding down commercial activities in April 2015.  In 2014, cash outflows for manufacturing, marketing, medical and commercial activities for SURFAXIN were approximately $19 million.  We also reduced our work force by approximately 50%, predominantly in commercial infrastructure and manufacturing.  In addition, we allowed our real property lease for our Totowa, NJ manufacturing operations to expire in June 2015.  Since that time, we have focused our capital and resources primarily on the AEROSURF clinical development program and further development of our lyophilized KL4 surfactant drug product and our aerosol delivery system (ADS), which is based on our capillary aerosol generator technology.

We expect to continue to require significant additional infusions of capital to execute our business strategy until such time as the net revenues from SURFAXIN and, potentially,the commercialization of AEROSURF, if approved, and from potential strategic alliance and collaboration arrangements, and other sources, are sufficient to offset our cash flow requirements.  Even if we succeed with the commercial introduction of SURFAXIN, we expect our revenues from SURFAXIN will be modest in the first 12-24 months and then increase slowly over time.  For the next several years, we do not expect thatto receive revenues from the sale of approved products, and our cash outflows for development programs, operations and debt service willare likely to far outpace the rate at which we may generate revenues and other cash inflows from product sales.  all available sources.  See, “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources.”

We cannot be certain that additional funding will be available on acceptable terms, or at all.  If we are unable to raise additional capital in sufficient amounts or on terms acceptable to us, we may have to significantly delay, scale back or discontinue the development or commercialization of our products or our research and development programs.  programs, or, if approved, commercialization of our products.
We also could be required to:

seek collaborators for one or more of our development programs for territories that we had planned to retain or on terms that are less favorable than might otherwise be available; and/or
relinquish or license on unfavorable terms our rights to technologies or product candidates that we otherwise would seek to develop or commercialize ourselves.

If we are unable to secure capital from strategic alliances and collaboration arrangements and other similar transactions, we may need to seek additional capital fromin the publicequity markets, which could have a dilutive impact on our stockholders and the issuance, or even potential issuance, of shares could have a negative effect on the market price of our common stock.  Depending onHowever, a number of factors, including our status as a smaller reporting company under the SEC regulations, conditions in the global financial markets, weand the timing and outcomes of our clinical activities, may facepresent significant challenges to accessing the capital markets at a time when we would like or require, and at an increased cost of capital.  Except for our at-the-market equity program (ATM Program) with Stifel, Nicolaus & Company, Incorporated (ATM Program)(Stifel), which can be cancelled at any time, we do not have in place arrangements to obtain additional capital.  Any such financing could be difficult to obtain or only available on unattractive terms and could result in significant dilution of stockholders’ interests.  In any such event, the market price of our common stock may decline.  In addition, failure to secure any necessary financing in a timely manner and on favorable terms could have a material adverse effect on our business plan, financial performance and stock price and could delay new product development and clinical trial plans.
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The financialOur status under SEC regulations as a smaller reporting company and operational projections that wethe related limitation on primary offerings under our universal shelf registration statement, which was filed with the SEC on Form S-3 (File No. 333-196420) and declared effective on June 13, 2014 (2014 Universal Shelf), may make it more difficult to raise additional capital in the public markets when needed, if at all, including under our ATM Program or pursuant to a public offering.
Our ability to use our ATM Program with Stifel or to raise additional capital from time to time arethrough a public offering under our 2014 Universal Shelf may be constrained by restrictions under the Form S-3, which limits the value of primary securities offerings in any 12-month period by companies whose equity securities held by nonaffiliated persons and entities (public float) is less than $75 million to no more than one-third of their public float.  To raise needed capital, we may be required to seek other forms of transactions, including, for example, under a registration statement on Form S-1, the preparation and maintenance of which would be more time consuming and costly, or privately placed, potentially with registration rights or priced at a discount to the market value of our stock, or contain other terms and conditions, or other transactions, any of which could result in substantial equity dilution of stockholders’ interests.  In addition, failure to secure any necessary financing in a timely manner and on favorable terms could have a material adverse effect on our business plan, financial performance and stock price and could delay new product development and clinical trial plans.

If we fail to adhere to the strict listing requirements of The Nasdaq Capital Market (Nasdaq), we may be subject to inherent risks.delisting.  As a result, our stock price may decline and our common stock eventually may be delisted.  If our stock were no longer listed on Nasdaq, the liquidity of our securities likely would be impaired.

The projectionsOur common stock currently trades on Nasdaq under the symbol DSCO.  If we fail to adhere to the market’s strict listing criteria, our stock may be delisted.  This could potentially 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 the potential reduction in media coverage.  As a result, an investor might find it more difficult to dispose of our management may provide fromcommon stock.  We believe that current and prospective investors would view an investment in our common stock more favorably if it continues to be listed on Nasdaq.  Any failure at any time to time (including, butmeet the continuing Nasdaq listing requirements could have an adverse impact on the value of and trading activity in our common stock.

On June 29, 2015, we received a letter from The Nasdaq Stock Market indicating that for 30 consecutive trading days our common stock had not limitedmaintained a minimum closing per share bid price of $1.00 (Minimum Bid Price Requirement) as required by Nasdaq Listing Rule 5550(a)(2).  Under Nasdaq’s Listing Rules, we initially had 180 calendar days from the date of the notification (the Compliance Period), or until December 28, 2015, to those relatingregain compliance with the Minimum Bid Price Requirement. To regain compliance, the closing bid price of our common stock must close above $1.00 for a minimum of 10 consecutive business days; thereafter, our common stock would continue to product approval, productionbe eligible for listing on Nasdaq.  At the end of the initial Compliance Period, Nasdaq notified that us we qualified for an extension of the Compliance Period to June 2016.  On January 21, 2016, at a Special Meeting of Stockholders, our stockholders approved a 1-for-14 reverse split, which was effective on January 22, 2016 and supply dates, commercial launch dates, andbrought us into compliance with the Minimum Bid Price Requirement.

Although we have regained compliance with the Minimum Bid Price Requirement, there can be no assurance that we will be able to maintain continued compliance with the Minimum Bid Price Requirement or the other financial or operational matters) reflect numerous assumptions made by management, including assumptions with respectlisting requirements of Nasdaq.  There can be no assurance that the closing bid price of our common stock will continue to trade above $1.00.  Moreover, if trading activity in our specific as well as general business, economic,common stock were to reduce the total market and financial conditions and other matters, allcapitalization of which areour company, we may find it difficult to predict and manyfund our activities, which would result in reductions in our stockholders’ equity.  In addition to the Minimum Bid Price Requirement, certain other Nasdaq continued listing requirements require that we maintain a market capitalization of whichat least $35 million or stockholders’ equity of at least $2.5 million.  If we are beyond our control. Accordingly, there is a risk that the assumptions made in preparing the projections,unable to meet these requirements we would receive another delisting notice from Nasdaq for failure to comply with one or the projections themselves, will prove inaccurate. There will be differences between actual and projected results, and actual results may be materially different from those contained in the projections. The inclusionmore of the projections in (or incorporated by reference in) this Annual Report on Form 10-K should not be regarded as an indication that we or our management or representatives considered or consider the projections to be a reliable predictioncontinued listing requirements.
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Our clinical development program for AEROSURF involves significant risks and uncertainties that are inherent in the clinical development and regulatory approval processes.  Our clinical trials may be delayed, or fail, which will harm our business prospects.

We are currently conducting a phase 2a clinical trial, which is an open label, single-dose study with the primary goal of program evaluating the safety and tolerability of aerosolized KL4 surfactant drug product administered in escalating inhaled doses into premature infants 2926 to 32 weeks28 week gestational age who are receiving nasal continuous positive airway pressure (nCPAP) for respiratory distress syndrome (RDS), compared to infants receiving nCPAP alone.  This initial  We are also conducting a phase 2b clinical trial in premature infants 26 to 32 weeks gestational age receiving nCPAP for RDS, which is designed to evaluate the first insafety and tolerability of aerosolized KL4 surfactant compared to infants receiving nCPAP alone and evaluate certain endpoints, including time to nCPAP failure (defined as the need for intubation and delayed surfactant therapy), incidence of nCPAP failure and physiological parameters indicating the effectiveness of lung function.  These clinical trials are two of a series of clinical trials that will be needed to gain marketing authorization for AEROSURF.AEROSURF, if at all.  Such development programs generally take two to five years or more to complete and may be delayed by a number of factors.  We may not reach agreement with the U.S. Food and Drug Administration (FDA)(FDA) or a foreign regulator on the design of any one or more of the clinical trials necessary for approval, or we may be unable to reach agreement on a single design that would permit us to conduct a single clinical program.  Conditions imposed by the FDA and foreign regulators on our clinical program could significantly increase the time required to complete and the costs of conducting clinical trials.  For example, we may not be successful in achieving a study design that is acceptable to both the FDA and regulators in other countries, which would cause us to limit the scope of our activities or greatly increase our investment.  Like many biotechnology companies, even after obtaining promising preliminary findings or results in earlier preclinical studies and clinical trials, we may suffer significant setbacks in any stage of our clinical trials.  Clinical data is susceptible to varying interpretations that 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 many factors, including the rate at which patients are enrolled.  Delays in patient enrollment in clinical trials may occur, which would be likely to result in increased costs, program delays, or both.  Patient enrollment is a function of many factors, including:

the number of clinical sites;
the size of the patient population;
the severity of the disease under investigation;
the eligibility and enrollment criteria for the study;
the willingness of patients’ parents or guardians to participate in the clinical trial;
the perceived risks and benefits of the product candidate under study;
the existence of competing clinical trials;trials;
the existence of alternative available products; and
geographical and geopolitical considerations.

We have opened a number of clinical sites outside the U.S. where our experience is more limited.  We use the services of third party clinical trial providers and third party contract research organizations (CROs) to carry out most of our clinical trial related activities and accurately report their results, which may impact our ability to control the timing, conduct, expense and quality of our clinical trials.  One CRO has responsibility for substantially all of our clinical trial related activities and reporting.  If our CROs do not successfully carry out their activities or meet expected deadlines, our trials may be delayed.  We may also need to replace our CROs.  Although we believe that there are a number of other third-party CROs we could engage to continue these activities, the replacement of an existing CRO may result in delay of the affected trials or otherwise adversely affect our efforts to obtain regulatory approvals and commercialize our drug candidates. If we fail to adequately manage the design, execution and regulatory aspects of our complex and diverse clinical trials, our studies and any potential regulatory approvals may be delayed, or we may fail to gain approvals for our product candidates.
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If patients are enrolled in our clinical trials, we succeed in achieving our patient enrollment targets, our patientsthey could suffer adverse medical events or side effects that are known to be associated with surfactant administration such as a decrease in the oxygen level of the blood, or currently unknown to us.  It is also possible that we, our AEROSURF Clinical Trial (ACT) Steering Committee, the Independent Safety Review Committee (SRC)(ISRC), or the FDA could interrupt, delay or halt any one or more of our clinical trials for AEROSURF or any of our product candidates.  If our ACT Steering Committee, the SRC,ISRC, any regulator or we believe that study participants face unacceptable health risks, any one or more of our clinical trials could be suspended or terminated.  In addition, clinical trials may be interrupted, delayed or halted, in whole or in part, for reasons other than health and safety concerns, including, among other things, matters related to the design of the study, drug availability, ACT Steering Committee and/or SRCISRC recommendation, or business reasons.
In addition to our planned clinical program to support AEROSURF, in the future, we also may initiate or support clinical trials evaluating other KL4 surfactant pipeline products.  All of these clinical trials will be time-consuming and potentially costly.  Should we fail to complete our clinical development programs or should such programs yield unacceptable results, such failures would have a material adverse effect on our business.

The regulatory approval process for our products is expensive and time-consuming and the outcome is uncertain.  We may not obtain required regulatory approvals to commercialize our products.

Before we can market our products, we must receive regulatory approvals for each product.  The FDA and foreign regulators, such as the European Medicines Agency (EMA), extensively and rigorously regulate the testing, manufacture, distribution, advertising, pricing and marketing of drug products.  This approval process includes (i) preclinical studies and clinical trials of each drug product candidate and active pharmaceutical ingredient to establish its safety and effectiveness, and (ii) confirmation by the FDA and foreign regulators that we maintain good laboratory and manufacturing practices during testing and manufacturing.  Even if favorable data are generated by clinical trials, the FDA or foreign regulator may not accept, file or approve a new drug application (NDA) or market authorization application (MAA) filed for a drug product on a timely basis or at all.  See, “Item 1 – Business – Government Regulation.”

We are currently conducting a phase 2 clinical program for AEROSURF.  There can be no assurance that issues requiring protracted and time-consuming preclinical studies will not arise or that our clinical program trials will be concluded successfully.  Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful.  As a result, data we obtain from our phase 2a clinical program may not accurately predict phase 2b or phase 3 results due to many factors such as differences in sample size, study arms, duration, endpoints and features of the ADS used.  In addition, if the ADS to be used in our phase 3 program differs in potentially important ways from that used in phase 2, we may be required to conduct bridging studies or repeat important studies conducted with the earlier version.  There can be no assurance that we will be successful in gaining regulatory approval for AEROSURF.

Clinical trials may indicate that our product candidates lack efficacy, have harmful side effects or raise safety or other concerns that may significantly reduce the likelihood of regulatory approval, result in significant restrictions on use and safety warnings in the approved label, adversely affect placement within the treatment paradigm, or otherwise significantly diminish the commercial potential of the product candidate. Also, positive results in a registration trial may not be replicated in subsequent confirmatory trials.  Even if later stage clinical trials are successful, regulatory authorities may disagree with our view of the data or require additional studies, may disagree with trial design or the endpoints employed in the trials, may fail to approve the processes used to manufacture a product candidate, may find the cGMP compliance status of a facility that manufactures a product candidate unsatisfactory, may fail to approve or delay approval of our product candidates, dosing or delivery methods, companion devices or may otherwise grant marketing approval that is more restricted than anticipated, including indications covering narrow patient populations and the imposition of safety monitoring or educational requirements or risk evaluation and mitigation strategies.  The occurrence of any such events could result in the incurrence of significant costs and expenses, have an adverse effect on our business, including our financial condition and results of operations, or cause our stock price to decline or experience periods of volatility.  Even if we are able to successfully develop new products or indications, we may make a strategic decision to discontinue development of such product or indication if, for example, we believe commercialization will be difficult relative to other opportunities in our pipeline.

For AEROSURF, we currently plan to pursue clinical development in the U.S., the European Union, Latin America and Canada, and, if approved, market and sell our products in the U.S. and potentially in other major markets.  To accomplish this objective, we must obtain and maintain regulatory approvals and comply with regulatory requirements in each jurisdiction.  To avoid the significant expense and lengthy time required to complete multiple clinical programs, we expect to meet with relevant regulatory authorities.  While we would prefer to design a single, global clinical program that would satisfy the regulators in all of our target markets, there can be no assurance that our efforts will be successful.  If we failare unable to successfully commercialize SURFAXIN,reach agreement with the various regulatory authorities, we may not be able to pursue regulatory approval of our products in all of our selected markets.
The FDA and foreign regulatory bodies have substantial discretion in the drug approval process, including the ability to delay, limit or deny approval of product candidates for many reasons, which may include:
·the FDA or a foreign regulator may disagree with the design or implementation of one or more clinical trials;
·the FDA or a foreign regulator may not deem a product candidate safe and effective for its proposed indication, or may deem a product candidate’s safety or other perceived risks to outweigh its clinical or other benefits;
·the FDA or a foreign regulator may not find the data from preclinical studies and clinical trials sufficient to support approval, or the results of clinical trials may not meet the level of statistical or clinical significance required by the FDA or the applicable foreign regulatory body for approval;
·the FDA or a foreign regulator may disagree with our interpretation of data from preclinical studies or clinical trials performed by us or third parties;
·the data collected from clinical trials may not be sufficient to support the submission of an NDA or other applicable regulatory filing;
·the FDA or a foreign regulator may require additional preclinical studies or clinical trials;
·the FDA or a foreign regulator may identify deficiencies in the formulation, quality control, labeling or specifications of our current or future product candidates;
·the FDA or a foreign regulator may grant approval contingent on the performance of costly additional post-approval clinical trials;
·the FDA or a foreign regulator also may approve our current or any future product candidates for a more limited indication or a narrower patient population than we originally requested;
·the FDA or a foreign regulator may not approve the labeling that we believe is necessary or desirable for the successful commercialization of our product candidates;
·the FDA or a foreign regulator may not approve of the manufacturing processes, controls or facilities of third-party manufacturers or testing labs with which we contract; or
·the FDA or a foreign regulator may change its approval policies or adopt new regulations in a manner rendering our clinical data or regulatory filings insufficient for approval.

The approval procedures vary among countries in complexity and timing.  We may not obtain approvals from regulatory authorities outside the U.S. on a timely basis, if at all, which would preclude us from commercializing products in those markets.  There may be situations in which demonstrating the efficacy and safety of a product candidate may not be sufficient to gain regulatory approval unless superiority to comparative products can be shown.  Also, legislative bodies or regulatory agencies could enact new laws or regulations or change existing laws or regulations at any time, which could affect our ability to obtain or maintain approval of our products or product candidates.  For example, the EU recently finalized legislation, which will apply as early as mid-2016, related to the conduct of clinical trials.  While the aim of the new legislation is to improve in operational efficiency and streamline the overall clinical trial authorization process, the new requirements also provide for increased transparency of clinical trial results and submission of quality data relating to the products and product candidates used for such trials.  Starting in 2015, the EMA will make certain clinical trial reports publicly available, which may limit our ability to protect competitively-sensitive information contained in our clinical trial reports. Failure to comply with new laws or regulations could result in significant monetary penalties as well as reputational and other harms. We are unable to predict when and whether any further changes to laws or regulatory policies affecting our business could occur, such as efforts to reform medical device regulation or the pedigree requirements for medical products or to implement new requirements for combination products, and whether such changes could have a material adverse effect on our business and results of operations. Regulatory authorities may also question the sufficiency for approval of the endpoints we select for our clinical trials.  Regulatory authorities could also add new requirements, such as the completion of additional studies, as conditions for obtaining approval or obtaining an indication. The imposition of additional requirements may delay our clinical development and regulatory filing efforts, and delay or prevent us from obtaining regulatory approval for new product candidates, new indications for existing products or maintenance of our current labels

In addition, some countries, particularly the countries of the EU, regulate the pricing of prescription pharmaceuticals.  In these countries, pricing discussions with governmental authorities can take considerable time after the receipt of marketing approval for a product.  To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of their product candidate to other available therapies.  Such trials may be time-consuming and expensive, and may not show an advantage in efficacy for our products.  If reimbursement of our products is unavailable or limited in scope or amount, or if pricing is set at unsatisfactory levels, in either the U.S. or the EU, we could be adversely affected.
Our research and development programs, including for AEROSURF, involve significant risks and uncertainties that are inherent in the clinical development and regulatory approval processes.

Development risk factors include, but are not limited to, whether we, or our third-party collaborators, CROs, drug substances and materials suppliers and contract manufacturing organizations (CMOs), will be able to:

competently execute and complete our preclinical and clinical trials of our KL4 surfactant product candidates with scientific results that are sufficient to support further development and regulatory approval;
receive the necessary regulatory approvals;
obtain adequate supplies of the active pharmaceutical ingredients, manufactured to our specifications and on commercially reasonable terms;
perform under agreements to supply drug substances, medical devices and related components and related services necessary to manufacture our KL4 surfactant product candidates;
provide for sufficient manufacturing capabilities with CMOs, to produce sufficient drug product and ADSs and related materials to meet our preclinical and clinical development requirements; and
obtain the capital necessary to fund our research and development efforts, including our business administration, preclinical and clinical organizations, and our quality and manufacturing operations.

Because these factors, many of which are outside our control, could have a potentially significant impact on our development activities, the success, timing of completion and ultimate cost of development of any of our product candidates is highly uncertain and cannot be estimated with any degree of certainty.  The timing and cost to complete drug trials alone may be impacted by, among other things:

our substantial reliance on third-party collaborators, CROs, CMOs and suppliers;
slow patient enrollment;
long treatment time required to demonstrate effectiveness;
lack of sufficient clinical supplies and material;
adverse medical events or side effects in treated patients;
lack of compatibility with complementary technologies;
failure of a drug product candidate to demonstrate effectiveness; and
lack of sufficient funds.

If we do not successfully complete clinical trials, we will not receive regulatory approval to market our KL4 surfactant pipeline products.  Failure to obtain and maintain regulatory approval and generate revenues from the sale of our products would have a material adverse effect on our financial condition and results of operations and likely reduce the market value of our common stock.

Failure to complete the development of our ADS and related componentry in a timely manner, if at all, would have a material adverse effect on our efforts to commercialize SURFAXINdevelop AEROSURF or our other aerosolized KL4 surfactant products, and our business strategy.

We have developed a clinic-ready ADS that is suitable for use in our ongoing phase 2 clinical program and currently are significantly delayedworking with Battelle Memorial Institute (Battelle) to further develop the ADS in our planned phase 3 clinical trial and potentially for commercial use.  Our development activities are subject to certain risks and uncertainties, including, without limitation:

We may not successfully develop an ADS that is acceptable for use in a phase 3 program and commercial environment, if at all, on a timely basis and such inability may delay or impaired,prevent initiation of our abilityphase 3 clinical program.
We will require access to growsophisticated engineering capabilities.  We have our revenuesown medical device engineering staff and continuewe are currently working with Battelle, which has expertise in medical device development and medical device design and a successful track record in developing aerosolization systems for the medical and pharmaceutical industries.  If for any reason we are unable to retain our own engineering capabilities, the agreement with Battelle is terminated, and we are unable to identify design engineers and medical device experts to support our development programs  will be impaired,efforts, including for a clinic-ready ADS for use in our planned phase 3 clinical program and, we may be unable to securepotentially, for commercial use and later versions of the additional capital that we require, whichADS, it would have a material adverse effect on our business financial conditionstrategy and results of operations and the price of our common stock would likely decline.

We initiated the commercial introduction of SURFAXIN in late 2013.  SURFAXIN product sales are expected to constitute most, if not all, of our total revenue from product sales over the next several years.  Our efforts to successfully execute the commercial introduction of SURFAXIN are subject to a variety of risks and uncertainties that could cause actual results to be materially different.  The commercial success of SURFAXIN andimpair our ability to generatecommercialize or develop AEROSURF or other aerosolized KL4 surfactant products.
We will also require additional capital to advance our development activities and increase revenues will depend onplan to seek a number of factors, including the following:

the number of hospitals and critical-care centers that agree to place SURFAXIN drug product on their formulary lists and the length of time required to achieve broad formulary acceptance;
the willingness of hospitals to accept and employ WARMING CRADLE® dry-block heater, a device that warms drug vials at the same temperature and for the time period designated in the SURFAXIN prescribing information;
the effectiveness of our marketing, sales and medical affairs organizations and their ability to (a) accurately describe SURFAXIN consistent with its approved labeling, and (b) educate and provide critical care providers and hospitals with medical and scientific education and information;
our ability to gain access to the entire market with our commercial organization;
our abilitypotential strategic partner or third-party collaborator to provide hospitals acceptable evidence of the safetyfinancial support and efficacy of SURFAXIN and the perceived advantages of SURFAXIN, a synthetic peptide-containing surfactant, over alternative animal-derived surfactants;
the pharmacoeconomic benefits (which are determined by comparing, among other things, the cost and effects of a product when compared to different treatment options) and cost-effectiveness of our products;
the impact of adding SURFAXIN and WARMING CRADLE heater to formulary andpotentially medical device hospital listsdevelopment and the availability, cost and potential advantages of alternative treatments, including less expensive generic drugs and other competitive products;
the availability of different size drug vials and medical devices to meet the specific needs of healthcare practitioners;
the claims, limitations, warnings and other information that appear in the package insert and labeling of SURFAXIN drug product;
the willingness of third-party payers, including government payers, to provide coverage and reimbursements to patients, physicians and other providers who wish to prescribe and use our products;
our ability to secure and maintain regulatory marketing approvals from the U.S. and foreign regulatory authorities;
the rate of preterm births;
the number of infants who are diagnosed with RDS and the number treated with SURFAXIN;
the growth of commercial sales;
our ability to meet commercial demand for SURFAXIN, including through maintenance of commercial supplies of our active drug substances and other excipients, and manufacturing capabilities, by ourselves and through contract manufacturing organizations (CMOs); and commercial inventory supplies of our medical device products; and
the sufficiency of coverage or reimbursement by third parties.

Generally, before we can attempt to sell products in a hospital, drug products must be approved for addition to that hospital’s list of approved drugs, or formulary list, by the hospital’s Pharmacy and Therapeutics (P&T) committee.  A hospital’s P&T committee typically governs all matters pertaining to the use of medications within the institution, including the review of medication formulary data and recommendations for the appropriate use of drugs within the institution to the medical staff.  The frequency of P&T committee meetings at hospitals varies considerably, and P&T committees often require additional information to aid in their decision-making process.  Therefore, we may experience substantial delays in obtaining formulary approvals.  In addition, our AFECTAIR® device must be approved for use by hospitals’ materials management, and we will need to arrange with each hospital to include WARMING CRADLE on the hospital’s list of approved laboratory equipment.commercialization expertise.  There can be no assurance, however, that we will successfully gain the required hospital approvals for our products.  Additionally, hospitals mayidentify or be concernedable to enter into agreements with such potential partners or collaborators on terms and conditions that the cost of acquiring our products for use in their institutions will adversely impact their overall budgets, which could cause resistanceare favorable to efforts to add our drugs to the formulary and products to the materials list, or cause hospitals to implement restrictions on the usage of our drugs and products in order to control costs.  We cannot guarantee that we will be successful in obtaining the approvals we need from enough hospitals quickly enough to optimize hospital sales of SURFAXIN, AFECTAIR or our other products.

Our efforts to achieve formulary acceptance of SURFAXIN, and to educate the medical community and third-party payers regarding the benefits of SURFAXIN will require significant, focused and competent resources and we may not be successful in achieving our objectives.us.  If we are unable to achieve formulary acceptance in our target hospitals,secure the revenues we generate from sales will be limited and we may never achieve profitability.
The commercial success of our product candidates, including SURFAXIN, AFECTAIR, and, if  approved, AEROSURF, will depend in large part upon the degree of market acceptance by physicians, patients, healthcare payers and others in thenecessary medical community.

Even if we are successful in achieving formulary acceptance of SURFAXIN and, if approved, AEROSURF, and adoption of AFECTAIR device in our target hospitals, if we do not achieve broad market acceptance of our products by physicians, respiratory therapists, nurses and other personnel in neonatal and pediatric intensive care units (NICUs and PICUS) and elsewhere in the hospital, as well as patients, healthcare payers and others in the medical community in general, we may not generate sufficient revenuesdevelopment expertise to support continued commercialization of these and our development program, this could impair our ability to commercialize or develop AEROSURF or other products, if approved for commercial sale.  The degree of market acceptance of our approved products will depend on a number of factors, including:

aerosolized KLthe willingness of physicians and hospitals to utilize our products and the willingness of hospitals’ 4P&T Committees to place our products on formulary or on the list of medical devices the hospital will purchase;
the safety and efficacy of our products, both in fact and as perceived by the medical community, regulatory agencies and insurers and other payers, on both a short and long-term basis;
the potential advantages of our products over alternative treatments;
the relative convenience and ease of use;
the prevalence and severity of any adverse events, including any unexpected adverse events of which we become aware; and
the degree to which the market believes that we are able to manufacture our products and produce supply sufficient to meet market demand. surfactant products.

As a company, we have limited experience in the fieldThe realization of marketing or selling pharmaceutical and medical device products and limited marketing capabilities, which may restrict our success in commercializing our products.  We have established our own commercial and medical affairs organization to launch our products in the U.S.  While we believe that this strategy greatly improves our ability to introduce our products in the U.S., it may also increase the cost to commercialize our products.

We have limited experience in marketing or selling pharmaceutical and medical device products, although we have endeavored to hire individuals that have significant experience in neonatal indications and/or hospital-based products.  We plan to rely solely on our own specialty respiratory critical care commercial and medical affairs organization to market and support SURFAXIN, and, if approved, AEROSURF and potentially SURFAXIN LS™, if approved, in the U.S.  We also plan to rely on our own commercial and medical affairs organization to introduce AFECTAIR device in the U.S.  We believe that AFECTAIR device will be of interest to manyany of the same hospitals, neonatologists and neonatal intensive care units that purchase SURFAXIN.  Commercializing our products in the U.S. on our own may cause our commercialization costs to increase, but will potentially avoid the transfer of rights to our products or drug product candidates and thereby potentially increase the revenue opportunity.  Building our own commercial and medical affairs capabilities is potentially expensive and time-consuming and requires a substantial capital investment.  Recruiting, training and retaining qualified personnel will be critical to our success.  Competition for such personnel can be intense, and we may be unable to attract and retain a sufficient number of qualified individuals to successfully support the launch and continued distribution of our products.  We also may be unable to provide competitive incentives to retain our sales force.  If we are unable to successfully retain, motivate and attract experienced individuals for our commercial and medical affairs organization to support the introduction, marketing and sale of our products, we will have difficulty selling, maintaining and increasing the sales of our products, which couldforegoing risks would have a material adverse effect on our business.

We are continually evaluating our business strategy and may modify this strategy in light of developments in our business and other factors.

In 2015, we modified our business strategy to focus primarily on the development of aerosolized KL4 surfactants, beginning with AEROSURF.  We plan to continually evaluate our business strategy and will modify our plans as necessary to achieve our objectives.  The execution of a clinical program is complex and involves the cooperation of many individuals and entities, including third parties that we may not be able to control, and require the coordination of a number of elements, any one of which could involve delays or unforeseen events or circumstances that require adjustment or the development of alternative strategies.  If we encounter such events or circumstances, we will change our strategy and plans if we believe that such a change will be in our best interest.  For example, when we experienced slower enrollment in our phase 2a clinical trials than we expected, we reassessed the number of sites that would be needed and expanded our activities ex-U.S.  In the future, if we determine that an alternative approach would better enable us to achieve our objectives, we will consider adopting such other approaches.  Similarly, if a potential partner or collaborator were to make observations or recommendations concerning the focus, sequence or approach of any or all of our research and development programs, we may consider taking such observations or recommendations into account in our planning process and activities.  There can be no assurance, whether or not we alter our strategy or plans for any reason, that we will be successful, or that we will secure regulatory approval for our products and execute any product launches effectively and on time, if at all, in all markets that we may identify.

Our ability to discover and develop new products depends on our internal research capabilities and our ability to acquire products.  Although we continue to conduct research and development activities on our KL4 surfactant products, our limited resources may not be sufficient to discover and develop new product candidates.  To assist us with the development of our products and, if approved, commercialization of our products in markets outside the U.S., we continue to evaluate potential strategic alliances, collaboration arrangements and other strategic transactions.  However, there can be no assurance that our efforts will be successful or that, even if we identify and enter into any strategic transaction, that such transactions will be successfully implemented, if at all, within our expected time frames.

We plan to continue evaluating our business strategy and may modify our strategy in the future.  To respond to changing circumstances, we may expand or alter our research and development activities from time to time, and allocate resources to work on development of different products or may pace, delay or halt the development of potential product programs.  As a result of changes in our strategy, we may also change or refocus our existing drug development and manufacturing activities or our plans for commercialization of our products, if approved.  This decisions could require changes in our facilities and personnel and restructuring various financial arrangements.  There can be no assurances that any product development or other changes that we implement will be successful or that, after implementation of any such changes, that we will not refocus our efforts on new or different objectives.
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We have limited resources, which could impair our ability to manage our diverse activities and accomplish our business objectives.

The demands on our management team have grown over time.  Our development program for AEROSURF has progressed into phase 2b and we are planning for a potential phase 3 clinical program.  Our planned clinical trials are expected to enroll more patients, be conducted in a larger number of sites both in the U.S. and abroad, and will require more of our management resources to be successful.  In addition to working on the AEROSURF development program, from time to time, we support studies of other potential KL may4 surfactant pipeline products.  We have also devoted resources to identifying potential strategic partnerships, collaboration arrangements and similar transactions, in the U.S. and EU and in other selected markets.  These activities have and will continue to place additional significant demands on our management and our financial and operational resources, and will require that we continue to develop and improve our financial, operational and other internal controls.  From time to time, we will be required to make difficult decisions on how to best allocate our resources.  For example, as a result of our limited resources, we determined to either seek a strategic alliance for SURFAXIN or cease our manufacturing and commercial activities.
If we are successful in identifying potential strategic or collaboration partners, we will be required to dedicate management resources and implement controls to establish alliance structures, and potentially add a layer of complexity to our operations.  We plan to distribute our products, if approved, in the U.S. on our own.  For other major markets, we plan to identify potential strategic alliances and/orand collaboration arrangements that would have the resources and capabilities to distribute our products.  This expansion could further increase the challenges involved in implementing appropriate operational and financial systems, expanding manufacturing and production capacity, expanding our infrastructure and capabilities, and providing adequate training and supervision to maintain high quality standards.  We believe that the significant challenges associated with these potential activities will require us to recruit, train and integrate skilled management, scientific, medical and operations personnel; establish and effectively manage strategic partnerships and collaboration arrangements to support the potential commercial introduction of SURFAXINour development and if approved, SURFAXIN LS in countries where regulatory marketing authorization is facilitated by the information contained in the SURFAXIN new drug application (NDA) approved by the FDA.  We also may consider strategic alliances and/or collaboration arrangements,commercialization activities; and provide for manufacturing, including third-party distributors or marketing alliances, to sell our AFECTAIR device in international markets.  We may not be successful in entering into any such arrangements,analytical testing and the terms of any such arrangements may not be favorable to us.  In addition, if we enter into co-marketing arrangements to market and sell additional products directly, we may need to further expand our commercial staff and incur additional expense.

If we enter into alliances,distribution and collaboration arrangements to commercialize our products, such arrangements will subject us to a number of risks, including:

our distributors or collaborators may require that we transfer to them important rights to our products and/or product candidates;
we may not be able to control the amount and timing of resources that our distributors or collaborators devote to the commercialization of our products;
if our distributors or collaborators fail to perform their obligations under our arrangements to our satisfaction, we may not achieve our projected sales and our revenues would suffer.  We also may incur additional expense to terminate such arrangements and to identify and enter into arrangements with replacement distributors or collaborators;
our distributors or collaborators may experience financial difficulties; and
business combinations or significant changes in a collaborator’s business strategy may adversely affect a collaborator’s willingness or ability to perform its obligations under any arrangement, which would adversely affect our business.

If we fail to enter into arrangements with third parties in a timely manner or if such parties fail to perform, it could adversely affect sales of our products.  We and our third-party distributors and collaborators must also market our products in compliance with federal, state and local laws related to providing incentives and inducements.  Violation of these laws can result in substantial penalties.

If we fail to maintain our commercial and medical affairs capabilities, or if we are unable to enter into arrangements with third parties in a timely manner when needed, or if such third parties fail to perform, it could adversely affect sales of our products.  In addition, even if we establish or secure such capabilities, our third-party collaborators and we must also market our products in compliance with federal, state and local laws relating to the restrictions on incentives and inducements.  Violation of these laws can result in substantial penalties.  If we are unable to successfully motivate our sales force, or if our distributors fail to promote our products, we will have difficulty maintaining and increasing the sales of our products.

If we do not adequately forecast customer demand for our approved products, including SURFAXIN and, if approved, AEROSURF, our business could suffer.  If we are successful, we also potentially are subject to risks associated with doing business globally.

Our business planning requires us to forecast demand and revenues despite numerous uncertainties.  Actual results of operations may deviate materially from projected results. The timing and amount of customer demand and the commercial requirements to meet changing customer demand are difficult to predict.  We may not be able to accurately forecast customer demand for our products, and product candidates, starting with SURFAXIN, or to respond effectively to unanticipated increases in demand.  This could have an adverse effect on our business.  If we overestimate customer demand, or attempt to commercialize products for which the market is smaller than we anticipate, we could incur significant unrecoverable costs from creating excess capacity.
In addition, the current economic conditions may result in reduced demandclinical capabilities for our products increased pricing pressure, longer sales cycles, and slower adoption rates for our products.  Conditions in the healthcare industry, including lower healthcare utilization, cost containment efforts by governments and other payers for healthcare services and other factors may result in weaker overall customer demand and increased pricing pressure for our products.  The current economic conditions may also adversely affect our suppliers, which could affect our abilityunder development.  Our inability to manufacture and sell our products.

We expect to offer certain of our products in the EU and elsewhere, which would subject us to risks associated with doing business globally and under the laws, regulations and customs of various jurisdictions and geographies.  These risks include fluctuations in currency exchange rates, changes in exchange controls, increasingly complex labor environments, expropriation and other governmental actions, availability of raw materials, changes in taxation, importation limitations, export control restrictions, changes in or violations of U.S. or local laws, including the FCPA, pricing restrictions, economic and political instability, diminished or insufficient protection of intellectual property, and disruption in a significant geographic region regardless of cause, including war, terrorism, riot, civil insurrection or social unrest. Failure to comply with, or material changes to, the laws and regulations that affectgrow our business could have an adverse effect oneffectively and appropriately or otherwise adapt to these challenges would cause our business, financial condition orand results of operations.

Our manufacturing strategy includes relying, at least in part in the future, on third partiesoperations to manufacture our current approved products as well as certain of our drug product candidates and medical devices, which exposes us to risks that may affect our ability to maintain supplies of our commercial products and/or delay our research and development activities, regulatory approval and commercialization of our drug product candidates.suffer.

We currently manufacture SURFAXIN at our Totowa Facility.  Our strategy includes potentially manufacturing SURFAXIN in the future and our lyophilized dosage form of our KL4 surfactant, as well as our capillary aerosol generator (CAG) for AEROSURF and AFECTAIR devices, using third-party contract manufacturing organizations (CMOs).  Our efforts to conduct a technology transfer of our manufacturing process and our planned future reliance on CMOs exposes us, among other things, to the following risks:

we may be unable to identify manufacturers with whom we might establish appropriate arrangements on acceptable terms, if at all, because the number of potential CMOs is limited and the FDA must approve any replacement CMO.  This approval could require one or more pre-approval inspections as well as a potentially lengthy qualification process.  In addition, a new manufacturer would have to be educated in, or develop substantially equivalent processes for, production of our approved products after receipt of FDA approval. This could take as long as 2 years to qualify and receive regulatory approval;
we may implement a plan to execute a technology transfer of our manufacturing process to a CMO and, after investing significant time and resources, learn that the CMO we chose is unable to successfully complete the technology transfer and thereafter manufacture our products in accordance with our plan;
CMOs might be unable to manufacture our products in the volume and to our specifications to meet our commercial and clinical needs, or we may have difficulty scheduling the production of drug product and devices in a timely manner to meet our timing requirements;
CMOs may not perform as agreed, or may not remain in the CMO business for a lengthy time, or may refuse to renew an expiring agreement as expected, or may fail to produce a sufficient supply to meet our commercial and/or clinical needs;
CMOs are subject to ongoing periodic unannounced inspection by the FDA, international health authorities, registered Notified Body(ies), the Drug Enforcement Administration, and corresponding state agencies to ensure strict compliance with cGMP and/or quality system regulations (QSR) and other government regulations and corresponding foreign standards.  We do not have control over a CMO’s compliance with these regulations and standards;
if we desire to make our drug products and/or devices available outside the U.S. for commercial or clinical purposes, our CMOs would become subject to, and may not be able to comply with, corresponding manufacturing and quality system regulations of the various foreign regulators having jurisdiction over our activities abroad.  Such failures could restrict our ability to execute our business strategies; and
if any third-party manufacturer makes improvements in the manufacturing process for our products, we may not have rights to, or may have to share, the intellectual property rights to any such innovation.  We may be required to pay fees or other costs for access to such improvements.
Each of the foregoing risks and others could delay our commercial manufacturing plans and our development programs, the approval, if any, of our product candidates by the FDA or result in higher costs or deprive us of potential product revenues.

We may enter into strategic alliances distributor, co-marketing or other collaboration arrangements, which could expose us to risks associated with the transfer of control to third parties and may require that we transfer rights to our products to our partners and collaborators.

To support our AEROSURF development program and potentially the commercial introduction of AEROSURF in markets outside the U.S., we seek a significant strategic alliance that potentially could provide development, regulatory and commercial market expertise as well as financial resources for our AEROSURF development program, and if approved,development, regulatory and commercial market expertise to support for the commercial introduction of AEROSURF in the EU and other selected markets outside the U.S.  While we are engaged in discussions with We seek to identify potential strategic partners who could provide local development and commercial expertise as well as financial resources (potentially in the form of upfront payments, milestone payments, commercialization royalties and a sharing of research and development expenses), although there can be no assurance that we will ultimately secure such an alliance, if at all, on acceptable terms.

To support the commercial introduction of SURFAXIN and our other KL4 surfactant products, including potentially SURFAXIN LS, in markets outside the U.S., we may enter into distributor arrangements or seek strategic alliances and/or collaboration arrangements to support the potential commercial introduction of SURFAXIN and, if approved, SURFAXIN LS, in countries where regulatory marketing authorization is facilitated by the recent approval of SURFAXIN by the FDA.  If we determine to distribute AFECTAIR devices in markets outside the U.S., we may enter into distributor arrangements in various countries.

If we succeed in entering into one or more strategic alliances or distributor, co-marketing or other collaboration arrangements,, our ability to execute our operating plan will depend upon numerous factors, including the performance of the strategic partners and collaborators with whom we may engage.  Under these arrangements, our partners may control key decisions relating to the development and, if approved,, commercialization, of our products.  Such partner rights of our partners would limit our flexibility in considering development strategies and in commercializing our products.  In addition, if we breach or terminate our agreements or if our strategic partners or collaborators otherwise fail to conduct their activities in a timely manner, or if there is a dispute about our respective obligations, we may need to seek other partners or collaborators or, in the alternative and after a potentially unacceptable delay, develop our own internal sales and marketing capabilities to develop and commercialize our products in markets outside the U.S.  If we fail to successfully develop these relationships, or if we or our partners or collaborators 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 our products.
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For example, our collaboration arrangement with Laboratorios del Dr. Esteve, S.A. (Esteve) for SURFAXIN and certain other of our drug product candidates is focused on Andorra, Greece, Italy, Portugal and Spain.Spain (Esteve Territory).  We have limited influence over the decisions made by Esteve or its sublicensees or the resources that they may devote to the marketing and distribution of our KL4 surfactant products in their licensed territory, and Esteve or its sublicensees may not meet their obligations in this regard.  Our marketing and distribution arrangement with Esteve may not be successful, and, as a result, we may not receive any revenues from it.  In addition, we may not be able to enter into marketing and sales agreements for our KL4 surfactant pipeline products on acceptable terms, if at all, in territories not covered by the Esteve agreement, or for any of our other drug product candidates.  If Esteve or we should fail to conduct our respective collaboration-related activities in a timely manner, or otherwise breach or terminate the agreements that make up our collaboration arrangements, or if a dispute should arise under our collaboration arrangements, such events could impair our ability to commercialize or develop our products forin the Esteve territory in Europe.Territory.  In that event, we may need to seek other partners andand/or collaboration arrangement,arrangements, or we may have to develop our own internal capabilities to market the covered products in the Esteve territory without a collaboration arrangements.Territory.

Our plan to use strategic alliances and collaboration arrangements to leverage our capabilities may not be successful if we are unable to integrate our partners’ capabilities with our own or if our partners’ capabilities do not meet our expectations.

As part of our strategy, we intend to continue to evaluate opportunities for strategic partnership opportunitiesalliances and collaboration arrangements.  In order forFor these efforts to be successful, we must first identify partners whose capabilities complement and integrate well with ours.  TechnologiesAmong other things, technologies to which we gain access may prove ineffective or unsafe.  Ownership of these technologies may be disputed.  The agreements that grant us access to such technologies may expire and may not be renewable or could be terminated if our partners or we do not meet our respective obligations.  In addition, our partners may provide certain services for us, such as product development support or distribution services.  These agreements may be subject to differing interpretations and we and our partners may not agree on the appropriate interpretation or specific requirements.  Among other things, our partners may prove difficult to work with, less effective than we originally expected or unable to satisfy their financial and other commitments to us.  Failure of our partners to perform as needed could place us at a competitive disadvantage.

If one of our strategic partners or collaborators pursues a product that competes with our products, there could be a conflict of interest and we may not receive expected revenues or milestone or royalty payments.

Certain of our potential strategic partners and collaborators may be developing or marketing a variety of products, some with other partners.  Partners or collaborators with whom we enter into distribution agreements may sell and market products that compete with ours, or they may seek to develop, market or sell existing or alternative products or technologies or products targeted at the same diseases or conditions as the products that are the subject of an arrangement with us.  Our strategic partners and collaborators may also develop products that are similar to or compete with products they are developing in collaboration with us.  If these entities pursue other products instead of our products, we may not receive the anticipated revenues or milestone or royalty payments, or our efforts to distribute our products may be adversely affected.
Ifaffected, and it is likely that we would have no recourse against our business development activities are unsuccessful, our business could suffer and our financial performance could be adversely affected.partners or collaborators.

As partWe plan to consider strategic alliances or collaboration agreements to potentially provide for the marketing and sale of our long-term growth strategy,products, if approved, including AEROSURF, which expose us to additional risks.

To secure the additional capital that we engage in businessrequire to advance the development activities intended to develop strategic opportunities, including potentialof our product candidates, we seek one or more strategic alliances, joint development opportunities, acquisitions, technology licensingdistribution or collaboration arrangements and other similar opportunities.  Such opportunitiesthat could support the commercialization of AEROSURF, if approved.  The terms of any such arrangements may result in substantial investments.  Our success in developingnot be favorable to us.

If we enter into alliances, distribution or collaboration arrangements to commercialize our products, or expanding into new markets from such activitiesarrangements will depend onsubject us to a number of factors, including our ability to find suitable opportunities for investment, alliance or acquisition; whether we are able to complete an investment, alliance or acquisition on terms that are satisfactory to us; the strength of our underlying technology, products and our ability to execute our business strategies; any intellectual property and litigation related to these products or technology; and our ability to successfully execute the investment, alliance or acquisition into our existing operations, including to fund our share of any in-process research and development projects.  If we are unsuccessful in our business development activities, we may be unable to meet our financial targets and our financial performance could be adversely affected.risks, including:

We
our alliance partners, distributors or collaborators may have difficulty managing our growth.

We have experienced significant growth in the scope of our operations as we have prepared for the anticipated launch of our products in the U.S., and thereafter, through strategic partnerships or distributorships, in the EU and in selected markets outside the U.S.  As this potential growth occurs, it has and will continue to place additional significant demands on our management and our financial and operational resources, and will require that we continuetransfer to develop and improve our operational, financial and other internal controls.  We also are engaged in discussions with potential strategic partners, which, if successful, will require additional management resources and controls to implement and potentially add a layer of complexitythem important rights to our operations.  We plan at various stages of development to distribute our products in the U.S. and potentially the EU and potentially other major markets, through potential strategic alliances and collaboration arrangements.  This expansion could further increase the challenges involved in implementing appropriate operational and financial systems, expanding manufacturing and production capacity, expanding our marketing and sales infrastructure and capabilities, and providing adequate training and supervision to maintain high quality standards.  We believe that the significant challenges associated with our potential growth will include our ability to recruit, train and integrate skilled marketing, sales, medical affairs, supply chain, administrative and management personnel; to establish and effectively manage strategic partnerships and collaboration arrangements to support our development and commercialization activities; and to provide for manufacturing, including analytical testing and distribution capabilities, for our products, and clinical capabilities for our products under development.  Our inability to grow our business effectively and appropriately and/or otherwise adapt to growth would cause our business, financial condition and results of operations to suffer.product candidates;

We are continually evaluating our business strategy and may modify this strategy in light of developments in our business and other factors.

As we proceed with our plans to commercialize SURFAXIN in markets both inside and potentially outside the U.S., we will continually evaluate our commercial strategy and will modify our plans as necessary to achieve our objectives.  The activities associated with introduction of a new product are complex, involve many persons and entities, including third parties that we may not be able to control the amount and requiretiming of resources that our distributors or collaborators devote to the coordination of a number of elements, any one of which could involve unforeseen events or circumstances that require adjustment or the development of alternative strategies.  If we encounter such events or circumstances, we will change our strategy and plans if we believe that such a change will be in our best interest.  For example, if we experience any significant delay in our efforts to commercialize our products, we may adjust our approach to take into account any potential impact such a delay may have on our cash resources and our ability to fund our activities, or, if we were to determine that an alternative approach or structure would allow us to maintain controlcommercialization of our products or improve the profitability of our products in one or more markets, we will consider adopting such other approaches, including increasing our investment in internal capabilities.  Similarly, if a potential partner or collaborator were to make observations or recommendations concerning the focus, sequence or approach of any or all of our research and development programs, we may consider taking such observations or recommendations into account in our planning process and activities.  There can be no assurance, whether or not we alter our strategy or plans for any reason, that we will be successful, or that our product launches will be effectively executed on time, if at all, in all markets that we may identify.products;
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Our ability
if our alliance partners, distributors or collaborators fail to discoverperform their obligations under our distribution or commercialization arrangements to our satisfaction, we may not achieve our goals within the desired time, if at all, and develop new products depends on our internal research capabilitiesprojected sales and our abilityrevenues would suffer.  We also may incur additional expense to acquire products.  Although we continueterminate such arrangements and to conduct research and development activities on products, our limited resources may not be sufficient to discover and develop new product candidates.  To assist us with the development of our products and, if approved, commercialization of our products in markets outside the U.S., we continue to evaluate potential strategic partnership and collaboration arrangements.  However, there can be no assurance that our efforts will be successful or that, even if we identify and enter into arrangements with replacement distributors or collaborators;
our alliance partners, distributors or collaborators may experience financial difficulties; and
business combinations or significant changes in a collaborator’s business strategy may adversely affect a collaborator’s willingness or ability to perform its obligations under any arrangement, which would adversely affect our business.

If we fail to enter into arrangements with third parties in a timely manner or if such strategic partnershipparties fail to perform, it could adversely affect our activities.  We and our third-party alliance partners, distributors and collaborators must also perform our respective activities in compliance with applicable federal, state and local or foreign laws.

In addition, if we establish alliance, distribution or collaboration arrangement, that such transactionsarrangements for the commercialization of our approved products, our third-party collaborators and we also market our products in compliance with federal, state and local laws relating to the restrictions on incentives and inducements.  Violation of these laws can result in substantial penalties.  If we are unable to successfully motivate our sales force, or if our distributors fail to promote our products, we will be successfully implemented, if at all, withinhave difficulty maintaining and increasing the sales of our expected time frames.products.

We continueplan to evaluaterely on third parties to manufacture our business strategylyophilized KL4 surfactant and as a result,medical devices, which exposes us to risks that may modifyaffect our strategy in the future.  With respectability to maintain supplies of our clinical materials and ADSs and could potentially delay our research and development activities, to respond to changing circumstances, we may, from time to time, refocusregulatory approval and commercialization of our drug product development efforts on different products or may pace, delay or halt the development of various products.  As a result of changes in our strategy, we may also change or refocus our existing drug discovery, development, commercialization and manufacturing activities.  This could require changes in our facilities and personnel and restructuring various financial arrangements.  There can be no assurances that any product development or other changes that we implement will be successful or that, after implementation of any such changes, that we will not refocus our efforts on new or different objectives.candidates.

Our existingmanufacturing strategy includes manufacturing our lyophilized KL4 surfactant and our ADS for AEROSURF, using third-party contract manufacturing organizations (CMOs).  Technology transfers of our manufacturing process and our planned future debt obligationsreliance on CMOs exposes us, among other things, to the following risks:

we may be unable to identify manufacturers with whom we might establish appropriate arrangements on acceptable terms, if at all, because the number of potential CMOs is limited and, after a product candidate is approved, the FDA must approve any transfer to a CMO.  This approval could impairrequire one or more pre-approval inspections as well as a potentially lengthy qualification process.  In addition, a new manufacturer would have to be educated in, or develop substantially equivalent processes for, production of our liquidityapproved products after receipt of FDA approval. To qualify and financial condition,receive regulatory approval for a new manufacturer could take as long as 2 years;
we may implement a plan to execute a technology transfer of our manufacturing process to a CMO and, after investing significant time and resources, learn that the CMO we chose is unable to successfully complete the technology transfer and thereafter manufacture our products in accordance with our plan;
CMOs might be unable to manufacture our products in the event we are unablevolume and to our specifications to meet our debt obligations,commercial and clinical needs, or we may have difficulty scheduling the lenders could foreclose onproduction of drug product and devices in a timely manner to meet our assets.timing requirements;

In connection with a facility agreement entered into on February 13, 2013, Deerfield advanced the Deerfield Loan to us, consisting of $30 million principal amount.  Our debt obligations:

could impairCMOs may not perform as agreed, or may not remain in the CMO business for a lengthy time, or may refuse to renew an expiring agreement as expected, or may fail timely to produce a sufficient supply to meet our liquidity;commercial and/or clinical needs;
could make it more difficult for us
CMOs are subject to satisfy our other obligations;
require usongoing periodic unannounced inspection by the FDA, international health authorities, registered Notified Body(ies), the Drug Enforcement Administration, and/or corresponding state agencies to dedicate cash flow to payments on our debt obligations, which would reduce the availability of our cash flow to fund working capital, capital expendituresensure strict compliance with cGMP and/or QSR and other corporate requirements;government regulations and corresponding foreign standards.  Although we do not have control over the day-to-day operations of any CMO we may use, we are responsible for ensuring compliance with these regulations and standards;
impose restrictions on
if we desire to make our drug products and/or devices available outside the U.S. for clinical or commercial purposes, our CMOs would become subject to, and may not be able to comply with, corresponding manufacturing and quality system regulations of the various foreign regulators having jurisdiction over our activities abroad.  Such failures could restrict our ability to incur other indebtedness, grant liens on our assets, other than permitted indebtedness and permitted liens, and could impede us from obtaining additional financing in the future for working capital, capital expenditures, acquisitions and general corporate purposes;
impose restrictions on us with respect to the use of our available cash, including in connection with future acquisitions;
could adversely affect our ability to enter into strategic transactions and similar agreements, or require us to obtain the consent of our lenders;
make us more vulnerable in the event of a downturn inexecute our business prospects and could limit our flexibility to plan for, or react to, changes in our licensing markets; andstrategies;
could place us at a competitive disadvantage when compared to our competitors who are not similarly restricted.

We have pledged substantially all of our assets to secure our obligations under the Deerfield Loan. In the event that we were to fail in the future to make any required payment under the Deerfield Loan or fail to comply with the covenants contained in the facility agreement and other related agreements, we would be in default regarding that indebtedness. A debt default would enable the lenders to foreclose on the assets securing such debt and could significantly diminish the market value and marketability of our common stock and could result in the acceleration of the payment obligations under all or a portion of our consolidated indebtedness.
Our activities are subject
if any third-party manufacturer makes improvements in the manufacturing process for our products, we may not have rights to, variousor may have to share, the intellectual property rights to any such innovation.  Such an event could limit our ability to conduct technology transfers to alternate and complex lawssuccessor manufacturers.  We may be required to pay fees or other costs for access to such improvements; and regulations, and
we are susceptiblemay have difficulty implementing changes or modifications to a changing regulatory environment.  Any failureour manufacturing processes that may be required by the FDA or foreign regulator, if, for example, such changes would burden our CMO or otherwise disrupt operations, or our CMO could impose significant financial terms to complyimplement any such change that could adversely affect our business, financial condition and results of operations.

Our products andbusiness.  Failure to achieve such required changes or modifications could delay or prevent our operations are regulated by numerous government agencies, both inside and outside the U.S.  Our druggaining regulatory approval for our product candidates, and medical devices must undergo lengthy and rigorous testing and other extensive, costly and time-consuming procedures mandated by the FDA and foreign regulatory authorities.  Our facilities and those of our third-party providers must be approved and licensed prioror prevent us from continuing to production and remain subject to inspection at any time thereafter.  Failure to comply with the requirements of the FDA or other regulatory authorities, including a failed inspection or a failure in our post-marketing reporting, could result in warning letters, product recalls or seizures, monetary sanctions, injunctions to halt the manufacture and distribution of our products, civil or criminal sanctions, refusal of a government to grant approvals or licenses, restrictions on operations or withdrawal of existing approvals and licenses.  Any of these actions could damage our reputation and have a material adverse effect on our sales.  In addition, requirements of the FDA and other regulatory authorities may change and implementing any additional compliance requirements may increase our costs, or force us or our third-party providers to suspend production, which could result in a shortage ofmarket our approved product or delays in the commercial introduction of our new product candidates, if approved.

With the commercial launch of SURFAXIN, AFECTAIR and, if approved, AEROSURF, we are and will be required to comply with not only the requirements of the FDA and potentially international regulators, but will also become subject to various federal, state and international laws regulating the sales, marketing, and distribution of healthcare-related products.  These laws govern such activities as our relationships with healthcare providers, the promotion of our products, and pricing of prescription drug products and medical devices.  The sales and marketing of products and relationships that pharmaceutical and medical device companies have with healthcare providers are under increasing scrutiny by federal, state and foreign government agencies.  The FDA and other federal regulators have increased their enforcement activities with respect to the Anti-Kickback Statute, False Claims Act, off-label promotion of products, and other healthcare related laws, antitrust and other competition laws.  The Department of Justice (DOJ) also has increased its focus on the enforcement of the U.S. Foreign Corrupt Practices Act (FCPA), particularly as it relates to the conduct of pharmaceutical companies.  Foreign governments have also increased their scrutiny of pharmaceutical companies’ sales and marketing activities and relationships with healthcare providers.

Of particular importance, federal and state anti-kickback laws make it illegal for a prescription drug manufacturer to solicit, offer, receive, or pay any remuneration in exchange for, or to induce, the referral of business, including the purchase or prescription of a particular drug. These laws can be complicated, are subject to frequent change and may be violated unknowingly.  In addition, the absence of guidance for some of these laws and the very few court decisions addressing industry practices increase the likelihood that our practices could be challenged under anti-kickback or similar laws.  False claims laws prohibit anyone from knowingly and willingly presenting, or causing to be presented, for payment to the government (including Medicare and Medicaid) claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed, or claims for medically unnecessary items or services.  In addition, a number of states require that companies implement compliance programs or comply with industry ethics codes, adopt spending limits, and report to state governments any gifts, compensation, and other remuneration provided to physicians.  Many pharmaceutical, device, and other health care companies have been investigated and prosecuted for alleged violations of these laws.  Sanctions under these laws may include civil monetary penalties, exclusion of a manufacturer's products from reimbursement under government programs (including Medicare and Medicaid), criminal fines, and imprisonment.  Companies that have chosen to settle these alleged violations have typically paid multi-million dollar fines to the government and agreed to abide by corporate integrity agreements, which often include significant and costly burdens.  Under the federal False Claims Act and related state laws, private individuals may bring similar actions.  In addition, an increasing number of state laws require manufacturers to report to the state certain pricing and marketing information. Many of these laws contain ambiguities as to what is required to comply with the laws.  Given the lack of clarity in laws and their implementation, our reporting actions could be subject to the penalty provisions of the state authorities.
We are continually evaluating our comprehensive compliance program, including policies, training and various forms of monitoring, designed to address the sales-and-marketing-related risks set forth above.  However, no compliance program can mitigate risk in its entirety.  Violations or allegations of violations of these laws may result in large civil and criminal penalties, debarment from participating in government programs, diversion of management time, attention and resources and may otherwisewould have a material adverse effect on our business, financial condition and results of operations.

The regulatory approval process for our products is expensive and time-consuming and the outcome is uncertain.  We may not obtain required regulatory approvals to commercialize our products.

To test, make and sell our products under development, we must receive regulatory approvals for each product.  The FDA and foreign regulators, such as the European Medicines Agency (EMA), extensively and rigorously regulate the testing, manufacture, distribution, advertising, pricing and marketing of drug products.  This approval process includes (i) preclinical studies and clinical trials of each drug product candidate and active pharmaceutical ingredient to establish its safety and effectiveness, and (ii) confirmation by the FDA and foreign regulators that we maintain good laboratory and manufacturing practices during testing and manufacturing.  Even if favorable data are generated by clinical trials, the FDA or foreign regulator may not accept or approve an NDA or Market Authorization Application (MAA) filed for a drug product on a timely basis or at all.  See, “Item 1 – Business – Government Regulation.”

We are currently conducting a phase 2a clinical program for AEROSURF.  There can be no assurance that issues requiring protracted and time-consuming preclinical studies will not arise or that our clinical program trials will be concluded successfully.  There can be no assurance that we will be successful in gaining regulatory approval for AEROSURF or, if we determine that there is a feasible development plan that can be accomplished with an acceptable investment and within an acceptable time, SURFAXIN LS, if at all.

We plan to pursue clinical development in the U.S. and potentially in the EU and other markets, and, if approved, market and sell our products in the U.S. and potentially in the EU and other major markets.  To accomplish this objective, we must obtain and maintain regulatory approvals and comply with regulatory requirements in each jurisdiction.  To avoid the significant expense and lengthy time required to complete multiple clinical programs, we expect to meet with relevant regulatory authorities with the goal of designing a single, global clinical program.  There can be no assurance that our efforts will be successful.  If we are unable to reach agreement with the various regulatory authorities, we may not be able to pursue regulatory approval of our products in all of our selected markets.
The approval procedures vary among countries in complexity and timing.  We may not obtain approvals from regulatory authorities outside the U.S. on a timely basis, if at all, which would preclude us from commercializing products in those markets.  In addition, some countries, particularly the countriesEach of the EU, regulate the pricing of prescription pharmaceuticals.  In these countries, pricing discussions with governmental authorities can take considerable time after the receipt of marketing approval for a product.  To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of their product candidate to other available therapies.  Such trials may be time-consumingforegoing risks and expensive, and may not show an advantage in efficacy forothers could delay our products.  If reimbursement of our products is unavailable or limited in scope or amount, or if pricing is set at unsatisfactory levels, in either the U.S. or the EU, we could be adversely affected.

Even though some of our product candidates have qualified for expedited review, the FDA may not approve them at all or any sooner than other product candidates that do not qualify for expedited review.

The FDA has notified us that two indications of our KL4 surfactant technology pipeline, BPD in premature infants and ARDS in adults, have been granted designation as “Fast Track” products under provisions of the Food and Drug Administration Modernization Act of 1997.  We believe that other potential products in our KL4 surfactant technology pipeline may also qualify for Fast Track designation.  Fast Track designation does not accelerate clinical trials nor does it mean that the regulatory requirements are less stringent.  Our products may cease to qualify for expedited reviewcommercial manufacturing plans and our other product candidates may fail to qualify for Fast Track designation or expedited review.  Moreover, even if we are successful in gaining Fast Track designation, other factors could result in significant delays in our development activities with respect to our Fast Track products.

Even if we succeed in gaining regulatory approval to market our drugs, if the FDA and foreign regulators later withdraw their approval or otherwise restrict marketing, our business would be materially harmed.

The FDA has approved SURFAXIN for marketing in the U.S.  Our development program for AEROSURF is in phase 2 clinical trials.  We currently are planning to seek regulatory advice from the FDA to determine if we could gain marketing authorization for SURFAXIN LS, a lyophilized dosage form of SURFAXIN, under a development plan that would be both capital efficient and capable of implementation within a reasonable time.  If feasible, we would likely seek to implement such a development plan.  Foreign regulators have not yet approved SURFAXIN or any of our KL4 surfactant products under development.  Without regulatory approval, we will not be able to market these products.  Even if we were to succeed in gaining regulatory approvals for any of our products, the FDA or a foreign regulator could at any time withdraw any approvals granted if there is a later discovery of previously unidentified problems or if we fail to comply with other applicable regulatory requirements at any stage in the regulatory process, or the FDA or a foreign regulator may restrict or delay our marketing of a product, including by requiring us to include warnings and other restrictions in the package inserts for our products, or force us to make product recalls.  In addition, the FDA could impose other sanctions such as fines, injunctions, civil penalties or criminal prosecutions.  Any withdrawal of our regulatory approval or significant restriction onprograms, limit our ability to marketmaintain continuity of supply for our approved products, afterdelay or impair the approval, would have a material adverse effect on our business.
Our research and development programs, including for AEROSURF, involve significant risks and uncertainties that are inherent in the clinical development and regulatory approval processes.

Development risk factors include, but are not limited to, whether we, or our third-party collaborators, contract research organizations (CROs), drug substances and materials suppliers and CMOs, will be able to:

competently execute and complete our preclinical and clinical trials of our KL4 surfactant product candidates with scientific results that are sufficient to support further development and regulatory approval;
receive the necessary regulatory approvals;
obtain adequate supplies of the active pharmaceutical ingredients, manufactured to our specifications and on commercially reasonable terms;
perform under agreements to supply drug substances, medical devices and related components and related services necessary to manufacture our KL4 surfactant product candidates;
provide for sufficient manufacturing capabilities, at our manufacturing operations in Totowa and with CMOs, to produce sufficient drug product, including for KL4 surfactant-related studies, AEROSURF and SURFAXIN LS development activities, and CAG devices and related materials to meet our preclinical and clinical development requirements; and
obtain the capital necessary to fund our research and development efforts, including our business administration, preclinical and clinical organizations, and our quality and manufacturing operations.

Because these factors, many of which are outside our control, could have a potentially significant impact on our development activities, the success, timing of completion and ultimate cost of development ofif any, of our product candidates is highly uncertain and cannot be estimated with any degreeby the FDA, or result in higher costs or deprive us of certainty.  The timing and cost to complete drug trials alone may be impacted by, among other things:

slow patient enrollment;
long treatment time required to demonstrate effectiveness;
lack of sufficient clinical supplies and material;
adverse medical events or side effects in treated patients;
lack of compatibility with complementary technologies;
failure of a drugpotential product candidate to demonstrate effectiveness; and
lack of sufficient funds.

If we do not successfully complete clinical trials, we will not receive regulatory approval to market our KL4 surfactant pipeline products.  Failure to obtain and maintain regulatory approval and generate revenues from the sale of our products would have a material adverse effect on our financial condition and results of operations and likely reduce the market value of our common stock.
Failure to complete the development of our CAG device and related componentry in a timely manner, if at all, would have a material adverse effect on our efforts to develop AEROSURF or our other aerosolized KL4 surfactant products, and our business strategy.

We have recently completed development of a clinic-ready CAG device that is suitable for use in our ongoing phase 2 clinical trial and currently are working to further develop our CAG device for use in our planned phase 3 clinical trial and potentially for commercial use.  Our development activities are subject to certain risks and uncertainties, including, without limitation:

We may not successfully develop a CAG device that is acceptable for use in a phase 3 program and commercial environment, if at all, on a timely basis and such inability may delay or prevent initiation of our phase 3 clinical trial.
We will require access to sophisticated engineering capabilities.  We have medical device engineering staff and we are currently working with Battelle Memorial Institute (Battelle), which has expertise in medical device development and medical device design and a successful track record in developing aerosolization systems for the medical and pharmaceutical industries.  If for any reason we are unable to retain our own engineering capabilities, the agreement with Battelle is terminated, and we are unable to identify design engineers and medical device experts to support our development efforts, including for a clinic-ready CAG system for use in our planned clinical trials and, potentially, for commercial use and later versions of the CAG systems, it would have a material adverse effect on our business strategy and impair our ability to commercialize or develop AEROSURF or other aerosolized KL4 surfactant products.
We will also require additional capital to advance our development activities and plan to seek a potential strategic partner or third-party collaborator to provide financial support and potentially medical device development and commercialization expertise.  There can be no assurance, however, that we will successfully identify or be able to enter into agreements with such potential partners or collaborators on terms and conditions that are favorable to us.  If we are unable to secure the necessary medical device development expertise to support our development program, this could impair our ability to commercialize or develop AEROSURF or other aerosolized KL4 surfactant products.

The realization of any of the foregoing risks would have a material adverse effect on our business.revenues.

Manufacturing problems potentially could cause us to experience shortages of SURFAXINactive pharmaceutical ingredients, lyophilized KL4 surfactant drug products, medical devices, and AFECTAIR product inventories, or delay our preclinical or clinical programs, which could have a material adverse effect on our business.

The manufacture of pharmaceutical and medical device products requires significant expertise and compliance with strictly enforced federal, state and foreign regulations.  We, our CMOs or our materials and drug substances suppliers may experience manufacturing or quality control and assurance problems that could result in a failure to maintain compliance with current good manufacturing practices (cGMP)cGMP and Quality System Requirements (QSR),QSR requirements, or those of foreign regulators or notified bodies, which is necessary to continue manufacturing of our drug products, materials, drug substances, or drug substances.medical devices.  Other problems that may be encountered include:

the need to make necessary modifications to maintain a qualified and facility;
difficulties with production and yields, including manufacturing and completing all required release testing on a timely basis to meet demand;
quality control and assurance problems related to, among other things, in-process monitoring and controls, and release and stability testing of our drug product, or materials and drug substances;
casualty damage to a facility; and
shortages of qualified personnel.

Such a failure could result in product production and shipment delays or an inability to obtain materials or drug substance supplies.
We currently manufacture our SURFAXIN drug product at our manufacturing  operations in Totowa, NJ (Totowa Facility).  We manufacture our lyophilized KL4 surfactant WARMING CRADLE dry-block heatersproduct candidate and AFECTAIRour ADS and aerosol-conducting airway connectors withconnector using CMOs.  InWe have in the past we have experienced manufacturing or quality control problems and such problems may again occur, at our Totowa Facility or at the facilities of a CMO or a manufacturer of our drug substances and materials suppliers.  Such problems may in the particular circumstance require potentially complex, time-consuming and costly comprehensive investigations to determine the root causes of such problems and may require detailed and time-consuming remediation efforts, which can further delay a return to normal manufacturing and production activities.  Any failure by our own or our CMOs’ manufacturing operations or by the manufacturing operations of any of our CMOs or suppliers to comply with applicable regulatory manufacturing standards, including cGMP or for devices, QSR, requirements or other FDA or similar foreign regulatory requirements could adversely affect our ability to manufacture our drug products,product candidates, which could have a material adverse effect on our ability to manufacture a supplyproduce our product candidates under development or obtain approval of commercial SURFAXIN drugour product or our products under development,candidates, and potentially adversely affect our research activities and our business and financial condition.  Any interruption of our manufacturing at the Totowa Facility could result in a shortage of our commercial drug supply of SURFAXIN.  We currently do not have a back-up facilityfacilities for the Totowa Facility or our CMOs or back-up suppliers of APIsactive pharmaceutical ingredients or excipients and other materials.

A number of factors could cause interruptions, including:

equipment malfunctions or failures;
technology malfunctions;
interruption of material availability;
work stoppages or slowdowns;
damage to or destruction of the facility;
regional power shortages; and
product tampering.

In connection with our drug product manufacturing activities, we own certain specialized manufacturing equipment, employ experienced manufacturing senior executive and managerial personnel, and continue to invest in enhanced quality systems and manufacturing capabilities.systems.  However, we do not have fully-redundant systems and equipment to respond promptly in the event of a significant loss at our or a CMO’s manufacturing operations.  Under certain conditions, we may be unable to produce SURFAXINour drug product and medical devices at the required volumes or to appropriate standards, if at all.  If we are unable to successfully maintain our manufacturing capabilities and at all times comply with cGMP and QSRs, it will adversely affect our effortsdevelopment activities and clinical programs.

For the development and, if approved, commercialization of AEROSURF, we will depend upon third parties to marketmanufacture and sell SURFAXINassemble our ADS.  If we are unable to identify qualified manufacturers and assemblers, the timeline of our plans for the development and, if approved, commercialization of AEROSURF and any other aerosolized KL4 surfactant products, could suffer.

In connection with the development of AEROSURF, which is a combination drug/device product candidate that delivers our aerosolized KL4 surfactant reconstituted from our lyophilized dosage form, we plan to rely on CMOs to manufacture and assemble the ADS and all subcomponents of the ADS to support any preclinical experiments, our ongoing and planned clinical trials and, if approved, commercial device.  The ADS includes an aerosol control unit and a disposable AEROSURF Delivery Pack (ADP).  The ADP includes the critical drug product-contact components that are either cleaned or manufactured in an environmentally-controlled, clean area.  The control unit and ADPs are assembled and packaged in a clean area.  Each ADP is tested for conformance to designated product specifications during assembly and each of the assembled control units must be quality control tested prior to release and monitored for conformance to designated product specifications.

We have worked with Battelle Memorial Institute (Battelle) to develop a clinic-ready ADS to support our phase 2 clinical program and currently are collaborating to develop a phase 3/commercial ADS device.  As with many device development initiatives, there is a risk that, even if we are able to finalize specifications for an adverse effectADS that is suitable for use in a phase 3 clinical trial and, if approved, commercial applications, we may have difficulty identifying manufacturers that are able to consistently manufacture and assemble the subcomponents of our ADS systems to our specified standards.  In addition, we may not be able to identify qualified additional or replacement manufacturers and assemblers to manufacture subcomponents and assemble the ADS and, if developed, later versions of the ADS, or we may not be able to enter into agreements with them on terms and conditions favorable and acceptable to us.  In addition, the manufacturers and assemblers that we identify may be unable to timely comply with FDA, or other foreign regulatory agency, regulatory manufacturing requirements.  If we do not successfully identify and enter into contractual agreements with manufacturers and assemblers that have the required expertise to produce our sales.ADS as and when needed, it will adversely affect our timeline for the development and, if approved, commercialization of our aerosolized KL4 surfactant, including AEROSURF.

If the parties we depend on for supplying our active drug substances, materials and excipients as well as manufacturing-related services do not timely supply these products and services, it may delay or impair our ability to manufacture and market our approved products and execute our development plans for our current and potential pipeline products.  Such delays could adversely impact our operations and financial performance.condition.

We rely on suppliers for our active drug substances, materials and excipients, and third parties for certain manufacturing-related services to manufacture drug product that meets appropriate content, quality and stability standards for commercial drug product use in preclinical programs and clinical trials and, for our approved products, commercial sales.trials.  Our ability to manufacture depends upon receiving adequate supplies and related services, which may be difficult or uneconomical to procure.  Supply chain or manufacturing interruptions could negatively impact our operations and financial performance. The supply of any of our manufacturing materials may be interrupted because of supply shortages, poor vendor performance or other events outside our control, which may require us, among other things, to identify alternate vendors, which could involve a lengthy process, and result in lost sales and increased expenses.
In somemost cases, we are dependent upon a single supplier to provide all of our requirements for one or more of our drug substances, materials and excipients or one or more of our drug product device subcomponents, components and subassemblies.  To assure compliance with cGMP requirements, we have entered into Quality Agreements with all of our suppliers of active drug substances and related materials.  However, we have a requirements contractsupply agreements relating to continued access to active drug substances with only one providertwo of the four providers of our drug substances.  If we do not maintain manufacturing and service relationships that are important to us and are not able to identify a replacement supplier or vendor or develop our own manufacturing capabilities, our ability to obtain regulatory approval for our products could be impaired or delayed and our costs could substantially increase.  Even if we are able to find replacement manufacturers, suppliers and vendors when needed, we may not be able to enter into agreements with them on terms and conditions favorable to us or there could be a substantial delay before such manufacturer, vendor or supplier, or a related new facility is properly qualified and registered with the FDA or other foreign regulatory authorities.  The process of changing a supplier could have an adverse impact on future growth opportunities during the transition period if supplies of drug substances, materials or excipients on hand are insufficient to satisfy demand.  Such delays could have a material adverse effect on our development activities and our business.

A catastrophic event at our Warrington, Pennsylvania facility or at our Totowa Facility or any of the facilities used by our third party-manufacturers would prevent us from producing many of our drug products candidates and/or medical devices.

Our facilities consist of our headquarters in Warrington, Pennsylvania and our Totowa Facility.  We maintain our analytical testing and device development laboratories in Warrington, Pennsylvania.  Our Totowa Facility is specifically designed for the aseptic manufacture and filling of sterile pharmaceuticals in compliance with cGMP and is our only drug manufacturing facility.  While we manufacture our SURFAXIN liquid instillate at our Totowa Facility, we depend upon third-party manufacturers to manufacture WARMING CRADLE dry-block heaters, our lyophilized KL4 surfactant, our AFECTAIR device and our CAG.  All of these products are or will be manufactured at a single facility.  If a catastrophic event occurred at any our facilities or the facilities of any of our third-party manufacturers, such as a fire, flood or tornado, many of those products could not be produced until the manufacturing portion of such facility was restored and cleared by the FDA. With respect to our Totowa Facility, we maintain a disaster plan to minimize the effects of such a catastrophe, and we have obtained insurance to protect against certain business interruption losses.  However, there can be no assurance that any such coverage will be adequate or that such coverage will continue to remain available on acceptable terms, if at all.

For the development and, if approved, commercialization of AEROSURF, we will depend in large measure upon the manufacturers and assemblers of our CAG devices.  If we are unable to identify qualified manufacturers and assemblers, the timeline of our plans for the development and, if approved, commercialization of AEROSURF and any other aerosolized KL4 surfactant products, could suffer.  We are exposed to similar risks with respect to the manufacture of our AFECTAIR devices.

In connection with the development of AEROSURF, which is a combination drug/device product that produces our  aerosolized KL4 surfactant, we plan to rely on CMOs to manufacture and assemble the CAG and all subcomponents of the CAG to support our preclinical experiments, planned clinical trials and, if approved, commercial device.  The CAG device includes an aerosol control unit and a disposable ADP. The ADP includes the critical drug product-contact components that are either cleaned or manufactured in an environmentally-controlled, clean area. The control unit and ADPs are assembled and packaged in a clean area.  Each of the ADP devices is tested for conformance to designated product specifications during assembly and each of the assembled control units must be quality control tested prior to release and monitored for conformance to designated product specifications.
We have worked with Battelle to develop an optimized CAG device to support our phase 2 clinical program.  As with many device development initiatives, there is a risk that, even if we are able to finalize specifications for a  CAG system that is suitable for use in a phase 3 trial and, if approved, commercial applications, we may have difficulty identifying manufacturers that are able to consistently manufacture and assemble the subcomponents of our CAG systems to our specified standards.  In addition, we may not be able to identify qualified additional or replacement manufacturers and assemblers to manufacture subcomponents and assemble our optimized CAG system and, if developed, later versions of our CAG systems, or we may not be able to enter into agreements with them on terms and conditions favorable and acceptable to us.  In addition, the manufacturers and assemblers that we identify may be unable to timely comply with FDA, or other foreign regulatory agency, regulatory manufacturing requirements.  If we do not successfully identify and enter into contractual agreements with manufacturers and assemblers that have the required expertise to produce our CAG devices as and when needed, it will adversely affect our timeline for the development and, if approved, commercialization of our aerosolized KL4 surfactant, including AEROSURF.

We are exposed to similar risks in the manufacture of our AFECTAIR device.  We are reliant on our CMO for, among other things, the manufacture, packaging and labeling of our AFECTAIR device.  These activities must be performed to specifications and in compliance with the regulations of the FDA and foreign regulators.  In the event of any release of defective product, our CMO is obligated to cooperate with us, including for those defects that result in product recalls or other similar events.  If our CMO is unable to manufacture to our specifications, or if our CMO fails to comply with the regulations of the FDA or foreign regulators, it could have a material adverse effect on our development and commercial activities and our financial condition and prospects.

Issues with product quality could have an adverse effect on our business, subject us to regulatory actions and costly litigation and cause a loss of customer confidence in our products or us.

Our success depends upon the quality of our products.  Our future revenues will depend upon our ability to develop, maintain, and continuously improve our quality management system, including an objective and systematic process for monitoring and the evaluation of key process indicators.  Quality and safety issues may occur with respect to any of our products.  We are dependent upon third-party suppliers, manufacturers and service providers to support our development and commercialization activities.  Third-party suppliers are required to comply with our quality standards.  Failure of a third-party supplier to provide compliant raw materials or supplies could result in delays or other quality-related issues.  A quality or safety issue could have an adverse effect on patients receiving our drug products and on our business, financial condition and results of operations and may result in warning letters, product recalls or seizures, monetary sanctions, injunctions to halt manufacture and distribution of products, civil or criminal sanctions, refusal of a government to grant approvals and licenses, restrictions on operations or withdrawal of existing approvals and licenses.  An inability to address a quality or safety issue in an effective and timely manner may also cause negative publicity, a loss of customer confidence in our current or future products or us, which may result in the loss of sales and difficulty in commercializing our products.

Adverse safety events or restrictions on use and safety warnings for our products can negatively affect our business, potential future product sales and stock price.

Adverse safety events involving our products under development and our marketed products may have a negative impact on our business.  Discovery of safety issues with our products could create product liability and could cause additional regulatory scrutiny and requirements for additional labeling, withdrawal of products from the market, and the imposition of fines or criminal penalties.  Adverse safety events may also damage physician and patient confidence in our products and our reputation.  Any of these could result in liabilities, loss of revenue, material write-offs of inventory, material impairments of intangible assets, goodwill and fixed assets, material restructuring charges and other adverse impacts on our results of operations.

Regulatory authorities are making greater amounts of stand-alone safety information directly available to the public through periodic safety update reports, patient registries and other reporting requirements.  The reporting of adverse safety events involving our products or products similar to ours or any public rumors about such events may give rise to claims against us and may also adversely affect our ability to market our products and conduct our clinical development programs.

Medical device product inadequacies could lead to recalls and harm our reputation, business and financial results.

The design, manufacture and marketing of our medical device products involve certain inherent risks.  Our products must be designed, manufactured and marketed to specific product specifications.  Manufacturing or design defects, unanticipated use of our products, or inadequate disclosure of risks relating to the use of our products can lead to injury or other adverse events.  Personal injuries relating to the use of our products can also result in product liability claims being brought against us.  In some circumstances, such adverse events could also cause delays in new product approvals.
We also may be restricted or prohibited from marketing or manufacturing a product, even after obtaining marketing authorization, if previously unknown problems with the product or its manufacture are subsequently discovered and we cannot provide assurance that newly discovered or developed safety issues will not arise following any regulatory clearance.  The FDA and similar foreign governmental authorities have the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture.  In the case of the FDA, the authority to require a mandatory recall must be based on an FDA finding that there is a reasonable probability that the device would cause serious adverse health consequences or death.  In addition, foreign governmental bodies have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture.  Manufacturers may, under their own initiative, initiate a field alert or action, known as a recall, for a product if any material deficiency in a device is found.  A government mandated or voluntary recall by us or our third-party manufacturers or suppliers could occur as a result of component failures, manufacturing errors, design  or labeling defects or other deficiencies and issues.  Recalls of any of our products would divert managerial and financial resources and have an adverse effect on our financial condition and results of operations.  The FDA requires that certain classifications of recalls be reported to the FDA within 10 working days after the recall is initiated.  We are required to maintain certain records of recalls, even if they are not reportable to the FDA.  We may initiate voluntary recalls involving our products in the future that we determine do not require notification to the FDA.  If the FDA disagrees with our determinations, they could require us to report those actions as recalls.  A future recall announcement could harm our reputation with customers and negatively affect our sales.  In addition, the FDA could take enforcement action for failing to report the recalls when they were conducted.

Under the FDA medical device reporting regulation, medical device manufacturers are required to report to the FDA information that a device has or may have caused or contributed to a death or serious injury or has malfunctioned in a way that may cause or contribute to death or serious injury if the malfunction of the device or one of our similar devices were to recur.  If we fail to report these events to the FDA within the required timeframes, or at all, the FDA could take enforcement action against us.  Any such adverse event involving our products also could result in future voluntary corrective actions, such as recalls or customer notifications, or agency action, such as inspection or enforcement action.  Any corrective action, whether voluntary or involuntary, as well as defending ourselves in a lawsuit, will require the dedication of our time and capital, distract management from operating our business, and may harm our reputation and financial results.

Marketing authorizationIf our business development activities are unsuccessful, our business could suffer and our financial performance could be adversely affected.

As part of our long-term growth strategy, we engage in business development activities intended to promote, manufacture and/identify strategic opportunities, including potential strategic alliances, joint development opportunities, acquisitions, technology licensing arrangements and other similar opportunities.  Such opportunities may result in substantial investments in our business.  Our success in developing products or sellexpanding into new markets from such activities will depend on a number of factors, including our ability to find suitable opportunities for investment, alliance or acquisition; whether we are able to complete an investment, alliance or acquisition on terms that are satisfactory to us; the strength of our underlying technology, products and our ability to execute our business strategies; any intellectual property and litigation related to these products or technology; and our ability to successfully execute the investment, alliance or acquisition into our existing operations, including to fund our share of any in-process research and development projects.  If we are unsuccessful in our business development activities, we may be unable to secure needed capital and expertise to support our development programs and our financial condition could be adversely affected.
The financial and operational projections that we may make from time to time are subject to inherent risks.

The projections that our management may provide from time to time (including, but not limited to, those relating to the cost or timing of clinical programs, product approval, production and supply dates, commercial launch dates, and other financial or operational matters) reflect numerous assumptions developed by management, including assumptions with respect to our specific as well as general business, economic, market and financial conditions and other matters, all of which are difficult to predict and many of which are beyond our control. Accordingly, there is a risk that the assumptions made in preparing the projections, or the projections themselves, will prove inaccurate. There will be limiteddifferences between actual and projected results, and actual results may be materially different from those contained in the projections. The inclusion of the projections and management’s expectations in (or incorporated by reference in) this Annual Report on Form 10-K should not be regarded as an indication that we or our management or representatives considered or consider the projections to be a reliable prediction of future events, and the projections should not be relied upon as such.

Our existing and future debt obligations could impair our liquidity and financial condition, and if we are unable to meet our debt obligations, the lenders could foreclose on our assets.
In connection with the Deerfield Loan, we have a secured loan from Deerfield, currently in the amount of $25 million, which is secured by a security interest on substantially all of our assets.  The principal amount is payable in two equal installments of $12.5 million in each of February 2018, subject to continuing review.a one-year potential deferral if we have achieved a specified market capitalization, and February 2019.  Our debt obligations:

We have successfully registered
could impair our AFECTAIR deviceliquidity;
could make it more difficult for us to satisfy our other obligations;
require us to dedicate cash flow to payments on our debt obligations, which would reduce the availability of our cash flow to fund working capital, capital expenditures and other corporate requirements;
impose restrictions on our ability to incur other indebtedness, grant liens on our assets, other than permitted indebtedness and permitted liens, and could impede us from obtaining additional financing in the future for working capital, capital expenditures, acquisitions and general corporate purposes;
impose restrictions on us with respect to the use of our available cash, including in connection with future acquisitions;
impose restrictions on us with respect to our ability to license our products in the U.S. This registration doesas well as other markets around the world;
could adversely affect our ability to enter into strategic transactions and similar agreements, or require us to obtain the consent of our lenders;
make us more vulnerable in the event of a downturn in our business prospects and could limit our flexibility to plan for, or react to, changes in our licensing markets; and
could place us at a competitive disadvantage when compared to our competitors who are not include substantial claimssimilarly restricted.

Should we fail in the future to make any required payment under the Deerfield Loan or fail to comply with respectthe covenants contained in the loan agreement and other related agreements, we would be in default regarding that indebtedness.  Since we have pledged substantially all of our assets to potential usesecure our obligations under the Deerfield Loan, a debt default would enable the lenders to foreclose on the assets securing such debt and could significantly diminish the market value and marketability of our common stock and could result in the acceleration of the payment obligations under all or efficacy.  a portion of our consolidated indebtedness.

If we register this productfail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results, which will likely result in significant legal and accounting expense and diversion of management resources, and current and potential stockholders may lose confidence in our financial reporting and the market price of our stock will likely decline.

We are required by the SEC to establish and maintain adequate internal control over financial reporting that provides reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles.  We are likewise required, on a quarterly basis, to evaluate the effectiveness of our internal controls and to disclose any changes and material weaknesses in those internal controls.
Any failure to maintain internal controls could adversely affect our ability to report our financial results on a timely and accurate basis.  If our financial statements are not accurate, investors may not have a complete understanding of our operations.  If we do not file our financial statements on a timely basis as required by the SEC and Nasdaq, we could face severe consequences from those authorities.  In either case, there could result a material adverse effect on our business.  Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.  We can give no assurance that material weaknesses or restatements of financial results will not arise in the European Union (EU), such clearancefuture due to a failure to implement and maintain adequate internal control over financial reporting or circumvention of these controls.  In addition, in the future our controls and procedures may no longer be adequate to prevent or identify irregularities or errors or to facilitate the fair presentation of our consolidated financial statements.  Responding to inquiries from the SEC or Nasdaq, regardless of the outcome, are likely to consume a significant amount of our management resources and cause us to incur significant legal and accounting expense.  Further, many companies that have restated their historical financial statements have experienced a decline in stock price and related stockholder lawsuits.

Our activities are subject to various and complex laws and regulations, and we are susceptible to a changing regulatory environment.  Any failure to comply could adversely affect our business, financial condition and results of operations.

Our products and our operations are regulated by numerous government agencies, both inside and outside the U.S.  Our drug product candidates and medical devices must undergo lengthy and rigorous testing and other extensive, costly and time-consuming procedures mandated by the FDA and foreign regulatory authorities.  Our facilities and those of our third-party providers must pass inspection and/or be approved or licensed prior to production and remain subject to inspection at any time thereafter.  Failure to comply with the requirements of the FDA or other regulatory authorities, including a failed inspection or a failure in our post-marketing reporting, could result in warning or untitled letters, product recalls or seizures, monetary sanctions, injunctions to halt the manufacture and distribution of our products, civil or criminal sanctions, refusal of a government to grant approvals or licenses, restrictions on operations or withdrawal of existing approvals and licenses.  Any of these actions could damage our reputation and have a material adverse effect on our sales.  In addition, requirements of the FDA and other regulatory authorities may change and implementing any additional compliance requirements may increase our costs, or force us or our third-party providers to suspend production, which could result in a shortage of our approved product or delays in the commercial introduction of our new product candidates, if approved.

If AEROSURF is approved for commercial sale, we will be required to comply with not only the requirements of the FDA and potentially international regulators, but will also become subject to limitations onvarious federal, state and international laws regulating the uses for whichsales, marketing, and distribution of healthcare-related products.  These laws govern such activities as our relationships with healthcare providers, the product may be marketedpromotion of our products, and reduce our potential to successfully commercialize the productpricing of prescription drug products and generate revenue from the product.  Similarly, although our label for SURFAXIN contains more information, including data from our pivotal phase 3 clinical trial, theremedical devices.  The sales and marketing of products and relationships that pharmaceutical and medical device companies have with healthcare providers are limitations that affect the manner in which we may marketunder increasing scrutiny by federal, state and sell our SURFAXIN drug product.foreign government agencies.  The FDA and other regulatory agencies actively enforce regulations prohibiting promotion offederal regulators have increased their enforcement activities with respect to the Anti-Kickback Statute, False Claims Act, off-label uses and the promotion of products, and other healthcare related laws, antitrust and other competition laws.  The Department of Justice (DOJ) also has increased its focus on the enforcement of the U.S. Foreign Corrupt Practices Act (FCPA), particularly as it relates to the conduct of pharmaceutical companies.  Foreign governments have also increased their scrutiny of pharmaceutical companies’ sales and marketing activities and relationships with healthcare providers.

Of particular importance, federal and state anti-kickback laws make it illegal for which marketing clearance has not been obtained.  Ifa prescription drug manufacturer to solicit, offer, receive, or pay any remuneration in exchange for, or to induce, the FDA werereferral of business, including the purchase or prescription of a particular drug. These laws can be complicated, are subject to determinefrequent change and may be violated unknowingly.  In addition, the absence of guidance for some of these laws and the very few court decisions addressing industry practices increase the likelihood that our promotional materials, labeling, trainingpractices could be challenged under anti-kickback or other marketingsimilar laws.  False claims laws prohibit anyone from knowingly and willingly presenting, or educational activities constitute promotion of an unapproved use, it could direct uscausing to cease or modify our training or promotional materials or subject usbe presented, for payment to serious regulatory enforcement actions.  It is also possible that other federal, state or foreign enforcement authorities could take action if they consider our training or other promotional materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting falsethe government (including Medicare and Medicaid) claims for reimbursement.  A companyreimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed, or claims for medically unnecessary items or services.  In addition, a number of states require that companies implement compliance programs or comply with industry ethics codes, adopt spending limits, and report to state governments any gifts, compensation, and other remuneration provided to physicians.  Many pharmaceutical, device, and other health care companies have been investigated and prosecuted for alleged violations of these laws.  Sanctions under these laws may include civil monetary penalties, exclusion of a manufacturer’s products from reimbursement under government programs (including Medicare and Medicaid), criminal fines, and imprisonment.  Companies that have chosen to settle these alleged violations have typically paid multi-million dollar fines to the government and agreed to abide by corporate integrity agreements, which often include significant and costly burdens.  Under the federal False Claims Act and related state laws, private individuals may bring similar actions.  In addition, an increasing number of state laws require manufacturers to report to the state certain pricing and marketing information. Many of these laws contain ambiguities as to what is foundrequired to have improperly promoted off-label uses maycomply with the laws.  Given the lack of clarity in laws and their implementation, our reporting actions could be subject to significant liability, including civil and administrative remedies as well as criminal sanctions.  Due to these legal constraints, our marketing and sales efforts will have to focus on the general technical attributes and benefitspenalty provisions of AFECTAIR and any FDA-cleared indications for use.  We have conducted a series of studies, and plan to conduct further studies, evaluating the utility of AFECTAIR in delivering specific inhaled therapies, but there can be no assurance that our efforts will be successful, or even if successful, that we will be able to expand our label to include the additional indications.  For SURFAXIN, our marketing and sales efforts will have to be based on our label, although there is other data and information available that speaks to the benefits of our KLstate authorities.
4 surfactants.43

In addition, for both our AFECTAIR device and SURFAXIN, we will havefailure to comply with reportingdomestic and international privacy and security laws can result in the imposition of significant civil and criminal penalties. The costs of compliance with these laws, including protecting electronically stored information from cyber attacks, and potential liability associated with failure to do so could adversely affect our business, financial condition and results of operations.  We are subject to various domestic and international privacy and security regulations, including but not limited to the Health Insurance Portability and Accountability Act of 1996, as amended by the Health Information Technology for Economic and Clinical Health Act of 2009, or collectively, HIPAA. HIPAA mandates, among other things, the adoption of uniform standards for the electronic exchange of information in common healthcare transactions, as well as standards relating to the privacy and security of individually identifiable health information, which require the adoption of administrative, physical and technical safeguards to protect such information.  In addition, many states have enacted comparable laws addressing the privacy and security of health information, some of which are more stringent than HIPAA. We are continually evaluating our compliance programs, including policies, training and various forms of monitoring, designed to address the outlined above.  However, no compliance program can mitigate risk in its entirety.  Violations or allegations of violations of these laws may result in large civil and criminal penalties, debarment from participating in government programs, diversion of management time, attention and resources and may otherwise have a material adverse effect on our business, financial condition and results of operations.

Even though some of our product candidates have Fast Track designation, the FDA may not approve them at all or any sooner than other product candidates that do not have Fast Track designation.

The FDA has notified us that two indications of our KL4 surfactant technology pipeline, BPD in premature infants and ARDS in adults, have been granted designation as “Fast Track” products.  Fast Track designation does not accelerate clinical trials nor does it mean that the regulatory requirements applicableare less stringent.  Instead, Fast Track designation provides opportunities for frequent interactions with FDA review staff, as well as eligibility for priority review, if relevant criteria are met, and rolling review.  We believe that other potential products in our KL4 surfactant technology pipeline may also qualify for Fast Track or other designations, including potentially breakthrough therapy, accelerated approval and priority review.  These designations and programs are intended to facilitate and expedite development and review of an NDA to address unmet medical devicesneeds in the treatment of serious or life-threatening conditions.  Our product candidates may cease to qualify for Fast Track designation and our other product candidates may fail to qualify for any such designation or program.  Moreover, even if we are successful in gaining a designation that is intended to facilitate or expedite development or review of a product candidate, other factors could result in significant delays in our development activities with respect to our Fast Track products.

We may not be able to obtain or maintain orphan drug products,exclusivity for our product candidates.

Regulatory authorities in some jurisdictions, including the reportingUnited States and Europe, may designate a drug for relatively small patient populations as Orphan Drugs. Under the Orphan Drug Act, the FDA may designate a product as an Orphan Drug if it is a drug intended to treat a rare disease or condition, which affects a patient population of adverse eventsfewer than 200,000 individuals in the United States.

The FDA has granted Orphan Drug designation for our KL4 surfactant for the treatment of RDS in premature infants.  If we develop AEROSURF for the treatment of RDS, we believe that this Orphan Drug designation is likely to apply, although the FDA may determine that our Orphan Drug designation does not apply to this product candidate.  Then, the only option for obtaining an Orphan Drug designation is to submit a new Orphan Drug designation request, which FDA may not grant.
If a drug that has Orphan Drug designation subsequently receives the first FDA approval for the disease or condition for which it has such designation, the drug is entitled to orphan drug marketing exclusivity for a period of seven years.  Orphan Drug marketing exclusivity generally prevents the FDA from approving an NDA to market a drug containing the same active moiety for the same indication for seven years, except in limited circumstances, including if the FDA concludes that the later drug is clinically superior to the approved drug.  A drug is clinically superior if it is safer, more effective or makes a major contribution to patient care.  Orphan Drug exclusivity may be lost if the FDA determines that the request for designation was materially defective or if the manufacturer is unable to assure sufficient quantity of the drug to meet the needs of patients with the rare disease or condition.

Even if we succeed in gaining regulatory approval to market our drugs, if the FDA and device malfunctions relatedforeign regulators later withdraw their approval or otherwise restrict marketing, our business would be materially harmed.

Our development program for AEROSURF is in phase 2 clinical trials.  Without regulatory approval, we would not be able to market these products in those markets.  Even if we were to succeed in gaining regulatory approvals for any of our products.  Laterproducts, the FDA or a foreign regulator could at any time withdraw any approvals granted if there is a later discovery of previously unknownunidentified problems or if we fail to comply with other applicable regulatory requirements at any stage in the regulatory process, or the FDA or a foreign regulator may restrict or delay our marketing of a product, including unanticipatedby requiring us to include warnings and other restrictions in the package inserts for our products, or force us to make product recalls.  In addition, the FDA could impose other sanctions such as fines, injunctions, civil penalties or criminal prosecutions.  Any withdrawal of our regulatory approval or significant restriction on our ability to market our products after approval would have a material adverse events or adverse events of unanticipated severity or frequency, manufacturing problems oreffect on our business.

Our corporate compliance program cannot ensure that we are in compliance with all applicable laws and regulations affecting our activities, including in the jurisdictions in which we may sell our products, if approved, and a failure to comply with regulatory requirements maysuch regulations or prevail in litigation related to noncompliance could harm our business.

Many of our activities, including the research, development, manufacture, sale and marketing of our products, are subject to extensive laws and regulation, including without limitation, health care “fraud and abuse” laws, such as the federal False Claims Act, the federal Anti-Kickback Statute, and other state and federal laws and regulations.  We have developed and implemented a corporate compliance policy and oversight program based upon what we understand to be current industry best practices, but we cannot assure you that this program will protect us from governmental investigations or other actions or lawsuits stemming from a failure to be in compliance with such laws or regulations.  If any such investigations, actions or lawsuits are instituted against us, and if we are not successful in defending or disposing of them without liability, such investigations, actions or lawsuits could result in changesthe imposition of significant fines or other sanctions and could otherwise have a significant impact on our business.

The increasing use of social media platforms presents new risks and challenges.

At the present time, we have not established channels of communication using social media, but we are nevertheless exposed to labeling,risks that derive from the use of social media by others.  Social media is increasingly being used to communicate about drug products and related diseases.  Social media practices in the biopharmaceutical industry continue to evolve and regulations relating to such use are not always clear or responsive to the changing technological environment.  This evolution creates uncertainty and risk of noncompliance with regulations applicable to our business.  For example, patients may use social media channels to comment on the effectiveness of a product or to report an alleged adverse event.  When such disclosures occur, there is a risk that we fail to monitor and comply with applicable adverse event reporting obligations or we may not be able to defend ourselves or the public’s legitimate interests in the face of political or market pressures generated by social media due to restrictions on such productswhat we may say about our products.  There is also a risk of inappropriate disclosure of sensitive information or manufacturing processes, withdrawalnegative or inaccurate posts or comments about us on any social networking website.  If any of the products from the marketthese events were to occur or we otherwise fail to comply with applicable regulations, we could incur liability, face overly restrictive regulatory enforcement actions.actions or incur other harm to our business.

Failure in our information technology systems could disrupt our operations and cause the loss of confidential information, customers and business opportunities.

AsFor our development programs, operations and administration, we prepare for the commercialization of our first approved products, we will need extensive information technology (IT) systems in virtually all aspects of our business, including billing, customer service, logistics and management of clinical trial and medical data management.business.  In selecting the appropriate software packages and systems to manage and support our activities, we will consider both in-house development and specialty software and system packages offered by third party vendors, service providers and consultants.  The systems we select may not be adequate to meet our needs or may fail to perform to the specified requirements.  We may be required to seek other sources of system support, which would increase our costs and potentially delay our implementation of necessary activities.  There can be no assurance that the systems that we selected or may select or choose to develop, will be adequate to our needs, that they will perform to our requirements or that we will be successful in integrating them into our operations.

In addition, our technology systems are potentially vulnerable to breakdown or other interruption by fire, power loss, system malfunction, unauthorized access and other events.  Our success will depend, in part, on the continued and uninterrupted performance of our IT systems.  IT systems may be vulnerable to damage, disruptions and shutdown from a variety of sources, including telecommunications or network failures, human acts and natural disasters.  They also may be subject to physical or electronic intrusions, computer viruses, unauthorized tampering and similar disruptive problems.  Likewise, data privacy breaches by employees and others with permitted access to our systems may pose a risk that sensitive data may be exposed to unauthorized persons or to the public.  Along withFor all of our new systems, we plan to take precautionary measures to prevent unanticipated problems.  Nevertheless, we may experience damagesdamage to our systems, system failures and interruptions and unauthorized disclosure of confidential information, and our data could be compromised.

There can be no assurance that our efforts will prevent significant breakdowns, breaches in our systems or other cyber incidents that could have a material adverse effect upon our reputation, business, operations or financial condition of the company.  In addition, there can be no assurancesassurance that a significant implementation issue may not arise as we continue to implement new systems and consolidate or replace existing (legacy) systems.  If we experience systems problems, or if the systems we implement do not meet our expectations, they may interrupt our ability to operate.  If we experience systems problems, or if we experience unauthorized disclosure of confidential information, it could adversely affect our reputation, result in a loss of customers and revenues and cause us to suffer financial damage, including significant costs to alleviate or eliminate the problem.

45The commercial success of our products will depend in large part upon the degree of market acceptance by physicians, patients, and others in the medical community.

Even if AEROSURF is accepted on formulary by our target hospitals, if our products do not achieve broad market acceptance by physicians, respiratory therapists, nurses and other personnel in neonatal and pediatric intensive care units (NICUs and PICUs) and elsewhere in the hospital, as well as patients and others in the medical community in general, or if we are placed in a “second line” position compared to our competition, we may not generate sufficient revenues, either directly, or indirectly through alliance or collaboration agreements, to support continued commercialization of these and our other products, if approved for commercial sale.  The degree of market acceptance of our approved products will depend on a number of factors, including:

the willingness of physicians and hospitals to utilize our products and the willingness of hospitals’ Pharmacy and Therapeutics (P&T) Committees to place our products on formulary or on the list of medical devices the hospital will purchase;
the safety and efficacy of our products, both in fact and as perceived by the medical community, regulatory agencies and insurers and other payers, on both a short and long-term basis;
the potential advantages of our products over alternative treatments;
the relative convenience and ease of use;
the prevalence and severity of any adverse events, including any unexpected adverse events of which we become aware; and
the degree to which the market believes that we are able to manufacture our products and produce supply sufficient to meet market demand.
the perception of the value-added provided by our products compared to the price of our products and the willingness of physicians and hospitals to pay
the willingness  of hospitals in the various markets, including those ex-U.S., to adopt continuous positive airway pressure (nCPAP) as a means of providing non-invasive respiratory support and for the administration of our aerosolized KL4 surfactant
FutureOur post-marketing activities, including promotion, marketing and manufacturing, will be subject to continuing review.

If we receive marketing authorization in the United States for AEROSURF, our approved labeling will contain, among other things, limitations that affect the manner in which we may promote, market and sell our approved product.  Any promotion, marketing and sales and issuancesefforts will have to be based on the content of our common stock or rightslabeling, although certain scientific information that speaks to purchase our common stock, including pursuant to our ATM Program, stock incentive plans and upon the exercise of outstanding securities exercisable for sharesbenefits of our common stock, could resultKL4 surfactant may be provided by our medical affairs representatives in substantial additional dilution of our stockholders, cause our stock priceresponse to fall and adversely affect our ability to raise capital.unsolicited requests for information.

The FDA and other regulatory agencies actively enforce regulations prohibiting promotion of off-label uses and the promotion of products for which marketing clearance has not been obtained.  If the FDA were to determine that promotional materials for our products, including labeling, training or other marketing or educational activities, constitute promotion of an unapproved use, it could issue to us and our alliance partner a warning or untitled letter or direct our alliance partner to cease using or modify training or promotional materials, or subject us or our alliance partner to serious regulatory enforcement actions.  For example, on March 6, 2015, we received an untitled letter from FDA regarding promotional materials alleged to contain unsubstantiated claims of the superiority of SURFAXIN to animal-derived surfactants and broaden the intended use of SURFAXIN by implying that it is approved for the treatment of RDS in premature infants when it is only approved for the prevention of RDS in premature infants.  We will require additional capital to continue to execute our businesspromptly implemented a plan and advance our research and development efforts.  Toresponded to the extentconcerns raised in the letter within the time period set forth therein.  It is also possible that other federal, state or foreign enforcement authorities could take action if they consider that we raise additional capital through the issuanceor our alliance partners have engaged in activities that constitute promotion of additional equity securities and through the exercise of outstanding warrants, our stockholders may experience substantial dilution.  We may sell shares of our common stock in one or more transactions at prices that may be at a discount to the then-current market value of our common stock and on such other terms and conditions as we may determine from time to time.  Any such transaction could result in substantial dilution of our existing stockholders.  If we sell shares of our common stock in more than one transaction, stockholders who purchase our common stock may be materially diluted by subsequent sales.  Such sales could also cause a drop in the market price of our common stock.  The issuance of shares of our common stock under the ATM Program, the issuance of shares upon exercise of outstanding warrants, including those issued to Deerfield in connection with the Deerfield Loan, will have a dilutive impact on our other stockholders and the issuance, or even potential issuance, of such shares could have a negative effect on the market price of our common stock.

If, during the term of certain of our warrants, we declare or make any dividend or other distribution of our assets to holders of shares of our common stock, by way of return of capital or otherwise (including any distribution of cash, stock or other securities, property or options by way of a dividend, spin off, reclassification, corporate rearrangement or other similar transaction), then the exercise price of such warrants may adjust downward and the number of shares of common stock issuable upon exercise of such warrants would increase.  In addition, in February 2011, we issued five-year warrants that contain an anti-dilution provision that, subject to certain exclusions, potentially adjusts the exercise price of these warrants upon the issuance of securities at prices lower than the warrant exercise price.  For the purpose of valuing securities that we may issue in the future in unit offerings, this anti-dilution provision values the warrant portion of a unit offering based on a Black Scholes pricing model.  When such Black Scholes value is subtracted from the actual per-unit price of the offering, per-share value of the shares issued in such unit offering is decreased for the purposes of the anti-dilution provision.  If we issue shares, units, or warrants in a financing that triggers the anti-dilution provision of these warrants, the exercise price of the February 2011 five-year warrants will be lowered thereby, increasing the likelihood that such warrants would be exercised.  As a result of such warrant adjustments, we may be required to issue more shares of common stock, or shares at lower prices, than previously anticipated,unapproved use, which could result in further dilution of our existing stockholders.

We filed a universal shelf registration statement with the SEC on Form S-3 (File No. 333-174786) on June 8, 2011 (which was declared effective shortly thereafter)significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for the proposed offering from time to time of up to $200 million of our securities, including common stock, preferred stock, varying forms of debt and warrant securities, or any combination of the foregoing.  We have issued securities pursuant to this shelf registration statement on several occasions, and may do so again in the future in response to market conditions or other circumstances on terms and conditions that will be determined at such time.  To provide flexibility and support any future transactions we may undertake, in 2014, we plan to replace this registration statement, which expires in June 2014, with a new universal shelf registration statement.
As of March 7, 2014, we had 84,696,919 shares of common stock issued and outstanding.  In addition, as of December 31, 2013, approximately (i) 14.8 million shares of our common stock were reserved for potential issuance upon the exercise of outstanding warrants, (ii) 5.4 million shares of our common stock were reserved for issuance pursuant to our equity incentive plans, and (iii) 166,243 shares of our common stock were reserved for issuance pursuant to our 401(k) Plan.  The exercise of stock options and other securities could cause our stockholders to experience substantial dilution.  Moreover, 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 securitiesreimbursement.  A company that is higher than the exercise price per security of the options or warrants.  Such exercises, or the possibility of such exercises, may impede our effortsfound to obtain additional financing through the sale of additional securities or make such financing more costly.  It may also reduce the price of our common stock.

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;
patient adverse reactions to our 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 U.S. or foreign regulatory policy during the period of product development;
changes in the U.S. or foreign political environment and the passage of laws, including tax, environmental or other laws, affecting the product development business;
developments in patent or other proprietary rights, including any third-party challenges of our intellectual property rights;
announcements of technological innovations by us or our competitors;
announcements of new products or new contracts by us or our competitors;
actual or anticipated variations in our operating results due to the level of development expenses and other factors;
changes in financial estimates by securities analysts and whether our earnings meet or exceed the estimates;
conditions and trends in the pharmaceutical and other industries;
new accounting standards; and
the occurrence of any of the risks described in these “Risk Factors” or elsewhere in this Annual Report on Form 10-K or our other public filings.

Our common stock is listed for quotation on The Nasdaq Capital Market®.  During the 12-month period ended December 31, 2013, the price of our common stock ranged between $1.50 and $3.05.  We expect the price of our common stock to remain volatile.  The average daily trading volume in our common stock varies significantly.  For the twelve month period ended December 31, 2013, the average daily trading volume in our common stock was approximately 549,650 shares, and the average number of transactions per day was approximately 1,502.  The instability observed in our daily volume and number of transactions per day may affect the ability of our stockholders to sell their shares in the public market at prevailing prices.
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.  Even if securities class actions that may be filed against us in the future were ultimately determined to be meritless or unsuccessful, they would involve substantial costs and a diversion of management attention and resources, which could negatively affect our business.

If we fail to adhere to the strict listing requirements of The Nasdaq Capital Market, wehave improperly promoted off-label uses may be subject to delisting.  As a result,significant liability, including civil and administrative remedies as well as criminal sanctions.

We expect to provide our stock priceAFECTAIR device with our AEROSURF drug-device product candidate.  If AEROSURF is approved, the FDA may decline and our common stock may be delisted.  If our stock weredetermine that AFECTAIR is no longer listed on The Nasdaq Capital Market,a Class I, 510(k)-exempt medical device.  During the liquiditydevelopment of our securities likely would be impaired.AEROSURF, we expect to discuss with the FDA the regulatory status of AFECTAIR.

Our common stock currently tradesIn addition, we will have to comply with reporting requirements applicable to drug products and medical devices, including the reporting of adverse events and device malfunctions related to our products.  Later discovery of previously unknown problems, including unanticipated adverse events or adverse events of unanticipated severity or frequency, manufacturing problems or failure to comply with regulatory requirements may result in changes to labeling, restrictions on The Nasdaq Capital Market undersuch products or manufacturing processes, withdrawal of the symbol DSCO.  If we fail to adhere toproducts from the market’s strict listing criteria, our stock may be delisted.  This could potentially 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 the potential reduction in media coverage.  As a result, an investor might find it more difficult to dispose of our common stock.  We believe that current and prospective investors would view an investment in our common stock more favorably if it continues to be listed on The Nasdaq Capital Market.  Any failure at any time to meet the continuing The Nasdaq Capital Market listing requirements could have an adverse impact on the value of and trading activity in our common stock.market or regulatory enforcement actions.

We expect to face uncertainty over reimbursement and healthcare reform.

In both the U.S. and other countries, sales of our products will depend in part upon the availability of reimbursement from third-party payers, which include governmental health administration authorities, managed care providers and private health insurers.  Government and other healthcare payers increasingly challenge the price and examine the cost effectiveness of medical products and services.  Moreover, the current political environment in the U.S. and abroad may result in the passage of significant legislation that could, among other things, restructure the markets in which we operate and restrict pricing strategies of drug development companies.  If, for example, price restrictions were placed on the distribution of our drugs, we may be forced to curtail development of our pipeline products and this could have a material adverse effect on our business, results of operations and financial condition.  Even if we succeed in commercializing our drug products, uncertainties regarding health care policy, legislation and regulation, as well as private market practices, could affect our ability to sell our products in quantities or at prices that will enable us to achieve profitability.

To obtain reimbursement from a third-party payer, it must determine that our drug product is a covered benefit under its health plan, which is likely to require a determination that our product is:

safe, effective and medically necessary;
appropriate for the specific patient;
cost-effective; and
neither experimental nor investigational.

Obtaining a determination that a product is a covered benefit may be a time-consuming and costly process that could require us to provide supporting scientific, clinical and cost-effectiveness data about our products to each payer.  We may not be able to provide sufficient data to gain coverage.  Even when a payer determines that a product is covered, the payer may impose limitations that preclude payment for some uses that are approved by the FDA or other regulatory authorities.  Cost-containment measures, if implemented to affect the coverage or reimbursement of our products could have a material adverse effect on our ability to market our products profitably.  Moreover, coverage does not imply that any product will be covered in all cases or that reimbursement will be available at a rate that would permit a health care provider to cover its costs of using our product.
Prices in many countries, including many in Europe, are subject to local regulation and certain pharmaceutical products may be subject to price controls in several of the world’s principal markets, including many countries within the EU.  In the U.S., where pricing levels for our products are substantially established by third-party payers, if payers reduce the amount of reimbursement for a product, it may cause groups or individuals dispensing the product to discontinue administration of the product, to administer lower doses, to substitute lower cost products or to seek additional price-related concessions.  These actions could have a negative effect on our financial results, particularly in cases where our products command a premium price in the marketplace.  The existence of direct and indirect price controls and pressures over our products could materially adversely affect our financial prospects and performance.

A catastrophic event at our Warrington, Pennsylvania facility or any of the facilities used by our third party-manufacturers would prevent us from producing many of our drug products candidates and/or medical devices.

All of our facilities are located our headquarters in Warrington, Pennsylvania.  We maintain our analytical testing and device development laboratories in Warrington, Pennsylvania.  We depend upon third-party manufacturers to manufacture our lyophilized KL4 surfactant, our AFECTAIR device and our ADS.  All of these products are or will be manufactured at a single source facility.  If a catastrophic event occurred at our headquarters facility or the facilities of any of our third-party manufacturers, such as a fire, flood or tornado, many of those products could not be produced until the manufacturing portion of such facility was restored and cleared by the FDA.  With respect to our headquarters facility, we maintain a disaster plan to minimize the effects of such a catastrophe, and we have obtained insurance to protect against certain business interruption losses.  However, there can be no assurance that any such coverage will be adequate or that such coverage will continue to remain available on acceptable terms, if at all.

The implementation of the 2010 Health Care Reform Law in the U.S. may adversely affect our business.

The Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act, each enacted in March 2010, generally known as the Health Care Reform Law, significantly expands health insurance coverage to uninsured Americans and changes the way health care is financed by both governmental and private payers.  We expect expansion of access to health insurance may increase the demand for our products generally, but other provisions of the Health Care Reform Law could affect us adversely.  We also expect that further federal and state proposals for healthcare reform are likely.  The changes contemplated by the health care reform law are subject to rule-making and implementation timelines that extend for several years, and thisfurther federal and state proposals for healthcare reform are likely.   This uncertainty limits our ability to forecast changes that may occur in the future.  However, any changes that lower reimbursements for our products could adversely affect our business and results of operations.

The Health Care Reform Law includes provisions, referred to as the federal “Open Payments” law (previously referred to as the “Sunshine Law”), that establish new reporting and disclosure requirements for pharmaceutical and medical device manufacturers.  Under the law, pharmaceutical and device manufacturers are required to annually report various types of payments and other transfers of value to physicians and teaching hospitals.  Implementation of the sunshine provisions has been subjectApplicable manufacturers are to delay byreport data to the U.S. Centers for Medicare and Medicaid Services (CMS).  Under the current regime, applicable manufacturers were to begin tracking relevant transfer-of-value data in August 2013, and must report data collected between August 1 on an annual basis, and the end of 2013 todata are made publicly available via a CMS in a two-phased approach by March 31, and May 31, 2014, respectively.  CMS will publish the data on a public website later in the year.website.  Inaccurate or incomplete reports may be subject to enforcement.enforcement, and it is expected that data will be subject to significant public scrutiny.  Like the federal Sunshine Law,Open Payments law, several states have existing laws that require manufacturers to report transfers of value to select healthcare providers licensed within the state, or even go so far as to prohibit certain marketing related activities.  Other states, such as California, Nevada, Massachusetts and Connecticut, require pharmaceutical and/or device companies to implement compliance programs or marketing codes.  In others, it is possible that we will be subject to the state’s reporting requirements and prohibitions.  Compliance activities with respect to these measures could increase our costs and adversely affect business operations.
The Health Care Reform Law contains many provisions designed to generate the revenues necessary to fund the coverage expansions and to reduce costs of Medicare and Medicaid, including imposing a 2.3% excise tax on domestic sales of medical devices by manufacturers and importers beginning in 2013, and a fee on branded prescription drugs that was implemented in 2011, both of which may affect sales of our products.  AsIn December 2015, legislation was enacted that imposed a two-year moratorium on the medical device excise tax, which means that the tax will not apply to sales during the period from January 1, 2016 through December 31, 2017.  However, we cannot predict the effect that subsequent legislation, if any, may have on the length of the moratorium or on the excise tax itself.  At the present time, the effect of this tax on our business is not material.  However, as U.S. net sales are expected to be a significant portion of our worldwide net sales in the coming years, beginning with AEROSURF, this additional tax burden may have a material, negative impact on our results of operations and our cash flows.  The Health Care Reform Law also mandates pharmacy benefit manager transparency regarding rebates, discounts and price concessions with respect to drug benefits under Medicare Part D, and in 2014 with respect to drug benefits offered through qualified health plans offered through state exchanges, which could affect pricing and competition.
Political, economic and regulatory influences are subjecting the healthcare industry to potential fundamental changes that could substantially affect our results of operations.  Government and private sector initiatives to limit the growth of healthcare costs, including price regulation, competitive pricing, coverage and payment policies, comparative effectiveness of therapies, technology assessments and managed-care arrangements, are continuing in many countries where we plan to do business, including the U.S.

The Health Care Reform Law establishes the Independent Payment Advisory Board, which will be responsible, beginning in 2014, annually to submit proposals aimed at reducing Medicare cost growth while preserving quality.  These proposals automatically will be implemented unless Congress enacts alternative proposals that achieve the same savings targets.  Further, the legislation calls for a Center for Medicare and Medicaid Innovation that will examine alternative payment methodologies and conduct demonstration programs.  The legislation provides for extensive health insurance reforms, including the elimination of pre-existing condition exclusions and other limitations on coverage, fixed percentages on medical loss ratios, expansion in Medicaid and other programs, employer mandates, individual mandates, creation of state and regional health insurance exchanges, and tax subsidies for individuals to help cover the cost of individual insurance coverage.  The legislation also permits the establishment of accountable care organizations, a new healthcare delivery model.  While the ultimate impact of the legislation on the healthcare industry is unknown, it is likely to be extensive and may result in significant change.  Our failure to adapt to these changes could have a material adverse effect on our business.

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results, which will likely result in significant legal and accounting expense and diversion of management resources, and current and potential stockholders may lose confidence in our financial reporting and the market price of our stock will likely decline.

We are required by the SEC to establish and maintain adequate internal control over financial reporting that provides reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles.  We are likewise required, on a quarterly basis, to evaluate the effectiveness of our internal controls and to disclose any changes and material weaknesses in those internal controls.

Any failure to maintain internal controls could adversely affect our ability to report our financial results on a timely and accurate basis.  If our financial statements are not accurate, investors may not have a complete understanding of our operations.  If we do not file our financial statements on a timely basis as required by the SEC and The Nasdaq Capital Market, we could face severe consequences from those authorities.  In either case, there could result a material adverse effect on our business.  Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.  We can give no assurance that material weaknesses or restatements of financial results will not ariseAdditionally, in the future due to a failure to implementnext several years regulations and maintain adequate internal control over financial reporting or circumvention of these controls.  In addition, inguidance implementing the future our controls and procedures may no longer be adequate to prevent or identify irregularities or errors or to facilitate the fair presentation of our consolidated financial statements.  Responding to inquiries from the SEC or The Nasdaq Capital Market, regardless of the outcome, are likely to consume a significant amount of our management resources and cause us to incur significant legal and accounting expense.  Further, many companies that have restated their historical financial statements have experienced a decline in stock price and related stockholder lawsuits.
We depend upon key employees and consultants in a competitive market for skilled personnel.  If we or our strategic partners or collaborators are unable to attract and retain key personnel, it could adversely affect our ability to develop and market our products.

As we prepared for the commercial introduction of SURFAXIN, we implemented a plan to hireHealth Care Reform Law, as well as additional qualified personnel to support (i) the commercial introduction of SURFAXIN and AFECTAIR, and (ii) the advancement of our AEROSURF and, potentially, SURFAXIN LS development programs.  In particular, we established our field-based sales and marketing and medical affairs organizations, and continue to invest in our regulatory affairs, quality control and assurance and administrative capabilities.  We compete for qualified individuals with numerous biopharmaceutical companies, universities and other research institutions.  Competition for such individuals is significant and attracting and retaining qualified personnel will be critical to our success, and any failure to do so successfullyhealthcare reform proposals, may have a material adverse effectfinancial impact on us.our business.

We are highly dependent upon the members of our executive management team and our directors, as well as our scientific advisory board members, consultants and collaborating scientists.  Many of these individuals have been involved with us for many years, have played integral roles in our progress and we believe that they continue to provide value to us.  A loss of any of our key personnel may have a material adverse effect on aspects of our business and clinical development and regulatory programs.

In March 2013, we entered into employment agreements with five executive officers, including the President and Chief Executive Officer and Chief Financial Officer; the Senior Vice President and Chief Operating Officer; the Senior Vice President, General Counsel and Corporate Secretary; the Senior Vice President, Human Resources; and the Senior Vice President, Research and Development.  These agreements expire on March 31, 2015, subject to automatic renewal for additional one-year periods, unless a party provides notice of non-renewal at least 90 days in advance.  In addition, we recently entered into new agreements with five other officers that also expire on March 31, 2015.  The loss of services from any of our executives could significantly adversely affect our ability to develop and market our products and obtain necessary regulatory approvals.  Further, we do not maintain key man life insurance.

As we proceed with the commercial introduction of our approved products and undertake our AEROSURF phase 2 clinical program, we need to attract and retain highly-qualified personnel to join our management, commercial, medical affairs and development teams, although there can be no assurances that we will be successful in that endeavor.  We may be unable to attract and retain necessary executive talent.

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.  While we attempt to provide competitive compensation packages to attract and retain key personnel at all levels in our organization, many of our competitors have greater resources and more experience than we do, making it difficult for us to compete successfully for key personnel.  We may 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 lawsuits brought by their former employers.
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 in many ways.   We need to successfully introduce new products to achieve our strategic business objectives.  The development and acquisition of innovative products and technologies that improve efficacy, safety, patients’ and clinicians’ ease of use and cost-effectiveness involve significant technical and business risks.  The success of new product offerings will depend on many factors, including our ability to properly anticipate and satisfy customer needs, adapt to new technologies, obtain regulatory approvals on a timely basis, demonstrate satisfactory clinical results, manufacture products in an economic and timely manner, and differentiate our products from those of our competitors.  If we cannot successfully introduce new products, adapt to changing technologies or anticipate changes in our current and potential customers’ requirements, our products may become obsolete and our business could suffer.

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 foreign regulatory approval or commercializing products before us.  Our competitors may successfully secure regulatory exclusivities in various markets, which could have the effect of barring us or limiting our ability to market our products in such markets.  As we commence commercial product sales, we will compete against companies with greater marketing and manufacturing capabilities that may successfully develop and commercialize products that are more effective or less expensive than our products.  In addition, developments by our competitors may render our drug product candidates obsolete or noncompetitive.

We also face, and will continue to face, competition from colleges, universities, governmental agencies and other public and private research organizations.  These competitors frequently aggressively seek 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 we cannot protect our intellectual property, other companies could use our technology in competitive products.  Even if we obtain patents to protect our products, those patents may not be sufficiently broad or they may expire and others could then compete with us.

We seek patent protection for our drug and device products and product candidates 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 successfully obtain patents, defend our patents, protect our trade secrets, and otherwise prevent others from infringing our proprietary rights.

The patent position of companies relying upon biotechnology is highly uncertain and involves complex legal and factual questions for which important legal principles are unresolved.  To date, the United States Patent and Trademark Office (USPTO) has not adopted a consistent policy regarding the breadth of claims that it will allowis accorded in biotechnology patents or the degree of protection that these types of patents afford.  As a result, there are risks that we may not secure proprietary rights to products or processes that appear to be patentable.

The parties licensingwho licensed technologies to us and we have filed various U.S. and foreign patent applications with respect to the products and technologies under our development, and the USPTO 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 USPTO or foreign patent office issuing patents.  In addition, 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, even if the USPTO or foreign patent offices were to 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 third parties may not provide us any protection against competitors.

The patents that we hold have a limited life.  We have licensed a series of patents for our KL4surfactant technology from J&J and its wholly-owned subsidiary Ortho Pharmaceutical Corporation (Ortho Pharmaceutical), which are important, both individually and collectively, to our strategy of commercializing our KL4 surfactant products.  These patents, which include important KL4 surfactant composition of matter claims, KL4 peptide method of manufacture claims and relevant European patents, began to expire in November 2009, and will expire on various dates ending in 2017 or, in some cases, possibly later.  Of the patents that have expired, we have extended the term of our most important patent until November 2014.  2017. For our aerosolized KL4 surfactant, we hold worldwide exclusive licenses from PMUSAPhilip Morris USA Inc. (PMUSA) and PMPSAPhilip Morris Products S.S. (PMPSA) to the CAGproprietary aerosol technology for use with pulmonary surfactants together or in combination with other products for all respiratory diseases.  Our exclusive license in the U.S. also extends to other (non-surfactant) drugs to treat a wide range of pediatric and adult respiratory indications in hospitals and other health care institutions.  The CAGproprietary aerosol technology patents expire on various dates beginning in May 2016 and ending in 2031, 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 U.S. and in foreign countries.  Certain of such patents related to lyophilized KL4 surfactant have issued in the U.S. and Europe and will expire in March 2033.  We may not be able to develop enhanced or additional products or processes that will be patentable under patent law and, if we do enhance or develop additional products that we believe are patentable, additional patents may not be issued to us.

Our technology platform is basedconsists solely onof our proprietary KL4 surfactant technology, our novel CAGproprietary aerosol technology, and our novel aerosol-conducting airway connector.

Our technology platform is based on the scientific rationale of using our KL4 surfactant technology, our CAGproprietary aerosol technology and our novel patient interface and related componentry to treat life-threatening respiratory disorders and to serve as the foundation for the development of novel respiratory therapies and products.  Our business is dependent upon the successful development and approval of our drug product candidates and our combination drug-device products based on these technologies.  Any material problems with our technology platforms could have a material adverse effect on our business.
Intellectual property rights of third parties could limit our ability to develop and market our products.

Our commercial success also depends upon our ability to operate our business without infringing the patents or violating the proprietary rights of others.  In certain cases, the USPTO keeps U.S. patent applications confidential while the applications are pending.  As a result, we cannot determine in advance what inventions third parties may claim in their pending patent applications.  We may need to defend or enforce our patent and license rights or to determine the scope and validity of the proprietary rights of others through legal proceedings, which would be costly, unpredictable and time consuming.  Even in proceedings where the outcome is favorable to us, they would likely divert substantial resources, including management time, from our other activities.  Moreover, any adverse determination could subject us to significant liability or require us to seek licenses that third parties might not grant to us or might only grant at rates that diminish or deplete the profitability of our products.  An adverse determination could also require us to alter our products or processes or cease altogether any product sales or related research and development activities.

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 J&J, Ortho Pharmaceutical, PMUSA, PMPSA and The Scripps Institute.  These agreements require us to make payments and satisfy performance obligations to maintain our rights under these licensing agreements.  All of these agreements last either throughout the life of the related patents or 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.  Finally, 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 agreements containing obligations regarding intellectual property, confidentiality and noncompetition provisions that could be breached and may be difficult to enforce.

Although we take what we believe to be reasonable steps to protect our intellectual property, including the use of agreements relating to the non-disclosure of our confidential and proprietary information and trade secrets to third parties, as well as agreements that provide for disclosure and assignment to us of all rights to the ideas, developments, improvements, discoveries and inventions of our employees, consultants, advisors and research collaborators while we employ them, such agreements can be difficult and costly to enforce.  We generally seek to enter into these types of agreements with consultants, advisors and research collaborators; however, to the extent that such parties apply or independently develop intellectual property in connection with any of our projects, disputes may arise concerning allocation of the related proprietary rights.  Such disputes often involve significant expense and yield unpredictable results.
Moreover, although all employees enter into agreements with us that include non-compete covenants, and our five senior executive officers have agreements that include broader non-competition covenants and provide for severance payments that are contingent upon the applicable employee’s refraining from competition with us, such non-compete provisions can be difficult and costly to monitor and enforce, such that, if any should resign, we may not be successful in enforcing our noncompetition agreements with them.

Despite the protective measures we employ, we still face the risk that:

agreements may be breached;
agreements may not provide adequate remedies for the applicable type of breach;
our trade secrets or proprietary know-how may otherwise become known;
our competitors may independently develop similar technology; or
our competitors may independently discover our proprietary information and trade secrets.

We depend upon key employees and consultants in a competitive market for skilled personnel.  If we or our strategic partners or collaborators are unable to attract and retain key personnel, it could adversely affect our ability to develop and market our products.

Over the past few years, we implemented a plan to hire additional qualified personnel to support the advancement of AEROSURF development, as well as our other KL4 surfactant products under development programs.  In particular, we enhanced our clinical operations, regulatory affairs, quality control and assurance and administrative capabilities.  We have competed and will continue to compete for qualified individuals with numerous biopharmaceutical companies, universities and other research institutions.  Competition for such individuals is significant and attracting and retaining qualified personnel will be critical to our success, and any failure to do so successfully may have a material adverse effect on us.

We are highly dependent upon the members of our executive management team and our directors, as well as our scientific advisory board members, consultants and collaborating scientists.  Many of these individuals have been involved with us for many years, have played integral roles in our progress and we believe that they continue to provide value to us.  A loss of any of our key personnel may have a material adverse effect on aspects of our business and clinical development and regulatory programs.
We have entered into employment agreements with five executive officers, including, in February 2016, our President and Chief Executive Officer; in March 2013, the Senior Vice President, General Counsel and Corporate Secretary; and the Senior Vice President, Human Resources; in March 2014, the Senior Vice President and Chief Financial Officer; and in December 2014, the Senior Vice President and Chief Development Officer.  The agreements of executive officers other than that of our President and Chief Executive Officer will expire on March 31, 2017.  In addition, we have agreements with three other officers that if not renewed will expire on March 31, 2017.  The loss of services from any of our executives could significantly adversely affect our ability to develop and market our products and obtain necessary regulatory approvals.  Further, we do not maintain key man life insurance.

As we conduct our AEROSURF phase 2 clinical program, and prepare to conduct a phase 3 clinical trial, we will need to attract and retain highly-qualified personnel to join our management, medical, development and operations teams, although there can be no assurances that we will be successful in that endeavor.  We may be unable to attract and retain necessary executive talent.

Our future success also will depend in part on the continued service of our key professional, scientific and management personnel and our ability to recruit and retain additional personnel.  While we attempt to provide competitive compensation packages to attract and retain key personnel at all levels in our organization, many of our competitors have greater resources and more experience than we do, making it difficult for us to compete successfully for key personnel.  We may 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 lawsuits brought by their former employers.

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 in many ways.  We need to successfully introduce new products to achieve our strategic business objectives.  The development and acquisition of innovative products and technologies that improve efficacy, safety, patients’ and clinicians’ ease of use and cost-effectiveness involve significant technical and business risks.  The success of new product offerings will depend on many factors, including our ability to properly anticipate and satisfy customer needs, adapt to new technologies, obtain regulatory approvals on a timely basis, demonstrate satisfactory clinical results, manufacture products in an economic and timely manner, and differentiate our products from those of our competitors.  If we cannot successfully introduce new products, adapt to changing technologies or anticipate changes in our current and potential customers’ requirements, our products may become obsolete and our business could suffer.

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, and technology 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 receiving FDA or foreign regulatory approval or commercializing products and obtaining patent protection before us.  Our competitors may successfully secure regulatory exclusivities in various markets, which could have the effect of barring us or limiting our ability to market our products in such markets.  For the sale of commercial products, we will compete against companies with greater marketing and manufacturing capabilities that may successfully develop and commercialize products that are more effective or less expensive than our products.  In addition, developments by our competitors may render our drug product candidates obsolete or noncompetitive.
We also face, and will continue to face, competition from colleges, universities, governmental agencies and other public and private research organizations.  These competitive forces frequently and aggressively seek patent protection and licensing arrangements to collect royalties for technologies that they develop.  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.

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;
patient adverse reactions to our 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 U.S. or foreign regulatory policy during the period of product development;
changes in the U.S. or foreign political environment and the passage of laws, including tax, environmental or other laws, affecting the product development business;
developments in patent or other proprietary rights, including any third-party challenges of our intellectual property rights;
announcements of technological innovations by us or our competitors;
announcements of new products or new contracts by us or our competitors;
actual or anticipated variations in our operating results due to the level of development expenses and other factors;
changes in financial estimates by securities analysts and whether our earnings meet or exceed the estimates;
conditions and trends in the pharmaceutical and other industries;
new accounting standards; and
the occurrence of any of the risks described in these “Risk Factors” or elsewhere in this Annual Report on Form 10-K or our other public filings.

Our common stock is listed for quotation on The Nasdaq Capital Market®.  During the 12-month period ended December 31, 2015, the price of our common stock ranged between $2.69 and $25.48.  We expect the price of our common stock to remain volatile.  The average daily trading volume in our common stock varies significantly.  For the twelve month period ended December 31, 2015, the average daily trading volume in our common stock was approximately 41,481 shares, and the average number of transactions per day was approximately 953.  The instability observed in our daily volume and number of transactions per day may affect the ability of our stockholders to sell their shares in the public market at prevailing prices.

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.  Even if securities class actions that may be filed against us in the future were ultimately determined to be meritless or unsuccessful, they would involve substantial costs and a diversion of management attention and resources, which could negatively affect our business.
Future sales and issuances of our common stock or rights to purchase our common stock, including pursuant to our ATM Program, stock incentive plans and upon the exercise of outstanding securities exercisable for shares of our common stock, could result in substantial additional dilution of our stockholders, cause our stock price to fall and adversely affect our ability to raise capital.

We will require additional capital to continue to execute our business plan and advance our research and development efforts.  To the extent that we raise additional capital through the issuance of additional equity securities and through the exercise of outstanding warrants, our stockholders may experience substantial dilution.  We may sell shares of our common stock in one or more transactions at prices that may be at a discount to the then-current market value of our common stock and on such other terms and conditions as we may determine from time to time.  Any such transaction could result in substantial dilution of our existing stockholders.  If we sell shares of our common stock in more than one transaction, stockholders who purchase our common stock may be materially diluted by subsequent sales.  Such sales could also cause a drop in the market price of our common stock.  The issuance of shares of our common stock in connection with a public financing, under the ATM Program, in connection with our compensation programs, and upon exercise of outstanding warrants will have a dilutive impact on our other stockholders and the issuance, or even potential issuance, of such shares could have a negative effect on the market price of our common stock.
We filed a universal shelf registration statement with the SEC on Form S-3 (File No. 333-196420) on May 30, 2014 (which was declared effective on June 13, 2014) for the proposed offering from time to time of up to $250 million of our securities, including common stock, preferred stock, varying forms of debt and warrant securities, or any combination of the foregoing.  We may issue securities pursuant to this shelf registration statement in the future in response to market conditions or other circumstances on terms and conditions that will be determined at such time.

As of March 15, 2016, there were 8,191,289 shares of common stock issued and outstanding.  In addition, as of December 31, 2015, approximately (i) 8.5 million shares of our common stock were reserved for potential issuance upon the exercise of outstanding warrants, (ii) 0.9 million shares of our common stock were reserved for issuance pursuant to our equity incentive plans, and (iii) 4,567 shares of our common stock were reserved for issuance pursuant to our 401(k) Plan.  The exercise of stock options and other securities could cause our stockholders to experience substantial dilution.  Moreover, 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.  Such exercises, or the possibility of such exercises, may impede our efforts to obtain additional financing through the sale of additional securities or make such financing more costly.  It may also reduce the price of our common stock.

The failure to prevail in litigation or the costs of litigation, including securities class actions, product liability claims and patent infringement claims, could harm our financial performance and business operations.

We are potentially susceptible to litigation.  For example, as a public company, we may be subject to claims  asserting violations of securities laws.  Even if such actions are found to be without merit, the potential impact of such actions, which generally seek unquantifiable damages and attorneys’ fees and expenses, is uncertain.  There can be no assurance that an adverse result in any future proceeding would not have a potentially material adverse effect on our business, results of operations and financial condition.

Our business activities, including the design,development, manufacture and marketing of our drug products and medical devices also exposes us to liability risks.  Using our drug product candidates or medical devices, including in clinical trials, may expose us to product liability claims.  For our products that are approved for commercial sale, the risk of product liability claims is increased.  Even if approved, our products may be subject to claims resulting from unintended effects that result in injury or death.   Product liability claims alleging inadequate disclosure and warnings in our package inserts and medical device disclosures also may arise.

Product liability claims may be brought by individuals or by groups seeking to represent a class.  The outcome of litigation, particularly class action lawsuits, is difficult to assess or quantify.  Plaintiffs in these types of lawsuits often seek recovery of very large or indeterminate amounts, and the magnitude of the potential loss relating to such lawsuits may remain unknown for substantial periods of time.

We presently carry general liability, excess liability, products liability and property insurance coverage in amounts that are customary for companies in our industry of comparable size and level of activity.  However, our insurance policies contain various deductibles, limitations and exclusions from coverage, and in any event might not fully cover any potential claims.  There can be no assurance that the insurance coverage we maintain is sufficient or will be available in adequate amounts or at a reasonable cost.  A successful claim brought against us in excess of available insurance or not covered by indemnification agreements, or any claim that results in significant adverse publicity against us, could have an adverse effect on our business and our reputation.
We may need to obtain additional product liability insurance coverage, including with locally-authorized insurers licensed in countries where we market our approved products or conduct our clinical trials, before initiating clinical trials; however, such insurance is expensive and may not be available when we need it.  In the future, we may not be able to obtain adequate insurance, with acceptable limits and retentions, at an acceptable cost.  Any product, general liability or product liability claim, even if such claim is within the limits of our insurance coverage or meritless and/or unsuccessful, could adversely affect the availability or cost of insurance generally and our cash available for other purposes, such as research and development.  In addition, such claims could result in:

uninsured expenses related to defense or payment of substantial monetary awards to claimants;
a decrease in demand for our drug product candidates;
damage to our reputation; and
an inability to complete clinical trial programs or to commercialize our drug product candidates, if approved.

Moreover, the existence of a product liability claim could affect the market price of our common stock.  In addition, as the USPTO keeps U.S. patent applications confidential in certain cases while the applications are pending, we cannot ensure that our products or methods do not infringe upon the patents or other intellectual property rights of third parties.  As the biotechnology and pharmaceutical industries expand and more patents are applied for and issued, the risk increases that our patents or patent applications for our KL4 surfactant product candidates or our medical device and combination drug/device products may give rise to a declaration of interference by the USPTO, or to administrative proceedings in foreign patent offices, or that our activities lead to claims of patent infringement by other companies, institutions or individuals.  These entities or persons could bring legal proceedings against us seeking to invalidate our patents, obtain substantial damages or enjoin us from conducting research and development activities.

Our corporate compliance program cannot ensure that we are in compliance with all applicable laws and regulations affecting our activities in the jurisdictions in which we may sell our products, if approved, and a failure to comply with such regulations or prevail in litigation related to noncompliance could harm our business.

Many of our activities, including the research, development, manufacture, sale and marketing of our products, are subject to extensive laws and regulation, including without limitation, health care "fraud and abuse" laws, such as the federal false claims act, the federal anti-kickback statute, and other state and federal laws and regulations.  We have developed and implemented a corporate compliance policy and oversight program based upon what we understand to be current industry best practices, but we cannot assure you that this program will protect us from governmental investigations or other actions or lawsuits stemming from a failure to be in compliance with such laws or regulations.  If any such investigations, actions or lawsuits are instituted against us, and if we are not successful in defending or disposing of them without liability, such investigations, actions or lawsuits could result in the imposition of significant fines or other sanctions and could otherwise have a significant impact on our business.

Provisions of our Amended and Restated Certificate of Incorporation, our Amended and Restated By-Laws our Shareholder Rights Agreement(By-Laws) and Delaware law could defer a change of our management and thereby discourage or delay offers to acquire us.

Provisions of our Amended and Restated Certificate of Incorporation, our Amended and Restated By-Laws our Shareholder 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 Amended and Restated 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 issue large blocks of preferred stock or 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, before the redemption of our common stock.  In addition, our Board of Directors, without further stockholder approval, could issue large blocks of preferred stock.  We have adopted a Shareholder Rights Agreement, which under certain circumstances would significantly impair the ability of third parties to acquire control of us without prior approval of our Board of Directors, thereby discouraging unsolicited takeover proposals.  This agreement expired in February 2014. The rights issued under the Shareholder 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 1B.
UNRESOLVED STAFF COMMENTS.
 
None.
 
ITEM 2.
PROPERTIES.

We maintain our principal executive offices at 2600 Kelly Road, Suite 100, Warrington, Pennsylvania 18976-3622, which consist of 39,594 square feet of space that we lease.  OnIn January 3, 2013, we amended the lease entered into a Second Amendment to Lease Agreement (Amendment) to extend the leaseterm for an additional five years until February 2018.  In addition,2018; reduce the Amendment providesbalance of a security deposit we maintain for a reduction to the base rent effective asbenefit of October 1, 2012; a reduction in the security depositlandlord over a two year period beginning in 2013, from $400,000 to $225,000; reduce the eliminationbase rent effective as of October 1, 2012; eliminate our obligation to remove certain improvements and restore the premises;premises upon expiration of the lease; and an adjustment ofadjust our option to extend the lease to an additional period of five years through February 2023.  The total aggregate base rental payments under the lease prior to the extension were approximately $7.2 million and the total aggregate base rental payments under the extended portion of the lease are approximately $4.9 million.  We do not own any real property.property.

We also maintain at our Warrington location our analytical and technical support laboratory that is involved predominantly in release testing of all active pharmaceutical ingredients (APIs), release and stability testing of SURFAXIN® drug product, and supporting our research and development work for our lyophilized and aerosolized KL4 surfactant dosage forms as well as our efforts to identify and protect our intellectual property.  We also maintain a controlled medical device development laboratory at this location that is used by our development engineering team to conduct preclinical development activities for AEROSURF® and our aerosol delivery technologies.  Having our own device development laboratory allows us to conduct a range of research activities while at the same time controlling the related expense and conserving our financial resources.  Our laboratory space includes a controlled environment with two class 10,000 hoods (for activities requiring clean room procedures).

We lease approximately 21,000 square feet of space for our manufacturing operations in Totowa, New Jersey (Totowa Facility), at an annual rent of $150,000.  In early 2014, we extended the term of this lease such that it will now expire on June 30, 2015.  This space is specifically designed for the manufacture and filling of sterile liquid pharmaceuticals in compliance with cGMP and is currently dedicated to the manufacture of SURFAXIN drug product.  We currently are in discussions with the landlord potentially to enable longer-term utilization of that facility for the manufacture of SURFAXIN and potentially lyophilized KL4 surfactant.  See, “Item 1 – Business – Business Operations – Manufacturing and Distribution – KL4 Surfactant.”
ITEM 3.
LEGAL PROCEEDINGS.

We are not aware of any pending or threatened legal actions to which we are a party or of which our property is the subject that would, if determined adversely to us, have a material adverse effect on our business and operations.

We have from time to time been involved in disputes and proceedings arising in the ordinary course of business, including in connection with the conduct of our clinical trials.  In addition, as a public company, we are also potentially susceptible to litigation, such as claims asserting violations of securities laws.  Any such claims, with or without merit, if not resolved, could be time-consuming and result in costly litigation.  There can be no assurance that an adverse result in any future proceeding would not have a potentially material adverse effect on our business, results of operations or financial condition.
 
PART II
 
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Our common stock is traded on The Nasdaq Capital Market® (Nasdaq) under the symbol “DSCO.”  As of March 7, 2014,15, 2016, we had 124 stockholders104 holders of record of shares of our common stock.  We also have been advised that, as of December 13, 2013, there are approximately 20,774 beneficial owners of our common stock whose positions are held in street name.  As of March 7, 2014,15, 2016, there were 84,696,9198,191,289 shares of our common stock issued and outstanding.

The following table sets forth the quarterly sales price ranges of our common stock for the periods indicated, as reported by The Nasdaq Capital Market.(adjusted for the 1-for-14 reverse stock split that was effective January 22, 2016).

 2013  2012  2015  2014 
 High  Low  High  Low  High  Low  High  Low 
Period: 
  
  
  
             
First Quarter $2.91  $2.11  $5.39  $1.67  $25.48  $15.89  $38.78  $29.40 
Second Quarter $2.40  $1.50  $3.15  $2.12  $20.72  $8.96  $32.76  $21.14 
Third Quarter $2.23  $1.54  $3.51  $2.30  $10.50  $3.50  $28.42  $21.14 
Fourth Quarter $3.05  $1.90  $3.29  $1.71  $7.53  $2.69  $28.14  $13.86 

We have not paid dividends on our common stock and do not expect to declare and pay dividends on our common stock in the foreseeable future.

Sales of Unregistered Securities

During the quarter ended December 31, 2013, we issued 8,750 unregistered shares of common stock to a consultant as compensation for management consulting services rendered during the period from August 31, 2013 through November 30, 2013.  The shares were issued in reliance upon the exemption from securities registration provided by Section 4(a)(2) of the Act.
ITEM 6.
SELECTED FINANCIAL DATA.

Consolidated Statement of Operations Data:
(in thousands, except per share data)
 
 For the year ended December 31, 
 2013  2012  2011  2010  2009 
Revenues from grants $388  $195  $582  $–  $– 
Operating expenses:                    
Cost of product sales  517                 
Research and development  27,661   21,570   17,230   17,136   19,077 
Selling, general and administrative  16,718   16,444   7,864   8,392   10,120 
Total expenses(1)
  44,896   38,014   25,094   25,528   29,197 
Operating loss  (44,508)  (37,819)  (24,512)  (25,528)  (29,197)
Change in fair value of common stock warrant liability  761   555   3,560   6,422   369 
Other (expense) / income  (1468)  (51)  (13)  (69)  (1,043)
Net loss $(45,215) $(37,315) $(20,965) $(19,175) $(29,871)
Net loss per common share – basic and diluted $(0.82) $(0.95) $(0.93) $(1.65) $(3.89)
Weighted average number of common shares outstanding – basic and diluted  55,258   39,396   22,660   11,602   7,680 

Not applicable.
(1)
Included in the net loss for 2013, 2012, 2011, 2010, and 2009  were non-cash charges for stock-based compensation and depreciation of $2.9 million, $3.3 million, $2.2 million, $2.8 million, and $4.3 million, respectively.

Consolidated Balance Sheet Data: 
 
(in thousands) December 31, 
 2013  2012  2011  2010  2009 
 
  
  
  
  
 
Cash and investments $86,283  $26,892  $10,189  $10,211  $15,741 
Working capital  75,384   16,107   (516)  2,920   176 
Total assets  89,317   29,943   13,324   14,537   21,403 
Long-term debt, net of discount of $11,646  18,354   –   –   –   – 
Other long-term obligations, less current portion  607   591   913   935   1,118 
Total stockholders’ equity $58,501  $17,653  $1,264  $6,026  $1,296 

ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
 
INTRODUCTION

Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business and related financing activities, includes forward-looking statements that involve risks and uncertainties.  You should review the “Forward Looking Statements” and “Risk Factors” sections of this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis or elsewhere in the Annual Report on Form 10-K.

Management’s discussion and analysis of financial condition and results of operations (MD&A) is provided as a supplement to the accompanying consolidated financial statements and footnotes to help provide an understanding of our financial condition, the changes in our financial condition and our results of operations.  This item should be read in connection with our Consolidated Financial Statements.Statements for the year ending December 31, 2015 and notes thereto (Notes) included in this Annual Report of Form 10-K.  See, “Item 158 – ExhibitsFinancial Statements and Financial Statement Schedules.Supplementary Data.”

Note: Information concerning the shares of our common stock and related share prices in this MD&A has been adjusted to reflect a 1-for-14 reverse split of our common stock and a change in the number of shares of common stock authorized for issuance under our Amended and Restated Certificate of Incorporation, as amended (Certificate of Incorporation), that were made effective on January 22, 2016.  (See, “Item 8 – Notes to consolidated financial statements – Note 2 – Basis of Presentation”).

Our discussion is organized as follows:

·Company Overview and Business Strategy:  this section provides a general description of our company and business plans.

·Critical Accounting Policies:  this section contains a discussion of the accounting policies that we believe are important to our financial condition and results of operations and that require the exercise of judgment and use of estimates on the part of management in their application.  In addition, all of our significant accounting policies, including the critical accounting policies and estimates, are discussed in Note 3 to the accompanying consolidated financial statements.

·Results of Operations:  this section provides an analysis of our results of operations presented in the accompanying consolidated statements of operations, including comparisons of the results for the years ended December 31, 2013, 20122015 and 2011.2014.

·Liquidity and Capital Resources:  this section provides a discussion of our capital resources, future capital requirements, cash flows, committed equity financing facilities, historical financing transactions, outstanding debt arrangements and commitments.
 
OVERVIEW

Discovery Laboratories, Inc. (referred to as “we,” “us,” or the “Company”) is a specialty biotechnology company focused on creating life-saving productsdeveloping novel KL4 surfactant therapies for critical-care patients with respiratory diseasediseases and improvingother potential applications.  Surfactants are produced naturally in the standard of care in pulmonary medicine.lung and are essential for normal respiratory function and survival.  Our proprietary drug technology producesplatform includes a synthetic, peptide-containing surfactant (KL4 surfactant) that is structurally similar to endogenous pulmonary surfactant, a substance produced naturally in the lung and essential for normal respiratory function and survival.  We are developing our KL4 surfactant in liquid, lyophilized and aerosolized dosage forms.  We are also developing novel drug delivery technologies potentiallybeing developed to enable efficient deliverynoninvasive administration of our aerosolized KL4 surfactant.  We believe that our proprietary technologiestechnology platform may make it possible for the first time, to develop a significant pipeline of surfactant products to address a variety of respiratory diseases for which there frequently are few or no approved therapies.

We are initiallyOur core development program, AEROSURF® (lucinactant for inhalation), is focused on improving the management of respiratory distress syndrome (RDS) in premature infants.  RDS isinfants, a serious respiratory condition caused by insufficientthat can result in long-term respiratory problems, developmental delay and death.  Premature infants born prior to 37 weeks gestational age may not have fully developed natural lung surfactant production in underdeveloped lungsand therefore may need surfactant therapy to sustain life.  Higher incidence and severity of RDS are correlated with younger gestational ages; however, RDS can occur at any premature infants.gestational age.  RDS is the most prevalent respiratory disease in the Neonatal Intensive Care Unitneonatal intensive care unit (NICU).  We estimate that 120,000 to 150,000 premature infants are given respiratory support after birth each year in the United States because they have or are at risk for RDS.

Surfactant therapy is a life-saving treatment for RDS and canthe primary therapy to address an underlying surfactant deficiency.  Surfactants currently available in the U.S. are animal-derived and must be administered using invasive endotracheal intubation and mechanical ventilation, each of which may result in long-termserious respiratory problems, developmental delayconditions and death.other complications.  Intubation is associated with airway trauma and clinical instability that can extend beyond the respiratory system such as increased intracranial pressure and risk for brain injury.  Mechanical ventilation is associated with ventilator-associated lung injury, chronic lung disease and increased risk of infection.  To avoid these risks, many premature infants are initially treated with noninvasive respiratory support, such as nasal continuous positive airway pressure (nCPAP).  Unfortunately, since nCPAP does not address the underlying surfactant deficiency, many premature infants respond poorly to nCPAP (typically within the first 72 hours of life) and may require intubation and delayed surfactant therapy (an outcome referred to as nCPAP failure).

Our firstIn addition, many premature infants with RDS who receive surfactant therapy as initial therapy are capable of breathing without mechanical ventilation, but require surfactant therapy for RDS.  Because surfactant therapy requires intubation, these infants generally are supported with mechanical ventilation for either a limited or extended period of time.  If surfactant therapy could be administered noninvasively, neonatologists would be able to provide surfactant therapy to these premature infants without exposing them to the risks associated with intubation and mechanical ventilation.

AEROSURF is an investigational combination drug/device product that combines our proprietary KL4surfactant with our novel aerosol delivery system (ADS), which is based primarily on our capillary aerosol generator technology.  We are developing AEROSURF to enable administration of aerosolized KL4 surfactant to premature infants receiving nCPAP, without invasive intubation and mechanical ventilation.  We believe that, if approved, AEROSURF will have the potential to transform the treatment of RDS, allow for earlier treatment of those premature infants who currently receive surfactants later in their course of treatment, decrease the morbidities and complications currently associated with surfactant administration, and reduce the number of premature infants who are subjected to invasive intubation and delayed surfactant therapy as a result of nCPAP failure.

The current surfactant market for RDS is estimated to be approximately $75 million annually in the U.S. and $250 to $300 million annually worldwide; however, we believe that this market has been constrained, in part, by the risks associated with surfactant administration and lack of medical innovation.  Treatment options for RDS have not improved significantly, nor have mortality and morbidity rates for RDS meaningfully improved over the last few decades.  We believe that the neonatal medical community would respond favorably to the introduction of a synthetic, peptide-containing (KL4) surfactant and a less-invasive method of surfactant administration.  By enabling delivery of our aerosolized KL4 surfactant using noninvasive methods, we believe that AEROSURF, if approved, will address a serious unmet medical need and potentially provide transformative clinical and pharmacoeconomic benefits.  We believe that AEROSURF has the potential to create a worldwide annual market opportunity of $600 million to a $1 billion per year.  See, “Item 1 – Business – Surfactant Therapy – The RDS Market.”
The drug product component of our AEROSURF product candidate is a lyophilized (freeze-dried) dosage form of our KL4 surfactant liquid instillate drug product that was approved by the U.S. Food and Drug Administration (FDA) in 2012 under the name SURFAXIN® (lucinactant) Intratracheal Suspension for the prevention of RDS in premature infants at high risk for RDS, was approved byRDS.  In the United States Foodsecond quarter of 2015, we determined to cease commercial and Drug Administration (FDA) in 2012.manufacturing activities for SURFAXIN isto focus our KL4 surfactant in liquid formlimited resources on advancing the AEROSURF clinical development program and is the first synthetic, peptide-containing surfactant approved by the FDA and the only alternative to animal-derived surfactants currently used in the United States (U.S.).  Since November 2013, SURFAXIN has been commercially available in the U.S.

Premature infants with severe RDS currently are treated with surfactants that can only be administered by endotracheal intubation supported with mechanical ventilation, both invasive procedures that may each result in serious respiratory conditions and other complications.  To avoid such complications, many neonatologists treat infants with less severe RDS by less invasive means, typically nasal continuous positive airway pressure (nCPAP).  Unfortunately, a significant number of premature infants on nCPAP will not respond well (an outcome referred to as nCPAP failure) and thereafter may require delayed surfactant therapy.  Since neonatologists currently cannot predict which infants will experience nCPAP failure, neonatologists are faced with difficult choices in treating infants with less severe RDS.  This is because the medical outcomes for those infants who experience nCPAP failure and receive delayed surfactant therapy may be less favorable than the outcomes for infants who receive surfactant therapy in the first hours of life.
AEROSURF® is an investigational combination drug/device product that combines our KL4 surfactant with our proprietary capillary aerosol generator (CAG).  With AEROSURF, neonatologists potentially will be able to administer aerosolized KL4 surfactant pipeline.  We believe that gaining the approval of SURFAXIN provided us valuable experience to premature infants supported with nCPAP, without having to use invasive intubation and mechanical ventilation.  By enabling deliverysupport the further development of our KL4 surfactant using less invasive procedures, we believe that AEROSURF will address a serious unmet medical need and potentially enable the treatment of a significantly greater number of premature infants with RDS who could benefit from surfactant therapy but are currently not treated.

We are also developing a lyophilized (freeze-dried) dosage form of our KL4 surfactant that is stored as a powder and reconstituted to liquid form prior to use with the objective of improving ease of use for healthcare practitioners, as well as potentially to prolong shelf life and eliminate the need for cold-chain storage.  We are initially developing this dosage form for use in our AEROSURF development program.  We are also planning to seek regulatory advice to determine if we could gain marketing authorization for a lyophilized dosage form of SURFAXIN under a development plan that would be both capital efficient and capable of implementation within a reasonable time.  If feasible, we would likely implement such a development plan and would plan to introduce it commercially as a life-cycle extension of SURFAXIN under the name SURFAXIN LS™, in the U.S. and potentially in other markets.

To support the commercial introduction of SURFAXIN in the U.S. and our other KL4 surfactant pipeline products, if approved, we have established our own specialty respiratory critical care commercial and medical affairs team.  This team includes medical professionals with experience in neonatal/pediatric respiratory critical care, and has focused on products that address neonatal indications,product candidates, beginning with SURFAXIN.  We believe that this team will be positioned to efficiently introduce our other KL4 surfactant products under development, if approved, including AEROSURF and potentially SURFAXIN LS and future applications of our aerosolized KL4 surfactant.

In addition we recognize that our commercial and medical affairs team could potentially support introductions of other synergistic pipeline products, including products  owned or developed by third parties for the NICU/PICU.  To that end, we would consider potential transactions focused on securing commercial rights to such synergistic products, including in the form of product acquisitions, in-licensing agreements or distribution, marketing or co-marketing arrangements.AEROSURF.

In the future, we expectbelieve that we may be able to leverage the information, data and know-how that we gain from our development efforts with SURFAXINactivities for our KL4 surfactant, in liquid, lyophilized and AEROSURFaerosolized dosage forms, to support development of a potential product pipeline of KL4 surfactant products to address serious critical care respiratory and other conditions in larger children and adults in pediatric and adult intensive care units (PICUSunits.  While we remain focused on AEROSURF, we have supported and ICUs),plan in the future to support potential opportunities to explore the utility of our KL4 surfactant to address a variety of respiratory conditions.  Although there can be no assurance, we would consider supporting such efforts in the future if we are able to secure separate funding, including through potential government-supported and other grant programs that are dedicated to advancing research and development initiatives.

We believe that our aerosolized KL4 surfactant, alone or in combination with other pharmaceutical compounds, has the potential to be developed to address a range of serious respiratory conditions and may be an effective intervention for such conditions as acute lung injury (ALI), including acute radiation exposure to the lung (acute pneumonitis and delayed lung injury), chemical-induced ALI, and influenza-induced ALI.  In addition, we may explore opportunities to apply KL4 surfactant therapies to treat conditions such as chronic rhinosinusitis, complications of certain major surgeries, mechanical ventilator-induced lung injury (often referred to as VILI), pneumonia, diseases involving mucociliary clearance disorders, such chronic obstructive pulmonary disease (COPD) and cystic fibrosis (CF).  AtThere can be no assurance however, that we will secure the present time, however,additional capital needed to undertake such explorations, that we are focusing our resources primarily on the commercial introduction of SURFAXIN and development of AEROSURF through phase 2 clinical trials.  Oncewill undertake such explorations or that, even if we have achieved these objectives,do, that we believe we wouldwill be in a better position to assess the potential of other development programs to address the critical care needs of patients in the PICU and ICU.successful.

We also have developed a disposable aerosol-conducting airway connector for infants that is intended to simplify the delivery of aerosolized medications (including our aerosolized KL4 surfactant) and other inhaled therapies to critical-care patients requiring ventilatory support.  This device introduces aerosolized medications directly at the patient interface and minimizes the number of connections in the ventilator circuit.  We have registered this device as a Class I, exempt medical device in the U.S. under the name AFECTAIR and it is currently commercially available in the U.S.

The reader is referred to, and encouraged to read in its entirety “Item 1 – Business” ofBusiness – Company Overview” and “– Business Strategy,” in this Annual Report on Form 10-K, which contains a discussion of our Business and Business Strategy, as well as information concerning our proprietary technologies and our current and planned KL4 pipeline programs.
 
CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S., requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

We believe the following accounting policies are the most critical for an understanding of our financial condition and results of operations.  For further discussion of our accounting policies, see, “Item 8 – Notes to consolidated financial statements – Note 34 – Accounting Policies and Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements for the year ended December 31, 2013, in Part IV to this Annual Report on Form 10-K.Pronouncements.”

Product Sales

Revenues from product sales are recognized when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the price is fixed or determinable and (4) collectability is reasonably assured. 

Our products are distributed in the U.S. using a specialty distributor.  Under this model, the specialty distributor purchases and takes physical delivery and title of product, and then sells to hospitals.  We began the commercial introduction of SURFAXIN in the fourth quarter of 2013 and, for that reason, we currently cannot make a reasonable estimate of future product returns when product is delivered to the specialty distributor.  Therefore, we currently do not recognize revenue upon product shipment to the specialty distributor, even though the distributor is invoiced upon product shipment.  Instead, we recognize revenue once product has been sold through to the hospital and all revenue recognition criteria have been met.  Once product has been delivered to the hospital, the risk of material returns is significantly mitigated. As of December 31, 2013, we have deferred revenue recognition on all product sales since the inception of the commercial launch of SURFAXIN in November 2013.  We will recognize those revenues at the point in time when all revenue recognition criteria have been met.

We will begin to recognize revenue at the time of shipment of product to our specialty distributor when we can reasonably estimate expected distributor sales deductions and returns. In developing estimates for sales returns we consider the shelf life of the product, expected demand based on market data and return rates of other surfactant products. 

Product sales are recorded net of accruals for estimated chargebacks, discounts, specialty distributor deductions and returns.

·Chargebacks.  Chargebacks are discounts that occur when contracted customers purchase directly from our specialty distributor.  Contracted customers, which currently consist primarily of member hospitals of Group Purchasing Organizations, generally purchase the product at a discounted price.  Our specialty distributor, in turn, charges back the difference between the price initially paid by the specialty distributor and the discounted price paid to the specialty distributor by the customer.  The allowance for specialty distributor chargebacks is based on known sales to contracted customers.
·Sales discounts:  Sales discounts are offered to certain contracted customers based upon a customer’s historical volume of surfactant product purchases.  Customers must enter into a Letter of Participation (LOP) with us to receive sales discounts.  Sales discounts are calculated on a quarterly basis based upon the customer’s quarterly purchases of SURFAXIN, as provided in the LOP.  The allowance for sales discounts is based on known sales to contracted customers.

·Specialty distributor deductions. Our specialty distributor is offered various forms of consideration including allowances, service fees and prompt payment discounts. Specialty distributor allowances and service fees are provided in our contractual agreement and are generally a percentage of the purchase price paid by the specialty distributor. The specialty distributor is offered a prompt pay discount for payment within a specified period.

·Returns.  Sales of our products are not subject to a general right of return; however, we will accept product that is damaged or defective when shipped or for expired product up to 6 months subsequent to its expiry date.  Product that has been administered to patients is no longer subject to any right of return.
Research and development

We trackaccount for research and development expense by activity, as follows:the following categories: (a) product development and manufacturing, (b) medical and regulatory operations, and (c) direct preclinical and clinical programs.   Research and development expense includes personnel, facilities, manufacturing and quality operations, pharmaceutical and device development, research, clinical, regulatory, other preclinical and clinical activities and medical affairs.  Research and development costs are charged to operations as incurred.
Inventory
Inventories, which are recorded at the lower of cost or market, include materials, labor, and other direct and indirect costs and are valued at cost using the first-in, first-out method.  We capitalize inventories produced in preparation for commercial launch when it becomes probable that the related product candidate will receive regulatory approval and that the related costs will be recoverable through commercial sale of the product.  Costs incurred prior to FDA approval of SURFAXIN drug product and registration of AFECTAIR device have been recorded in our statement of operations as research and development expense.  Inventories are evaluated for impairment based on consideration of such factors as the net realizable value, lower of cost or market, obsolescence, and product expiry.  Inventories do not have carrying values that exceed either cost or net realizable value.

We establish expiry risk by evaluating current and future product demand relative to product shelf life.  We build demand forecasts based on consideration of such factors as overall market potential, market share, market acceptance and hospital ordering practices.
Deferred revenue
Deferred revenue reflects amounts related to sales of SURFAXIN to our specialty distributor, which are then deferred and recognized as revenue once product has been sold through to the hospital and all revenue recognition criteria have been met.  See, “– Product Sales.”

Warrant accounting

We account for common stock warrants in accordance with applicable accounting guidance provided in ASC Topic 815, “Derivatives and Hedging – Contracts in Entity’s Own Equity”Equity (ASC Topic 815), as either derivative liabilities or as equity instruments depending on the specific terms of the warrant agreement.  We classify derivative warrant liabilities on the consolidated balance sheet as current liabilities, which are revalued at each balance sheet date subsequent to the initial issuance.  WeDepending on the terms of a warrant agreement, we use the Black-Scholes or trinomial pricing models depending on the applicable terms of the warrant agreement, to value the related derivative warrant liabilities.  Changes in the fair value of the warrants are reflected in the consolidated statement of operations as “Change in the fair value of common stock warrant liability.”  See, “Item 8 –Note– Notes to consolidated financial statements – Note 8 – Common Stock Warrant Liability,” for a detailed description of our accounting for derivative warrant liabilities.
RESULTS OF OPERATIONS

Net Loss and Operating Loss

The net loss for the years ended December 31, 2013, 2012,2015 and 20112014 was $45.2$55.2 million (or $0.82$7.98 basic net loss per share), $37.3 and $44.1 million (or $0.95 per share), and $21.0 million (or $0.93$7.28 basic net loss per share), respectively.  Included in the net loss is (i) the change in fair value of certain common stock warrants classified as derivative liabilities, resulting in non-cash income of $0.8 million, $0.6$0.9 million and $3.6$3.8 million for 2013, 2012,2015 and 2011, respectively.2014, respectively; (ii) interest expense of $4.5 million and $4.6 million for 2015 and 2014, respectively, associated with the Deerfield Loan; and (iii) for 2015, an $11.8 million non-cash loss on debt extinguishment.

The operating loss for the years ended December 31, 2013, 2012,2015 and 20112014 was $44.5 million, $37.8$39.8 million and $24.5$43.3 million, respectively.  The operating loss includes $2.9 million, $3.3 million, and $2.2 million for non-cash items related to depreciation and stock-based compensation for 2013, 2012, and 2011, respectively.  Excluding non-cash items related to depreciation and stock-based compensation, the operating loss was $41.6 million, $34.5 million, and $22.4 million for 2013, 2012, and 2011, respectively.
The increasedecrease in operating loss from 20122014 to 20132015 was primarily due to (i) a $3.2$5.3 million increasedecrease in investment in AEROSURF development activities, primarily to develop and manufacture a clinic-ready CAG for use in our AEROSURF phase 2 clinical program and in the technology transfer and further development of our lyophilized KL4 surfactant manufacturing process at DSM Pharmaceuticals, Inc. (DSM), (ii) a $3.2 million increase in investment in our specialty commercial and medical affairs organization that is focused on neonatal/pediatric respiratory critical care in NICUs/PICUs across the U.S.; and (iii) a $1.7 million increase in purchases of raw materials to manufacture drug product for SURFAXIN and our AEROSURF development program, which wereoperating expenses partially offset by a $2.0$1.5 million one-time chargedecrease in the fourth quarter of 2012 associated with certain contractual severance obligationsgrant revenues and stock-based compensation charges related to the resignation of our former Chief Executive Officer.

The increasea $0.3 million decrease in operating loss from 2011 to 2012 was primarily due to (i) a $6.5 million investment to establish our commercial and medical affairs organization; (ii) a $1.6 million investment to advance the development of our CAG for potential use in our AEROSURF phase 2 clinical program; and (iii) a $2.0 million one-time charge in the fourth quarter of 2012 associated with certain contractual severance obligations and stock-based compensation charges related to the resignation of our former Chief Executive Officer.

Product Sales

As of December 31, 2013, we have deferred revenue recognition on allSURFAXIN product sales since the initiation of the commercial launch of SURFAXIN in November 2013.  In accordance with our revenue recognition policy, we will recognize revenue once product has been sold through to the hospital and all revenue recognition criteria have been met..

Grant Revenue

We recognized grant revenue of $0.4 million, $0.2$1.0 million and $0.6$2.5 million for the years ended December 31, 2013,  20122015 and 2011, respectively.  The grant revenue in 2012 and 2013 represents funds received and expended2014, respectively, under two grants discussed below.

During the second quarter of 2014, we were awarded the final $1.9 million of a $2.4 million Fast Track Small Business Innovation Research (SBIR) grant from the National Heart, Lung, and Blood Institute (NHLBI) of the National Institutes of Health (NIH).  This award provided support for the initial AEROSURF phase 2a clinical trial in premature infants 29 to 34 week gestational age with RDS.  We received and expended $1.8 million in 2014 under this award and received and expended the remaining award amount in the first quarter of 2015.
During the second quarter of 2015, we were awarded an additional $1.0 million under a previously awarded Phase I awardII SBIR grant from National Institute of Health’s (NIH)the National Institute of Allergy and Infectious Diseases (NIAID) Center for Medical Counter Measures Against Radiation and Nuclear Threatsof the NIH valued at up to assess$3.0 million over three years to support continued development of the ability ofcompany’s aerosolized KL4 surfactant as a potential medical countermeasure to mitigate the effects of acute radiation exposure to the lung, including acute pneumonitis and delayedchronic/late-phase radiation-induced lung injury.  The total amountWe were awarded an initial $1.0 million under this grant during the third quarter of 2014.  For the Phase Iinitial award, was $0.6 million and we have received and expended $0.7 million in 2014 and $0.3 million through the full amount asthird quarter of December 31, 2013.

In2015.  During the future,fourth quarter, we expect thatreceived and expended $0.7 million under the additional $1.0 million awarded in the second quarter of 2015, and we anticipate receiving the balance of this award through the third quarter of 2016.  Additionally, next year we may be ableeligible for a third award of up to leverage the information, data and know-how that we gain from our development efforts with SURFAXIN and AEROSURF to support developmentan additional $1.0 million following completion of a potential product pipeline to address serious critical care respiratory conditions in larger children and adults in pediatric and adult intensive care units (PICUS and ICUs), including acute lung injury (ALI), chronic obstructive pulmonary disease (COPD) and cystic fibrosis (CF).  While we are currently focused on RDS, we are currently, and will consider in the future, collaborating with leadingcertain research institutions to conduct preclinical studies, including those that may be funded through various U.S. government-sponsored, biodefense-related initiatives, including NIAID.
The grant revenue in 2011 represents funds received and expended under a Fast Track SBIR from NIH to support the development of aerosolized KL4 surfactant for RDS.activities.

Cost of Product Sales

(in thousands) 
Years Ended
December 31,
 
 2013  2012  2011 
 
 
Cost of product sales $517  $–  $– 
(in thousands) 
Years Ended
December 31,
 
  2015  2014 
Cost of product sales $929  $2,671 
 
Cost of product sales for 2013 primarily reflects2015 and 2014 includes $0.7 million and $2.4 million, respectively, of inventory reserves for costs of SURFAXIN finished goods inventory that iswas not expected to be recoverable through commercial sale of the product during the initial launch period due to product expiration.  The decrease in cost of product sales from 2014 to 2015 is due to our decision in the second quarter of 2015 to cease our manufacturing and commercial activities for SURFAXIN and focus our limited resources on AEROSURF.

Research and Development Expenses

Our research and development expenses are charged to operations as incurred and we trackaccount for such costs by category rather than by project.  As many of our research and development activities form the foundation for the development of our KL4 surfactant and drug delivery technologies, they are expected to benefit more than a single project.  For that reason, we cannot reasonably estimate the costs of our research and development activities on a project-by-project basis.  We believe that tracking our expenses by category is a more accurate method of accounting for these activities.  Our research and development costs consist primarily of expenses associated with (a) product development and manufacturing, (b) medical and regulatory operations, and (c) direct preclinical and clinical programs.  We also trackaccount for research and development and report by major expense category as follows: (i) salaries and benefits, (ii) contracted services, (iii) raw materials, aerosol devices and supplies, (iv) rents and utilities, (iv)(v) depreciation, (v) raw materials and supplies, (vi) contract manufacturing, (vii) travel, (viii) stock-based compensation and (viii)(ix) other.

Research and development expenses by category for the years ended December 31, 2013, 20122015 and 20112014 are as follows:

 
Years Ended
December 31,
 
 
2013  2012  
2011(1)
 
 
(in thousands) 
Product development and manufacturing $20,471  $15,788  $12,359 
Medical and regulatory operations  5,966   4,818   3,452 
Direct preclinical and clinical programs  1,224   964   1,419 
Total Research and Development Expenses $27,661  $21,570  $17,230 

(1)  Certain prior year expenses have been reclassified to conform to 2013 presentation.
(in thousands)
 
Years Ended
December 31,
 
  2015  2014 
       
Product development and manufacturing $14,446  $14,920 
Medical and regulatory operations  7,125   8,126 
Direct preclinical and clinical programs  7,317   3,644 
Total Research and Development Expenses $28,888  $26,690 

Research and development expenses include non-cash charges associated with stock-based compensation and depreciation of $1.4 million, $1.3$1.1 million and $1.4$1.8 million for 2013, 2012,2015 and 2011,2014, respectively.

For a description of the clinical programs included in research and development expenses, See, “Item 1 – Business – Surfactant Replacement Therapy for Respiratory Medicine.Therapy.”

Product Development and Manufacturing

Product development and manufacturing includes (i) the cost of our manufacturing operations, both in-house and with our CMOs, validation activities, and quality assurance and analytical chemistry capabilities tothat support productionthe manufacture of drug supply for our KL4 surfactant products,used in conformance with current good manufacturing practices (cGMP),research and development activities, and our medical devices, including AFECTAIR, the WARMING CRADLE®, and the CAG, in accordance with Quality System Regulations (QSR),our ADS, (ii) design and development activities related to our CAG deviceADS for use in our AEROSURF phase 2 clinical program; and (iii) designpharmaceutical and development activities related to our AFECTAIR aerosol-conducting airway connector; and (iv) pharmaceuticalmanufacturing development activities, including development of a lyophilized dosage form of our KL4 surfactant.  These costs include employee expenses, facility-related costs, depreciation, costs of drug substances (including raw materials), supplies, quality control and assurance activities, analytical services, and expert consultants and outside services to support pharmaceutical and device development activities.

Product development and manufacturing expenses increased $4.7decreased $0.5 million from 20122014 to 2013 primarily2015, due to increasesa decrease of $3.6 million in (i) investmentsmanufacturing costs due to the closure of our manufacturing facility for SURFAXIN in design andTotowa, New Jersey (Totowa Facility) in June 2015, partially offset by an investment of $3.1 million in 2015 for development activities related tounder our CAGcollaboration agreement with Battelle for the further development of our ADS for use in our planned AEROSURF phase 2 clinical trials,  including work with third-party device experts and work that we began in June 2012 with Battelle Memorial Institute (Battelle), which assisted in a multi-phase project to design, test, and manufacture clinic-ready CAG devices for the AEROSURF phase 2a clinical trial; (ii) costs associated with the technical transfer and further development of our KL4 surfactant manufacturing processes at DSM; and (iii) purchases of active pharmaceutical ingredients (APIs) used in the manufacture of SURFAXIN drug product and our lyophilized KL4 surfactant, for commercial use and preclinical development activities, including to complete the technical transfer and further develop our KL4 surfactant manufacturing process at DSM, and activities to develop a clinic-ready CAG and prepare for our AEROSURF phase 2 clinicalprogram.

Product development and manufacturing expenses increased $3.4 million from 2011 to 2012 primarily due to (i) an increase in investments in manufacturing and quality activities as we prepared for commercial introduction of SURFAXIN and the AFECTAIR device for infants; (ii) costs associated with our efforts to optimize the design of our CAG with our engineering staff and third-party medical device experts, including work that we began in June 2012 with Battelle Memorial Institute (Battelle), which assisted us in a multi-phase development program focused on design, testing, and manufacturing of clinic-ready CAG devices for our AEROSURF phase 2 clinical trials, and (iii) an increase in costs associated with employee incentive compensation plans.

Product development and manufacturing expenses include non-cash charges associated with stock-based compensation and depreciation of $0.9 million, $1.0 million, and $1.2 million, for the years ended December 31, 2013, 2013 and 2011, respectively.

Consistent with our long-term strategy, in 2014 and beyond, we plan to invest in and assure long-term manufacturing development capabilities.  We currently are in discussions with the landlord of our Totowa, NJ, manufacturing operations (Totowa Facility) potentially to enable longer-term utilization of that facility for the manufacture of SURFAXIN and potentially lyophilized KL4 surfactant.  The lease for that facility currently expires on June 30, 2015.  To assure continuity of supply, we are working with DSM to provide for the manufacture of both SURFAXIN and our lyophilized KL4 surfactant for use initially in our AEROSURF development program.  We are also working to identify a second contract manufacturing organization (CMO) to potentially supply SURFAXIN commercial drug product and lyophilized KL4 surfactant. We also will continue to invest in the development of our manufacturing process for our lyophilized KL4 surfactant with DSM, and plan to manufacture drug product for preclinical and clinical activities, including for our AEROSURF phase 23 clinical program and, potentially our other KL4 surfactant development programs.  By manufacturing our drug products at our Totowa Facility and with CMOs, we believe that we will be able to bring our own manufacturing expertise to our CMOs, maintain an appropriate balance between capital investments and variable manufacturing expense, and remain flexible while potentially reducing the risk profile of meeting the long-term requirements for development andif approved, initial commercial supply of our drug products. For a discussion of our long-term business strategy to provide for the long-term continuity of supply and continued integrity and reliability of our manufacturing and quality capabilities, see,activities. “Item 1 – Business – Business Operations – Manufacturing and Distribution.”

Medical and Regulatory Operations

Medical and regulatory operations includes (i) medical, scientific, clinical, regulatory, data management and biostatistics activities in support of our research and development programs; and (ii) medical affairs activities to provide scientific and medical education support related primarily to SURFAXIN, as well asfor our other KL4 surfactant and aerosol delivery products under development.  These costs include personnel, expert consultants, outside services to support regulatory and data management, symposiums at key medical meetings, facilities-related costs, and other costs for the management of clinical trials.

Medical and regulatory operations expenses increased $1.1decreased $1.0 million from 20122014 to 2013 primarily2015 due to a full year investment$1.5 million decrease in 2013 in our medical affairs organizationactivities resulting from the cessation of manufacturing and commercial activities and the related reduction in work force that occurred beginning in April 2015, partially offset by a $0.7 million increase in preclinical and clinical capabilities to support the commercial introduction of SURFAXIN and the AFECTAIR device.

Medical and regulatory operations expenses increased $1.4 million from 2011 to 2012 primarily due to (i) investment to establish our medical affairs organization in preparation for the commercial introduction of SURFAXIN and the AFECTAIR device for infants, and (ii) costs associated with employee incentive compensation plans.

Medical and regulatory operations expenses include non-cash charges associated with stock-based compensation and depreciation of $0.4 million, $0.3 million, and $0.2 million for the years ended December 31, 2013, 2012, and 2011, respectively.AEROSURF development program.

Direct Preclinical and Clinical Programs

Direct preclinical and clinical programs include: (i) development activities, including for the AEROSURF clinical program, toxicology studies and other preclinical studies to obtain data to support our investigational new drug (IND) application and, potentially, our New Drug Application (NDA) filings for AEROSURF, and potentially our other KL4 surfactant product candidates;studies; and (ii) activities if any, associated with conducting clinical trials, including patient enrollment costs, externalclinical site costs, clinical device and drug supply, and related external costs, such as research consultant fees and expenses.

Direct preclinical and clinical programs expenses increased $3.7 million from 2014 to 2015 due to a $4.0 million increase in AEROSURF clinical trial activities, including patient enrollment in the ongoing Phase 2a clinical trial in premature infants 26 to 28 week gestational age and manufacture of additional clinic-ready ADS to support further clinical activities, including the recently initiated AEROSURF Phase 2b clinical trial, partially offset by a $0.3 million from 2012 to 2013 primarily due to investmentsdecrease in activities to prepare forpreclinical studies.

If our early clinical results are encouraging, we anticipate that our direct clinical program costs will increase significantly over the next two years as we execute the remainder of the AEROSURF phase 2 clinical development program and prepare for a potential phase 3 clinical program.  Such activities included manufacture of a sufficient number of clinic-ready CAG devicesIf successful, we estimate that direct clinical program costs for 2016 for the AEROSURF Phase 2 program will be approximately $13 to support our phase 2a clinical trial, implementation of clinical data management systems and selection of clinical site locations.  Costs in 2012 included a $0.5 million charge related to a milestone payment that became payable to Johnson and Johnson (J&J) upon FDA approval of SURFAXIN in March 2012.$15 million.

Direct preclinical and clinical programs expenses decreased $0.5 million from 2011 to 2012 primarily due to a decrease in costs associated with activities completed in 2011 to respond to a Complete Response Letter received from the FDA in 2009 (2009 Complete Response Letter), offset by a $0.5 million charge related to a milestone payment that became payable to J&J upon FDA approval of SURFAXIN in March 2012.

We anticipate that direct clinical program costs associated with conducting the AEROSURF phase 2 clinical program will be approximately $8 -10 million for 2014 through the anticipated completion of the AEROSURF phase 2 program in 2015.
Research and Development Expense by Major Expense Category

We also trackaccount for our research and development expense by major expense category as shown in the following table:

(in thousands) 
Years Ended
December 31,
 
 2013  2012  2011 
Salaries & Benefits $11,213  $9,986  $8,231 
Contracted Services  8,248   6,332   3,317 
Raw Materials & Supplies  3,633   1,652   1,871 
Rents & Utilities  1,186   1,366   1,531 
Depreciation  659   841   1,141 
Contract Manufacturing  1,441   15   143 
Travel  447   316   188 
Stock-Based Compensation  784   488   289 
All Other  50   574   519 
Total $27,661  $21,570  $17,230 
(in thousands) 
Years Ended
December 31,
 
  2015  2014 
       
Salaries & benefits $10,320  $12,755 
Contracted services  11,943   7,064 
Raw materials, aerosol devices and supplies  2,010   3,969 
Rents and utilities  1,225   1,431 
Depreciation  476   755 
Contract manufacturing  1,568   87 
Travel  616   749 
Stock-based compensation  642   1,014 
Other  863   1,315 
Allocation to batch production  (775)  (2,449)
Total $28,888  $26,690 

The increasedecrease in salaries and benefits from 20122014 to 2013 and from 2011 to 20122015 is primarily due to the establishment of our medical affairs organization primarilydecision to support thecease manufacturing and commercial introduction ofactivities for SURFAXIN and AFECTAIR, increased benefit costs and employee incentive payments.to close our Totowa Facility upon expiration of the lease on June 30, 2015.

Contracted services include the cost of preclinical studies, clinical trial activities, certain components of our manufacturing operations, quality control and analytical stability and release testing of our drug product, including our BAT, consulting services, aerosol device design and engineering services, etc.  The increase from 20122014 to 2013 and from 2011 to 20122015 is primarily due to costs associated with work that we beganAEROSURF clinical trial activities, including patient enrollment in June 2012 with Battelle to optimize design, test, and manufacture clinic-ready CAG devices to be used in our AEROSURF phasethe ongoing Phase 2a clinical trial in premature infants 26 to 28 week gestational age and investmentsmanufacture of additional clinic-ready ADS to support further clinical activities, including the recently initiated AEROSURF Phase 2b clinical trial as well as development activities under our collaboration agreement with Battelle for the further development of our ADS for use in our manufacturingplanned AEROSURF phase 3 clinical program and, quality activities as we prepare for theif approved, initial commercial introduction of SURFAXIN.activities.

Raw materials, aerosol devices and supplies consist of purchases of our active pharmaceutical ingredients (APIs) for the manufacture of our KL4 surfactant product candidates and supplies to support our manufacturing and analytical testing and development laboratories operations.  In addition, rawRaw materials, aerosol devices and supplies include component parts used in the development of our CAG and raw materials and supplies used in manufacturing and product development activities for our AFECTAIR aerosol-conducting airway connector. The increase in raw materials and suppliespurchases decreased from 20122014 to 2013 is primarily due to a $1.6 million increase in purchases of raw materials to manufacture drug product for SURFAXIN commercial supply and to support manufacturing development activities.  The decrease in raw materials and supplies from 2011 to 2012 is2015 primarily due to a decrease in purchases of raw material purchases following submissionmaterials and supplies and a decrease in 2011 ofaerosol devices for use in our response to the 2009 Complete Response Letter.AEROSURF phase 2 clinical trials.

Rents and utilities are costs related to our leased manufacturing, laboratory, and corporate facilities. The decrease from 20122014 to 20132015 is primarily due to (i) decreased rentthe expiration of the lease for our corporate and laboratory facility in Warrington, PA in connection with an amended lease agreement executed in January 2013, and (ii) decreased utility costs at our manufacturing facility.  The decrease from 2011 to 2012 is primarily due to decreased utility costs at our manufacturing facility due to decreased manufacturing activity for SURFAXIN.Totowa Facility on June 30, 2015.

Depreciation is primarily associated with leasehold improvements at our laboratories and headquarters in Warrington, Pennsylvania as well as manufacturing and laboratory equipment, and leasehold improvements at the Totowa Facility. The decrease from 2012 to 2013 and from 2011 to 2012 is primarily due to capitalized assets becoming fully depreciated.
Contract manufacturing represents costs related to the technology transfer of our liquid and lyophilized KL4 surfactant manufacturing processes to a CMO.  The increase in contract manufacturing from 2012 to 2013 was due to an increase in activities to transfer our KL4 manufacturing processes for ourCMO and manufacture of a sufficient supply of lyophilized KL4 surfactant to support the planned AEROSURF phase 2 clinical program.  The costs in 2015 related to activities to complete a technology transfer of our lyophilized surfactant manufacturing process to our CMO as well as SURFAXIN.  The decrease in contract manufacturing costs from 2011 to 2012 is due to pacing of oura second technology transfer activities while we focusedto a new facility at our efforts on responding to the 2009 Complete Response Letter and securing marketing authorization for SURFAXIN.CMO.

The category “All Other”other” consists primarily of ongoing research and development costs such as insurance, taxes, education and training and software licenses.
Allocation to batch production represents manufacturing, quality and analytical testing costs related to SURFAXIN batch production for commercial supply, medical affairs programs and other development activities.

Research and Development Projects

A substantial portion of our cumulative losses to date relate to investments in our research and development projects, for which we incurred $66.5$55.6 million in expenses for the three-yeartwo-year period ended December 31, 2013.  2015.  Due to the significant risks and uncertainties inherent in the clinical development and the regulatory approval processes, the nature, timing and costs of the efforts necessary to complete individual projects in development are not reasonably estimable.  With every phase of a development project, there are significant unknowns that may significantly affect cost projections and timelines.  As a resultIn view of the number and nature of these factors, many of which are outside our control, the success, timing of completion and ultimate cost of development of any of our product candidates is highly uncertain and cannot be estimated with any degree of certainty.

In addition to the risks and uncertainties affecting our research and development projects discussed in this MD&A including those affecting(see, “Item 1A – Risk Factors”), other risks could arise that we  may not foresee that could affect our ability to estimate projections and timelines,timelines. see, “Item 1 – Business – Government Regulation,” and “Item 1A – Risk Factors – The regulatory approval process for our products is expensive and time-consuming and the outcome is uncertain.  We may not obtain required regulatory approvals to commercialize our products;” “–

Our research and development activities involve significant risks and uncertainties that are inherent in the clinical development and regulatory approval processes;” “– Our clinical trials may be delayed, or fail, which will harm our business,” “– Manufacturing problems potentially could cause us to delay preclinical or clinical programs or, if our products are approved, product launch, or cause us to experience shortages of products inventories, which could have a material adverse effect on our business;” as well as elsewhere in this Annual Report on Form 10-K.

Our lead development projectsbeen focused initially are focused on the management of RDS in premature infants, including (i) SURFAXIN liquid instillate, which has been approved by the FDAinfants.  Our lead program, AEROSURF for the preventiontreatment of RDS at high risk for RDS, (ii) ourin premature infants, involves the following projects (i)  lyophilized KL4surfactant, which we are developing initially for use in our AEROSURF development program and, if we determine that we could gain marketing authorization for a lyophilized dosage form of SURFAXIN under a development plan that would be both capital efficient and capable of implementation within a reasonable time, we would likely implement such a plan and would plan to introduce it commercially as a life-cycle extension of SURFAXIN under the name SURFAXIN LS; and (iii) ourprogram; (ii) aerosol delivery technology, including preparationtechnologies, in particular the development and manufacture of a clinic-ready CAG deviceADS to support our AEROSURF phase 2 clinical program and further development of the ADS for use in a potential Phase 3 clinical program and, if approved initial commercial supply; and (iii) AEROSURF phase 2 clinical trial activities and preparatory work for the planned AEROSURF phase 3 clinical program.  We also developed SURFAXIN liquid instillate for the prevention of RDS in premature infants at high risk for RDS, which was approved by the FDA in 2012, but after initiating commercial activities in 2013, we determined to cease our manufacturing and commercial activities in 2015 to focus our limited resources on AEROSURF.

With respect to activities in support ofFor our AEROSURF clinical program, we are enrolling a phase 2a clinical trial and have initiated our AEROSURF phase 2b clinical trial.  We are focused on advancing the AEROSURF phase 2 clinical program.  Our lead projects, including the potential timing and milestones, are also discussed in “Item 1 – Business – Business Strategy.”  We are also planning for our potential phase 3 clinical program.  We expect to make additional investments in our development program, from 2012 through December 2013, we invested approximately $7 million to develop the CAG and complete the technology transfer and further developcapabilities, including for manufacturing development of our lyophilized KL4surfactant, manufacturing process at DSM, in preparation for initiationfurther development of our ADS under our collaboration agreement with Battelle, and the conduct of the AEROSURF phase 2 program.ongoing and planned clinical trials.  In addition, as noted above,particular, we anticipate that direct clinical program costs associated with conductingfor AEROSURF will increase significantly over the AEROSURFnext few years as we complete our phase 2 clinical program, will be approximately $8 - 10 million for 2014 throughassess the anticipated completionresults and execute the later stages of the planned AEROSURF phase 2clinical development program in 2015..

The status of our lead projects and our other pipeline candidates, including the potential timing and milestones for each, is discussed in “Item 1 – Business – Surfactant Replacement Therapy for Respiratory Medicine.”  See also, “Item 1 – Business – Business Strategy,” and “Item 1A – Risk Factors – We may not successfully develop and market our products, and even if we do, we may not become profitable,”  “– We will require significant additional capital to continue our planned research and development activities and continue to operate as a going concern.  Moreover, such additional financing could result in equity dilution.”
In the future, we expectbelieve that, if we are successful with AEROSURF, our aerosolized KL4 surfactant, alone or in combination with other pharmaceutical compounds, may be an effective intervention for people at risk for, or with, manifestations of, acute lung injury (ALI), including acute radiation exposure to the lung (acute pneumonitis and delayed lung injury), chemical-induced ALI, and influenza-induced ALI.  In addition, in the future we may explore other opportunities to apply KL4 surfactant therapies to treat conditions such as chronic sinusitis, complications of certain major surgeries, and mechanical ventilator-induced lung injury (often referred to as VILI), severe acute respiratory syndrome (SARS), pneumonia and sepsis.  However, there can be no assurance that we may be ablewill secure the additional capital needed, through government-funded grant programs or otherwise, to leverage the information, data and know-howundertake such explorations, that we gain from our development efforts with SURFAXIN and AEROSURF to support development of a potential product pipeline to address serious critical care respiratory conditions in larger children and adults in pediatric and adult intensive care units (PICUS and ICUs), including Acute Lung Injury (ALI), Chronic Obstructive Pulmonary Disorder (COPD) and Cystic Fibrosis (CF).  At the present time,will undertake such explorations or that, even if we are focusing our resources primarily on the commercial introduction of SURFAXIN and development of AEROSURF through phase 2 clinical trials.  Oncedo, that we have achieved these objectives, we believe we wouldwill be in a better position to assess the potential of other development programs to address the critical care needs of patients in the PICU and ICU.  See, “Item 1 – Business – Business Strategy,” and “– Surfactant Replacement Therapy For Respiratory Medicine.”successful.

Ultimately, if we do not successfully develop and gain marketing approval for our drug product candidates, in the U.S. or elsewhere, we will not be able to commercialize, or generate any revenues from the sale of our products and the value of our company and our financial condition and results of operations will be substantially harmed.

Selling, General and Administrative Expenses

(in thousands) 
Years Ended
December 31,
 
  2015  2014 
        
Selling, General and Administrative Expenses $11,004  $16,732 
(in thousands) Years Ended December 31, 
 
 2013  2012  2011 
Selling, General and Administrative Expenses $16,718  $16,444  $7,864 

Selling, general and administrative expenses consist primarily of the costs of sales and marketing activities, executive management, business development, intellectual property, finance and accounting, legal, human resources, information technology, facility and other administrative costs.

Selling, general and administrative expenses increased $0.3 million from 2012 to 2013 primarily due to an increase in investments in our marketing and field-based sales force to execute the commercial introduction of SURFAXIN and the AFECTAIR device for infants.  Selling, general and administrative expenses in 2012 include a $2.0 million one-time charge associated with certain contractual cash severance obligations and stock-based compensation charges related to the resignation of our former Chief Executive Officer.

 Selling, general and administrative expenses increased $8.6 million from 2011 to 2012 primarily due to (i) investments in our marketing and field-based sales force to support the anticipated commercial introduction of SURFAXIN; (ii) marketing-related activities primarily for SURFAXIN; (iii) a $2.0 million one-time charge associated with certain contractual cash severance obligations and stock-based compensation charges related to the resignation of our former Chief Executive Officer; and (iv) increased costs associated with employee incentive compensation plans.

Selling, general and administrative expenses include non-cash charges associated with stock-based compensation and depreciation of $1.5 million, $2.0$1.1 million and $0.7$2.0 million for the years ended December 31, 2013, 20122015 and 2011,2014, respectively.  The 2012 amount includes $0.8 million of stock-based compensation charges related to the resignation of our former Chief Executive Officer.

In addition to developing our commercial marketing and sales organization, we have made additional investments to enhance certain of ourSelling, general and administrative expenses decreased $5.7 million from 2014 to 2015 due to our decision in April 2015 to cease manufacturing and commercial activities for SURFAXIN and focus our limited resources including in legal, finance and accounting, and information technologies, to supporton the commercial introductiondevelopment of our products.  With these investments, we believe that our general and administrative resources will be sufficient to support our business operations.aerosolized KL4 surfactant, beginning with AEROSURF.

We plan to continue our investments in prosecuting and maintaining our existing patent portfolio and trademarks, and in protecting our existing intellectual property, and in pursuing potential additional intellectual property rights, including patents, trademarks, and trade secrets, and regulatory exclusivity designations, includingsuch as potential orphan drug, and new drug product exclusivities.  We also plan, when appropriate, to invest in potential patent extensions, new patents, new trademarks,exclusivities, Fast Track, breakthrough therapy, accelerated approval and new regulatory exclusivity designations, when available.priority review.  See, “Item 1 – Business – Licensing, Patents and Other Proprietary Rights and Regulatory Designations.”
Change in Fair Value of Common Stock Warrant Liability

(in thousands) 
Years Ended
December 31,
  
Years Ended
December 31,
 
 2013  2012  2011  2015  2014 
 
       
Change in fair value of common stock warrant liability $761  $555  $3,560  $851  $3,791 

We account for common stock warrants in accordance with applicable accounting guidance provided in ASC Topic 815, “Derivatives and Hedging – Contracts in Entity’s Own Equity”Equity (ASC 815), either as derivative liabilities or as equity instruments depending on the specific terms of the warrant agreement.  Derivative warrant liabilities are valued at the date of initial issuance and as of each subsequent balance sheet date using the Black-Scholes or trinomial pricing models, depending on the terms of the applicable warrant agreement.  Changes in the fair value of the warrants are reflected in the consolidated statement of operations as “Change in the fair value of common stock warrant liability.”

The form of warrant agreement for the registered warrants that we issued in our May 2009 and February 2010 public offerings generally provide that, in the event a related registration statement or an exemption from registration is not available for the issuance or resale of the warrant shares upon exercise of the warrant, the holder may exercise the warrant on a cashless basis.  Notwithstanding the availability of cashless exercise, generally accepted accounting principles (GAAP) provide that these registered warrants are deemed to be subject to potential net cash settlement and must be classified as derivative liabilities because (i) under federal securities laws, providing freely-tradable shares upon exercise of the warrants may not be within our control in all circumstances, and (ii) the warrant agreements do not expressly provide that there is no circumstance in which we may be required to effect a net cash settlement of the warrants.  The accounting guidance expressly precludes an evaluation of the likelihood that cash settlement could occur.  Accordingly, the May 2009 and February 2010 warrants have been classified as derivative liabilities and reported, at each balance sheet date, at estimated fair value determined using the Black-Scholes option-pricing model.

The form of warrant agreement for the registered five-year warrants that we issued in the February 2011 public offering (February 2011 five-year warrants)(2011 Warrants) contain anti-dilutive provisions that adjust the exercise price if we issue any common stock, securities convertible into common stock, or other securities (subject to certain exceptions) at a value below the then-existing exercise price of the February 2011 five-year warrants.Warrants.  Although by their express terms, these warrants are not subject to potential cash settlement, due to the nature of the anti-dilution provisions, these warrantsthey have been classified as derivative liabilities and reported, at each balance sheet date, at estimated fair value determined using a trinomial pricing model.

Changes in our common stock warrant liability are primarily related to changes in our common stock share price during the periods.

Other Income / (Expense)

(in thousands)
Years Ended
December 31,
  
Years Ended
December 31,
 
Other Income / (Expense):2013  2012  2011  2015  2014 
       
 
  
  
 
Loss on debt extinguishment $(11,758) $– 
Interest income $3  $3  $13   4   6 
Interest expense  (1,471)  (13)  (20)  (4,583)  (4,597)
Other income / (expense)  –   (41)  (6)  150   – 
Other income / (expense), net $(1,468) $(51) $(13) $(16,187) $(4,591)

The restructuring of the Deerfield Loan (see, Note 9, “Deerfield Loan”) qualifies as an extinguishment of debt in accordance with ASC 470, Debt-Modifications and Extinguishments, and as a result, we have incurred an $11.8 million non-cash loss on debt extinguishment consisting of  the difference between the reacquisition price of the Deerfield Loan and the net carrying amount of the extinguished Deerfield Loan, which includes $4.1 million in fair value of the Series A and Series B warrants issued to Deerfield as part of the $5 million of Series A and Series B units Deerfield agreed to purchase and accept in our July 2015 public offering in satisfaction of $5 million of future interest payments due under the Deerfield Notes.

Interest income consists of interest earned on our cash and cash equivalents.  To ensure preservation of capital, we invest our cash in an interest-bearing operating cash account and U.S. treasury-based money market funds.
Interest expense in 2013primarily consists of interest expense associated with the Deerfield Loan (see, “– Liquidity and Capital Resources – Deerfield Loan”) and interest expense incurred under our equipment financing facilities.  Interest expense for 2012 and 2011 consists of interest expense incurred under our equipment loan..

The following amounts comprise the Deerfield Loan interest expense for the periods presented:

(in thousands) 
Years Ended
December 31,
  December 31, 
 2015  2014 
 2013  2012  2011       
Cash interest expense $911  $–  $–  $1,451  $2,625 
Non-cash amortization of debt discounts  534   –   –   1,287   1,948 
Debt discount write-off  707   – 
Amortization of prepaid interest expense  971   – 
Amortization of debt costs  18   –   –   12   19 
Write-off of debt costs  66   – 
Total Deerfield Loan interest expenses $1,463  $–  $–   4,494  $4,592 

Cash interest expense represents interest at an annual rate of 8.75% calculated on the outstanding principal amount for the period, paid in cash on a quarterly basis.  Non-cash amortization of debt discount represents the amortization of transaction fees and the fair value of the Deerfield Warrants.  Debt discount write-off represents the proportional write-off of unamortized debt discount at the time of a $2.5 million pre-payment of principal amount outstanding under the Deerfield Loan.  Amortization of prepaid interest expense represents non-cash amortization of the $5 million of Series A and Series B units Deerfield agreed to purchase in our July 2015 public offering and accept in satisfaction of $5 million of future interest payments due under the Deerfield Notes.  The amortization of debt costs represents professional fees incurred in connection with the Deerfield Loan.Loan, and the write-off of debt costs represents the write-off of the remaining costs at the time of the debt restructuring.
 
LIQUIDITY AND CAPITAL RESOURCES

As of December 31, 2015, we had cash and cash equivalents of approximately $38.7 million, current accounts payable and accrued expenses of $10.8 million, and $25 million of long-term debt under a secured loan (Deerfield Loan) with affiliates of Deerfield Management, L.P. (Deerfield).  The principal portion of the debt is payable in two equal installments in February 2018 (subject to potential deferral in certain circumstances) and February 2019.  Before any additional financings or other transactions, we anticipate that we will have sufficient cash available to support our development programs, business operations and debt service obligations through the first quarter of 2017.
We have incurred substantial losses since inception, due to investments in research and development, manufacturing, and, more recently,the commercialization of SURFAXIN, including marketing, commercial and medical affairs activities, and we expect to continue to incur substantial losses over the next severalfour to five years.  Historically,To secure the significant additional capital that we will need, we expect to utilize all or a combination of potential strategic alliances, collaboration agreements and other strategic transactions, public or private equity offerings (including our ATM Program), or through debt arrangements.  We also believe that our success in these efforts will be largely dependent upon our ability to successfully and timely complete the AEROSURF phase 2b clinical trial.  Failure to complete the clinical trial within the expected time line in the fourth quarter of 2015 and obtain acceptable and promising results could have fundeda material adverse effect on our business operationsability to secure the additional capital that we will require, through various sources, includingstrategic transactions or otherwise, and our ability to continue as a going concern.

Our ability to secure capital under our ATM Program or pursuant to public offerings under our 2014 Universal Shelf will be constrained by the value of our equity securities held by nonaffiliated persons and privateentities (public float), which as of March 18, 2016 is approximately $13.4 million.  Our 2014 Universal Shelf was filed on Form S-3, which limits the size of primary securities offerings debt facilities, strategic alliances,conducted by companies that have a public float of less than $75 million in any 12-month period to no more than one-third of their public float.  Based on the use of committed equity financing facilities (CEFFs) and at-the-market equity programs, and capital equipment financings.

As of December 31, 2013, we had cash and cash equivalents of $86.3 million and $30 million ($18.4 million net of discount) of long-term debt under our Deerfield Loan with affiliates of Deerfield Management  Company, L.P. (Deerfield).  See, “– Deerfield Loan.”  During 2013, we raised aggregate gross proceeds of $75.8 million through public offeringsclosing market price of our common stock includingon March 18, 2016 ($1.65) we could raise up to approximately $4.5 million under our ATM Program (see, “– At-the-Market Program (ATM Program)”).2014 Universal Shelf.  To raise capital, we may be required to seek other forms of transactions, including, for example, under a registration statement on Form S-1, the preparation and maintenance of which would be more time consuming and costly, or private placements, potentially with registration rights or priced at a discount to the market value of our stock, or other transactions, any of which could result in substantial equity dilution of stockholders’ interests.  In February 2013,addition, although we entered intogave regained compliance with the Deerfield Loan and, upon executionMinimum Bid Price Requirement of the agreement, Deerfield advanced to us $10 million ($9.85 million net of transaction fee).  In May 2013, we completed a public offering of 10.847 million shares of common stock, including 1.347 million shares under an option granted to and exercised by the underwriters, at an offering price of $1.50 per share, resulting in gross proceeds of $16.3 million ($15.1 million net of commissions, discounts and expenses).  In October 2013, we completed an offering under the ATM Program and issued 713,920 shares of our common stock resulting in net proceeds to us of approximately $1.8 million (net of  commissions).  In November 2013, we completed a public offering of 28.75 million shares of common stock, including 3.75 million shares under an option granted to and exercised by the underwriters for over-allotments, at an offering price of $2.00 per share resulting in gross proceeds of $57.5 million ($53.9 million net of commissions, discounts and expenses).  In December 2013, we received an additional $20 million under the Deerfield Loan ($19.7 million net of transaction fee), which became available under the Deerfield Loan upon the first commercial sale of SURFAXIN.  Before any additional financings, including under our ATM Program, we anticipate that we will have sufficient cash available to fund our operations and debt service obligations through the third quarter of 2015.
Our future capital requirements depend upon many factors, primarily the success of our efforts to (i) execute the commercial introduction of SURFAXIN in the U.S.; (ii) advance the AEROSURF development program to completion of the phase 2 clinical program as planned in the second half of 2015; and (iii) secure one or more strategic alliances or other collaboration arrangements to support the development and, if approved, commercial introduction of AEROSURF and potentially SURFAXIN in markets outside the U.S.  We believe that, if we are able to complete the AEROSURF phase 2 clinical program on a timely basis and obtain encouraging results, and if we are able to successfully advance the commercial introduction of SURFAXIN, our ability to enter into a significant strategic alliance will be enhanced.  ThereNasdaq Listing Rules, there can be no assurance however, that our efforts will be successful, or that we will be able to obtainmaintain continued compliance, including with certain other Nasdaq listing requirements that require us to maintain a market capitalization of at least $35 million or stockholders’ equity of at least $2.5 million.  If we fail to meet both of these requirements, we would receive another delisting notice from Nasdaq, which could further depress the value of our stock. In addition, to be able to raise sufficient capital to support our activities in the near term through public or private equity offerings, given our current per share market price, we may have to seek approval from our stockholders to increase the number of shares of common stock authorized for issuance under our Certificate of Incorporation.  Moreover, if any such offering were to involve the issuance of common stock in excess of 20% of our outstanding common stock, we may be required under Nasdaq Listing Rules to seek stockholder approval before we can proceed.  There can be no assurance that we would be successful in obtaining such approvals.  Failure to secure the additional capital that we will need, whether from non-dilutive sources or from equity offerings, would have a material adverse impact on our business and our ability to continue as a going concern.
We have in the past collaborated with research organizations and universities to assess the potential utility of our KL4 surfactant in studies funded in part through non-dilutive grants issued by U.S. Government-sponsored drug development programs, including grants in support of initiatives related to our AEROSURF clinical program and medical and biodefense-related initiatives under programs that encourage private sector development of medical countermeasures against chemical, biological, radiological, and nuclear terrorism threat agents, and pandemic influenza, and provide a mechanism for federal acquisition of such countermeasures.  Although there can be no assurance, we continue to pursue such funding opportunities and expect that we may qualify for similar programs in the future.

An important priority for us is to identify potential strategic transactions, including without limitation strategic alliances and collaboration arrangements that would potentially provide additional capital to support our AEROSURF development activities when needed on acceptable terms,and strategic resources to support the registration and commercial introduction of AEROSURF.  We seek a significant strategic alliance partner that has broad experience, including local regulatory and product-development expertise and, if at all.
Even if we succeed withAEROSURF is approved, an ability to support the commercial introduction of SURFAXIN, given the time required to secure formulary acceptance at our target hospitals, we expect our revenues from SURFAXIN to be modestAEROSURF in the first 12-24 monthsEU and then increase slowly over time.  For the next several years, we expect that our cash outflows for marketing, commercial and medical activities, development programs, operations and debt service will far outpace the rate at which we may generate revenues.  Therefore, to execute our business strategy and fund our operations over the long term, we will require significant additional infusions of capital until such time as the net revenues from the sale of approved products, from potential strategic alliances and from other sources are sufficient to offset our cash flow requirements.  To secure the necessary capital to fund our development programs, we would prefer to enter into strategic alliances or collaboration arrangements with partners having broad experience inselected markets outside the U.S., including regulatory and product-development expertise as well as an ability to commercialize our products, if approved.  Such alliances typically would also provide financial resources, in the form of upfront payments, milestone payments, commercialization royalties and a sharing of research and development expenses.  Collaboration, co-marketingWe have engaged in discussions with potential counterparties and other similar arrangements would provide,a number of these entities have expressed interest in additionAEROSURF and our KL4 surfactant and drug delivery technologies.

Our future capital requirements will depend upon many factors, including our efforts to an ability(i) advance the AEROSURF development program to introduce our products in markets outside the U.S., a sharing of revenues.  Under our ATM Program, subject to market conditions, we may sell up to approximately $23 million of common stock at such times and in such amounts that we deem appropriate, subject to a 3% commission.  However, usecompletion of the ATM Program is subjectphase 2b clinical trials as planned; (ii) assure near- and long-term continuity of supply for our lyophilized KL4 surfactant and ADS and related components with CMOs to marketsupport our clinical activities, (iv) develop our ADS for use in a planned phase 3 clinical program and, other conditionsif approved, early commercial activities, (v) prepare for and the ATM Program couldconduct an AEROSURF phase 3 clinical program, which likely will be cancelled at any time by either party.  We also may consider publicdesigned to enroll significantly more premature infants than our phase 2 clinical trials, and private equity offerings(vi) secure one or more strategic alliances or other financing transactions, including potentially secured equipment financing facilities or other similar transactions.collaboration arrangements to support our development programs and commercialization of our approved products, if any.  There can be no assurance however, that our AEROSURF and other research and development projectsprogram will be successful thatwithin our products under development will obtain necessary regulatory approval in the U.S. and other markets, that any approved product, including SURFAXIN, will be commercially viable, that the ATM Program will be available when needed,anticipated time frame, if at all, orall; that we will be able to obtainsecure regulatory approval for AEROSURF and our other potential KL4 surfactant product candidates in the U.S. and other markets; or that we will be successful in securing the capital we will require when needed.  Failure to secure the necessary additional capital when needed could have a material adverse effect on acceptable terms, if at all.  our business, financial condition and results of operations and could compel us to pace, delay or cease our new product development and clinical trial activities and ultimately cease operations.  Even if we succeed in raising additional capital and developingour efforts and subsequently commercializing product candidates,commercialize our products, we may never achieve sufficient sales revenue to achieve or maintain profitability.
As of December 31, 2015, we had outstanding warrants to purchase approximately 8.5 million shares of our common stock that are exercisable at various prices on different dates into 2024.  This includes 4.8 million warrants issued in a July 2015 public offering with an exercise price of $9.80 per share, and 2.9 million pre-funded warrants, of which the entire purchase price was pre-paid upon issuance.  Upon exercise of the pre-funded warrants, we would issue the shares to the holders and receive no additional proceeds.

The accompanying financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.  ForIn the next several years,future, our ability to continue as a going concern will beis dependent on our ability to raise additional capital to fund our research and development and commercial programs and meet our obligations including debt service, on a timely basis.  If we are unable to successfully raise sufficientsecure the required additional capital, when needed, we will likely not have sufficient cash flows and liquidity to fund our business operations, which could significantly limit our ability to continue as a going concern.  In that event, we may be forced to further limit our development programs and consider other means of creating value for our stockholders, such as licensing the development andand/or commercialization of products that we consider valuable and wouldmight otherwise likelyplan to develop ourselves.  If we are unable to raise the necessary capital, we may be forced to curtail all of our activities and, ultimately, potentially cease operations.  Even if we are able to raisesecure additional capital, such financings may only be available on unattractive terms, or could result in significant dilution of stockholders’ interests and, in such event, the market price of our common stock may decline.  The balance sheetsMoreover, if we fail in the future to make any required payment under our Deerfield Loan or fail to comply with any commitments contained in the loan documents, Deerfield would be able to declare us in default regarding that indebtedness, which could result in the acceleration of the payment obligations under all or a portion of our indebtedness.  Since we have pledged substantially all of our assets to secure our obligations under the Deerfield Loan, a debt default would enable the lenders to foreclose on our assets securing the debt and could significantly diminish the market value and marketability of our common stock.  Our December 31, 2015 financial statements do not include any adjustments relating to recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue in existence.

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As of December 31, 2013, 1502015, 36 million shares of common stock and 5 million shares of preferred stock were authorized under our Amended and Restated Certificate of Incorporation and approximately 42.118.3 million shares of common stock and 5 million shares of preferred stock were available for issuance and not otherwise reserved.

In addition, as of December 31, 2013, we had outstanding warrants to purchase approximately 14.8 million shares of our common stock at various prices, exercisable on different dates into 2019.  Of these warrants, 7 million warrants were issued to Deerfield in connection with the Deerfield Loan at an exercise price of $2.81 per share.  The Deerfield Warrants may be exercised for cash or on a cashless basis.  In lieu of paying cash upon exercise, the holders also may elect to reduce the principal amount of the Deerfield loan in an amount sufficient to satisfy the exercise price of the Deerfield Warrants.  In addition to the Deerfield Warrants, we have outstanding warrants to purchase approximately 4.8 million shares of common stock that were issued in February 2011, are exercisable for five-years, and contain anti-dilution provisions that adjust the exercise price if we issue any common stock, securities convertible into common stock, or other securities (subject to certain exceptions) at a value below the then-existing exercise price of the warrants.  These warrants were originally issued with an exercise price of $3.20 per share and thereafter adjusted downward, first to $2.80 per share in March 2012 and then to $1.50 per share following a public offering in May 2013.  If the market price of our common stock should exceed $1.50 at any time prior to the expiration date of these warrants (February 2016) and if the holders determine in their discretion to exercise these warrants (and we have an effective registration statement covering the warrant shares to be issued upon exercise of the warrants), we potentially could receive up to $7.3 million. Although we believe that, in the future, we will secure additional capital from the exercise of at least a portion of our outstanding warrants, there can be no assurance that the market price of our common stock will equal or exceed price levels that make exercise of outstanding warrants likely or that holders of outstanding warrants will choose to exercise any or all of their warrants prior to the warrant expiration date.  Moreover, if our outstanding warrants are exercised, such exercises likely will be at a discount to the then-market value of our common stock and have a dilutive effect on the value of our shares of common stock at the time of exercise.
Although we currently believe that we will be able to successfully execute our business strategy, there can be no assurance that we will be successful.  We will require significant additional capital to satisfy debt obligations and sustain operations, and to complete the development and support the commercial introduction of our products.  Failure to secure the necessary additional capital would have a material adverse effect on our business, financial condition and results of operations.reserved.

Cash Flows

As of December 31, 2013, 20122015 and 2011,2014, we had cash and cash equivalents of $86.3 million, $26.9$38.7 million and $10.2$44.7 million.  Cash outflows before financing activities for 20132015 consisted of $40.5$33.5 million used for ongoing operating activities and $0.6$0.2 million for purchasesinvesting activities.  Cash provided by financing activities consisted of property$32.6 million of proceeds from the July 2015 registered public offering and equipment.  During 2013, we raised aggregate net$0.1 million of proceeds from the exercise of $100.4warrants, partially offset by $5.0 million including a $30 million ($29.6 million net of expenses) advanced underin principal payments on the Deerfield Loan $15.1and $0.1 million and $53.9 millionin repayment of net proceeds from registered public offerings that we completed in May 2013 and November 2013, respectively, and $1.8 million of net proceeds from a financing under the ATM Program.equipment loans.

Operating Activities

Net cash used in operating activities was $40.5 million, $32.9$33.5 million and $22.7$41.2 million for the years ended December 31, 2013, 20122015 and 2011,2014, respectively.  Net cash used in operating activities is a result of our net losses for the period, adjusted for non-cash items and changes in working capital.

The increase in net cash used in operating activities from 2012 to 2013 is primarily due to (i) investment in our specialty commercial and medical affairs organization that is focused on neonatal/pediatric respiratory critical care in NICUs/PICUs across the U.S., and manufacturing and quality activities in preparation for the commercial introduction of SURFAXIN; (ii) costs to develop and manufacture clinic-ready CAGs for the AEROSURF phase 2a clinical trial, including work with third party device experts and work that began June 2012 with Battelle, which assisted in a multi-phase project to design, test, and manufacture clinic-ready CAG devices; and (iii) purchases of APIs used in the manufacture of SURFAXIN drug product and our lyophilized KL
4 surfactant, for commercial use and preclinical development activities, including to complete the technical transfer and further develop our KL4 surfactant manufacturing process at DSM, and activities to develop a clinic-ready CAG and prepare for our AEROSURF phase 2 clinicalprogram.68

The increase in net cash used in operating activities from 2011 to 2012 is primarily due to (i) investments in marketing, field-based sales and medical affairs capabilities, and manufacturing and quality activities in preparation for the commercial introduction of SURFAXIN; (ii) costs to develop and manufacture clinic-ready CAGs for the AEROSURF phase 2a clinical trial, including work with third party device experts and work that began June 2012 with Battelle, which assisted in a multi-phase project to design, test, and manufacture clinic-ready CAG devices; and (iii) a one-time charge associated with certain contractual cash severance obligations and stock-based compensation charges related to the resignation of our former Chief Executive Officer.

Investing Activities

Net cash used in investing activities primarily represents capital expenditures of $0.6 million, $0.6was $0.2 million and $0.1$0.8 million for the years ended December 31, 2013, 2012,2015 and 2011, respectively.
2014, respectively, and represents capital expenditures, partially offset by proceeds from sale of property and equipment during 2015.

Financing Activities

Net cash provided by financing activities was $100.5 million, $50.2$27.7 million and $22.8$0.4 million for the years ended December 31, 2013, 2012,2015 and 2011,2014, respectively, summarized as follows:

(in millions) 
Years Ended
December 31,
 
 
 2013  2012  2011 
 
 
 
 
 
  
  
 
Financings pursuant to common stock offerings $69.0  $42.1  $21.6 
Proceeds from issuance of long-term debt, net  29.6   –   – 
Financings under the 2010 CEFF  –   –   1.3 
Exercise of common stock warrants and options  0.2   6.7   – 
Financings under the ATM Programs  1.8   3.0   – 
Debt service payments  (0.1)  (0.1)  (0.1)
Cash flows from financing activities, net $100.5  $50.2  $22.8 
(in thousands) 
Years Ended
December 31,
 
  2015  2014 
       
Issuance of securities, net of expenses $32,629  $– 
Exercise of common stock warrants and options  136   457 
Principal payments on long-term debt  (5,000)  – 
Repayment of equipment loans  (62)  (80)
Cash flows from financing activities, net $27,703  $377 

The following sections provide a more detailed discussion of our cash flows from available financing facilities and activities.

Financings Pursuant to Common Stock Offerings

Historically, we have funded, and expect tothat we will continue to fund, our business operations through various sources, including financings pursuant toin the form of common stock offerings.  In May 2014, we filed a universal shelf registration statement on Form S-3 (No. 333-196420) (2014 Universal Shelf) with the SEC that was declared effective on June 13, 2014 for the proposed offering from time to time of up to $250 million of our securities, including common stock, preferred stock, varying forms of debt and warrant securities, or any combination of the foregoing, on terms and conditions that will be determined at the time of an offering.  The 2014 Universal Shelf replaces an expired 2011 Universal Shelf.  As of December 31, 2015, after reserves for outstanding unexercised warrants and amounts remaining available under our ATM Program, approximately $139.0 million remained available under the 2014 Universal Shelf.  The 2014 Universal Shelf will expire in June 2017.

Registered Public Offerings

On November 5, 2013,July 22, 2015, we completed a registered public offering of 25,000,000 shares of our common stock,1,791,667 Series A units and 3,000,000 Series B units each at a price per unit of $2.00 per share$8.40, resulting in gross proceeds of $50.0$40.25 million ($46.837.6 million net proceeds).  We also grantedafter underwriting discount and expenses), including the exercise in full by the underwriters a 30-dayof their option to purchase up to an additional 3,750,000 shares625,000 Series A units at a price per unit of $8.40 to cover over-allotments.  The proceeds included $5.0 million in non-cash consideration from Deerfield in the form of a reduction in future interest payments due under the Deerfield Loan (see, Note 9, “Deerfield Loan”).  Each Series A unit consists of one share of common stock and a Series A warrant to purchase one share of common stock at an offeringexercise price of $2.00$9.80 per share.  On November 8, 2013,Each Series B unit consists of a fully paid pre-funded Series B warrant to purchase one share of common stock at an exercise price of $8.40 per share, and a Series B warrant to purchase one share of common stock at an exercise price of $9.80 per share.  The shares of common stock and warrants were immediately separable such that no units were issued.  The warrants are exercisable immediately at the underwriters exercised their optionelection of the holder for cash or through a net cashless exercise, provided that a holder may not exercise a warrant to the extent that after giving effect to such exercise, such holder would beneficially own in full, resulting in additional gross proceedsexcess of $7.5 million ($7.1 million net proceeds).

On May 10, 2013, we completed a registered public offering9.99% (or 4.99% as may be elected by such holder) of 9,500,000the shares of our common stock atoutstanding immediately after such exercise.  All warrants will expire on the seventh anniversary of the issue date.  The net proceeds will be used primarily (i) to advance the AEROSURF development program, and (ii) for general corporate purposes.  The offering was made pursuant to a price of $1.50 per share resulting in gross proceeds of $14.3 million ($13.2 million net proceeds).  We also grantedpreliminary prospectus supplement dated July 16, 2015 to the underwriters a 30-day option to purchase up to an additional 1,425,000 shares of common stock at an offering price of $1.50 per share.  On May 28, 2013, the underwriters exercised their option to purchase 1,347,000 shares of common stock at a price of $1.50 per share, resulting in additional gross proceeds of $2.0 million ($1.9 million net proceeds).2014 Universal Shelf.

On March 21, 2012, we completed a registered public offering of 16,071,429 shares of our common stock, at a price of $2.80 per share resulting in gross proceeds of $45.0 million ($42.1 million net proceeds).  We also granted the underwriters a 30-day option to purchase up to an additional 2,410,714 shares of common stock at an offering price of $2.80 per share, which expired unexercised in April 2012.

On February 22, 2011, we completed a registered public offering of 10,000,000 shares of our common stock, 15‑month warrants to purchase five million shares of our common stock, and five-year warrants to purchase five million shares of our common stock.  The securities were sold as units, with each unit consisting of one share of common stock, a 15-month warrant to purchase one half share of common stock, and a five-year warrant to purchase one half share of common stock, at a public offering price of $2.35 per unit, resulting in gross proceeds to us of $23.5 million ($21.6 million net).  The 15-month warrants had an exercise price per share of $2.94 and expired in May 2012.  The five-year warrants expire in February 2016 and were initially exercisable at a price per share of $3.20.  The exercise price of the five-year warrants is subject to adjustment if we issue or sell common stock or securities convertible into common stock (in each case, subject to certain exceptions) at a price (determined as set forth in the warrant) that is less than the exercise price of the warrant.  In connection with the closing of our public offerings in March 2012 and May 2013, the exercise price of the five-year warrants was adjusted downward to a price per share of $2.80 and $1.50, respectively.
In addition, withrespect to the warrants issued in connection with the foregoing offerings, the exercise price and number of shares of common stock issuable upon exercise are subject to adjustment in the event of any stock split, reverse stock split, stock dividend, recapitalization, reorganization or similar transaction.  The exercise price and the amount and/or type of property to be issued upon exercise of the warrants are also subject to adjustment if we engage in a “Fundamental Transaction” (such as consolidation or merger, sale or disposal of substantially all of our assets, and among others as defined in the form of the warrant).  The warrants are exercisable for cash only, except that if the related registration statement or an exemption from registration is not otherwise available for the resale of the warrant shares, the holder may exercise on a cashless basis.

Committed Equity Financing Facility (CEFF)

From 2004 through June 2013, we maintained one or more Committed Equity Financing Facilities (CEFFs) with Kingsbridge Capital Limited (Kingsbridge), a private investment group, under which Kingsbridge was committed to purchase, subject to certain conditions, newly-issued shares of our common stock.  The CEFFs allowed us, at our discretion, to raise capital, at the time and in amounts deemed suitable to us, to support our business plans.  We were not obligated to utilize any of the funds available under any CEFF and our ability to access funds at any time was subject to certain conditions, including stock price and volume limitations.

As of December 31, 2013, we have no CEFF agreements.  Three CEFF agreements, dated May 22, 2008, December 12, 2008, and June 11, 2010 (2010 CEFF) expired in June 2011, February 2011, and June 2013, respectively.  There were no financings under the May 2008 CEFF or December 2008 CEFF during 2013, 2012 and 2011.

The 2010 CEFF Agreement originally provided for the purchase of the lesser of up to 2.1 million shares or a maximum of $35 million, and expired in June 2013.  There were no financings completed under the 2010 CEFF in 2012 and 2013.

In 2011, we received $1.3 million of gross proceeds from the issuance of 514,990 shares at an average discounted price of $2.56 per share under the 2010 CEFF.

Warrants

During the year ended December 31, 2013,2015, holders of the February 2011 five-year warrantsWarrants exercised warrants to purchase 113,80051,193 shares of our common stock at an exercise price of $1.50$2.66 per share, resulting in proceeds to us of $170,700.$0.1 million.

During the year ended December 31, 2012,2014, holders of the 15‑month warrants that we issued in February 2011 Warrants exercised warrants to purchase 2,238,00020,346 shares of our common stock at an exercise price of $2.94$21.00 per share, resulting in proceeds to us of $6.6$0.4 million.  The remaining 15-month warrants to purchase 2,762,000 shares expired unexercised on May 22, 2012.  In addition, holders of the February 2011 five-year warrants exercised warrants to purchase 51,250 shares of our common stock at an exercise price ranging from $2.80 to $3.20 per share, resulting in proceeds to us of $162,000.  For a listing of outstanding warrants, see, “Item 8 – Notes to consolidated financial statements – Note 11 – Stockholders’ Equity – Common Shares Reserved for Future Issuance – Common shares reserved for potential future issuance upon exercise of warrants.”

At-the-Market Program (ATM Program)

Stifel ATM Program

On February 11, 2013, we entered into an At-the-Market Equity Sales Agreement (ATM Agreement) with Stifel, under which Stifel, as our exclusive agent, at our discretion and at such times that we may determine from time to time, may sell over a three-year period up to a maximum of $25,000,000 of shares of our common stock (ATM Program).  We are not required to sell any shares at any time during the term of the ATM Program.

If we issue a sale notice to Stifel, we may designate the minimum price per share at which shares may be sold and the maximum number of shares that Stifel is directed to sell during any selling period.  As a result, prices are expected to vary as between purchasers and during the term of the offering.  Stifel may sell the shares by any method deemed to be an “at-the-market” equity offering as defined in Rule 415 promulgated under the Securities Act of 1933, as amended, which may include ordinary brokers’ transactions on The Nasdaq Capital Market®, or otherwise at market prices prevailing at the time of sale or prices related to such prevailing market prices, or as otherwise agreed by Stifel and us.  Either party may suspend the offering under the ATM Agreement by notice to the other party.

The ATM Agreement, as amended on February 11, 2016, will terminate upon the earliest of: (1) the sale of all shares subject to the ATM Agreement, (2) February 11, 20162019 or (3) the termination of the ATM Agreement in accordance with its terms.  Either party may terminate the ATM Agreement at any time upon written notification to the other party in accordance with the ATM Agreement, and upon such termination, the offering will terminate.

We agreed to pay Stifel a commission equal to 3.0% of the gross sales price of any shares sold pursuant to the ATM Agreement. With the exception of expenses related to the shares, Stifel will be responsible for all of its own costs and expenses incurred in connection with the offering.

On October 15, 2013, we completed an offering under the ATM Program and issued 713,920 shares of our common stock for an aggregate purchase price of approximately $2.0 million, resulting in net proceeds to us of approximately $1.8 million, after deducting commissions.  As of December 31, 2013, approximately $23 million remained available under the ATM Program.

Lazard ATM Program

On December 14, 2011, we entered into a Sales Agency Agreement (Agency Agreement) with Lazard Capital Markets LLC (Lazard), under which Lazard, as our exclusive agent, at our discretion and at such times that we may determine from time to time, could sell over a two-year period up to a maximum of $15,000,000 of shares of our common stock through an “at-the-market” program (Lazard ATM Program).

We agreed to pay Lazard a commission equal to 3.0% of the gross proceeds of any sales under the Lazard ATM Program.  We also agreed to reimburse Lazard for certain expenses incurred in connection with entering into the Agency Agreement and provided Lazard with customary representations, warranties and indemnification rights.  In connection with initiation of coverage of our stock by an analyst affiliated with Lazard, we agreed with Lazard to terminate the Lazard ATM Program effective August 6, 2012.

On March 12, 2012, we completed an offering of 350,374 shares of our common stock for an aggregate purchase price of approximately $1.6 million, resulting in net proceeds to us of approximately $1.5 million, after deducting commissions.

Deerfield Loan

On February 13, 2013, we entered intoLong-term debt consists solely of amounts due under a secured$25 million loan facility (Deerfield Loan) with affiliates of Deerfield Management Company, L.P. (Deerfield) for up to $30 million in secured financing in 2013.  As of December 31, 2013, long-term debt consists solely of amounts due under this facility as follows:the periods presented:

(in thousands) December 31, 
Note Payable $30,000 
 2015  2014 
      
Note payable $25,000  $30,000 
Unamortized discount  (11,646)  –   (9,698)
Long-term debt, net of discount $18,354  $25,000  $20,302 

Under the terms of the relatedDeerfield loan agreement, Deerfield advanced funds to us inmade two separate disbursements.  Deerfield madeadvances, the first disbursement,upon execution of the agreement in February 2013 in the amount of $10 million, on February 13, 2013, upon execution of the related agreement (First Disbursement).  Deerfield madeand the second disbursement,upon the first commercial sale of SURFAXIN in December 2013 in the amount of $20 million, on December 3, 2013 (Second Disbursement), following the first commercial sale of SURFAXIN.
The amount received and outstanding under the Deerfield Loan will accrue interest at an annual rate of 8.75%, payable quarterly in cash.  The Deerfield Loan agreement contains customary terms and conditions but does not require us to meet minimum financial and revenue performance covenants.million. In connection with each advance, we paid Deerfield a transaction fee equal to 1.5% of the amount disbursed. The outstanding principal accrued interest at a rate of 8.75%, payable quarterly in cash. The Deerfield Loan agreement also contains variouscustomary terms and conditions, representations and warranties and affirmative and negative covenants, customary for financings of this type, including restrictions on our ability to incur additional indebtedness and grant additional liens on our assets.assets, but it does not require us to meet minimum financial and revenue performance covenants. In addition, all amounts outstanding under the Deerfield Loan may become immediately due and payable upon (i) an “Event of Default,” as defined in the Deerfield Loan agreement, in which case Deerfield would have the right to require us to repay the outstanding principal amount of the loan, plus any accrued and unpaid interest thereon, or (ii) the occurrence of certain events as defined in the facility agreement, including, among other things, the consummation of a change of control transaction or the sale of more than 50% of our assets (a Major Transaction).

In connection with theUpon execution of the Deerfield Loan, and receipt of the First Disbursement, we issued to Deerfield warrants to purchase approximately 2.30.2 million shares of our common stock at an exercise price of $2.81$39.34 per share.  Upon receipt of the Second Disbursement,second advance in December 2013, we issued to Deerfield warrants to purchase an additional 4.70.3 million shares of our common stock at an exercise price of $2.81$39.34 per share (together with the warrants issued in connection with the First Disbursement,execution of the agreement, the Deerfield Warrants).  The number of shares of common stock into which the Deerfield Warrants are exercisable and the exercise price of any Deerfield Warrant will be, and have been, adjusted to reflect any stock splits, recapitalizations or similar adjustments in the number of outstanding shares of common stock.  stock.  The Deerfield Warrants will expire on the sixth anniversary of the facilityDeerfield Loan agreement, February 13, 2019, and contain certain limitations that generally preventon the ability of a holder from acquiring shares uponto exercise of the Deerfield Warrants or any part thereof thatif after such exercise, the holder would result in the number of shares beneficially owned by such holder to exceedown more than 9.985% of the total number of shares of our common stock then issued and outstanding.  Foroutstanding.  The Deerfield Warrants may be exercised in whole or in part either for cash or on a discussioncashless basis.  In connection with a Major Transaction, as defined in the Deerfield Warrants, to the extent of additional rightsconsideration payable to stockholders in cash in connection with such Major Transaction, the holder may have the option to redeem the Deerfield Warrants or that portion of the holders, see, “Item 8 – NotesDeerfield Warrants for cash in an amount equal to consolidated financial statements – Note 9 –the Black-Scholes value (as defined in the Deerfield Loan.”Warrants) of the Deerfield Warrants or that portion of the Deerfield Warrants redeemed.  In addition, in connection with a Major Transaction, to the extent of any consideration payable to stockholders in securities, or in the event of an Event of Default, the holder may have the option to exercise the Deerfield Warrants and receive therefor that number of shares of common stock that equals the Black-Scholes value of the Deerfield Warrants or that portion of the Deerfield Warrants exercised.  Prior to a holder exercising the Deerfield Warrants for shares in such transactions, the Company may elect to terminate the Deerfield Warrants or that portion of the Deerfield Warrants being exercised and pay the holder cash in an amount equal to the Black-Scholes value of the Deerfield Warrants.

We haveinitially recorded the loan as long-term debt at its face value of $30.0 million less debt discounts and issuance costs consisting of (i) $11.7 million fair value of the Deerfield Warrants issued upon the First Disbursement and the Second Disbursement (7(0.5 million warrants in total), and (ii) a $450,000 transaction fee.  The discount iswas being accreted to the $30 million loan over its term using the effective interest method.  The Deerfield Warrants are derivatives that qualify for an exemption from liability accounting as provided for in ASC Topic 815 “Derivatives and Hedging – Contracts in Entity’s Own Equity” (ASC 815) and have been classified as equity.

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Equipmentthe amendment, (i) upon execution, we prepaid in cash $2.5 million of the principal amounts outstanding, (ii) on July 22, 2015, upon the occurrence of the July 2015 public offering, we prepaid in cash an additional $2.5 million of the principal amounts outstanding, (iii) the principal installment originally due in February 2017 was eliminated and (iv) each of the principal payments due in February 2018 and February 2019 was increased to $12.5 million.  We also paid Deerfield’s expenses (including reasonable counsel fees and expenses) incurred in connection with the amendment.  Under the Deerfield Loan agreement, the $12.5 million principal installment due in February 2018 may be deferred one year if we achieve the market capitalization milestone set forth in the Deerfield Loan agreement.

In September 2008,On July 22, 2015, we entered into a second amendment to our Deerfield Loan Agreementagreement and Security Agreement with the Commonwealth of Pennsylvania, Department of Community and Economic Development (Department),Deerfield Notes, pursuant to which (a) upon closing the Department made a loanJuly 2015 public offering on July 22, 2015, we prepaid in cash $2.5 million of the principal amounts outstanding, as contemplated by the first amendment, and (b) Deerfield purchased and accepted $5 million Series A and Series B units offered in our July 2015 public offering in satisfaction of $5 million of future interest payments due under the Deerfield Notes.  In addition, (i) we paid in cash when due on September 30, 2015, all accrued and unpaid interest under the Deerfield Notes for the period from June 30, 2015 to usJuly 22, 2015 at the original rate of 8.75%; (ii) Deerfield agreed to apply the $5 million prepaid interest accruing from the Machinery and Equipment Loan Fund in the amount of $500,000 (MELF Loan)after July 23, 2015, as and when such payments are due and payable, as follows; first, to fund the purchase and installation of new machinery and equipment and the upgrade of existing machinery and equipment at our analytical and development laboratory in Warrington, Pennsylvania.  Principal and interest accruing on the MELF Loan$12.5 million principal installment due on February 13, 2019, and second, to interest accruing on the $12.5 million principal installment due on February 13, 2018, until fully allocated, which is payable in equal monthly installments over a periodscheduled to occur at the end of seven years.  Interestthe second quarter of 2016; (iii) after the full allocation of the $5 million interest prepayment, any remaining interest due on the principal amount accruesof the Deerfield Notes will accrue at a fixed rate of five percent (5.0%)8.25% per annum.  We may prepayannum; and (iv) no credit will be given with respect to prepaid interest on principal under the MELFDeerfield Notes that is prepaid, in whole or in part, except for a prepayment at our election or a prepayment required under the Deerfield Loan at any time without penalty.agreement in connection with a Major Transaction that qualifies as a “Qualified Major Transaction.”  A “Qualified Major Transaction” means a change of control transaction (as defined in the Deerfield Warrants), in which (i) we are not the surviving entity and (ii) our common stock valuation (as defined in the Deerfield Warrants) immediately prior to the change of control transaction equals or exceeds $100 million.  In addition, we paid Deerfield’s expenses (including reasonable counsel fees and expenses) incurred in connection with the second amendment.

In addition to customary terms and conditions, the MELF Loan requires us to meet certain job retention and job creation goals in Pennsylvania within a three-year period (Jobs Covenant).  If we fail to comply with the Jobs Covenant, the Department, in its discretion, may change the interest rate on the Promissory Note to a fixed rate equal to two percentage points above the current prime rate for the remainderThe restructuring of the term.  AsDeerfield Loan was accounted for as an extinguishment of September 30, 2011, the enddebt in accordance with ASC Topic 470, Debt – Modifications and Extinguishments, and as a result, we have incurred an $11.8 million non-cash loss on debt extinguishment consisting of the three-year Jobs Covenant period,difference between the reacquisition price of the Deerfield Loan and the net carrying amount of the extinguished Deerfield Loan, which includes $4.1 million in fair value of the Series A and Series B warrants issued to Deerfield as part of the $5 million of Series A and Series B units Deerfield agreed to purchase and accept in our July 2015 public offering in satisfaction of $5 million of future interest payments due to our efforts to conserve resources while we focused on securing approval for SURFAXIN, we had not complied withunder the Jobs Covenant.  In response to a request that we filed with the Department November 2013 for a waiver, the Department granted us an extension through December 31, 2014 to come into compliance with the Jobs Covenant and has waived any interest adjustment until that date.
Deerfield Notes.
 
Contractual Obligations and Commitments

Future payments due under contractual obligations at December 31, 2013 are as follows:

(in thousands) 2014  2015  2016  2017  2018  
There-
after
  Total 
Operating lease obligations  1,087   1,024   934   936   158   –   4,139 
Equipment loan obligations (1)
  79   69   –   –   –   –   148 
Total
 $1,166  $1,093  $934  $936  $158  $–  $4,287 
(1)  See, Note 10 – Equipment LoanOperating Leases

Operating Lease AgreementsOur operating leases consist primarily of facility leases for our operations in Pennsylvania and New Jersey.

We leasemaintain our headquarters location in Warrington, Pennsylvania.  The facility consists ofis 39,594 square feet and also serves as the main operating locationfacility for drug and device development, regulatory, analytical technical services, research and development, and administration.  In January 2013, we entered into anthe lease amendmentwas amended to extend the term an additional five years from February 2013 through February 2018.  The total aggregate base rental payments under the lease prior to the extension were approximately $7.2 million and the total aggregate base rental paymentsremaining under the extended portion of the lease are approximately $4.9$2.0 million.

We also leaseUntil June 30, 2015, we leased approximately 21,000 square feet of space atfor our manufacturing operations in Totowa, Facility, our only manufacturing facility,New Jersey (Totowa Facility), at an annual rent of $150,000.  We have secured an extension of the$525,000.  The lease for this facility, which was originally scheduledused to expire in December 2014, until June 30, 2015.  We currently are in discussions with the landlord potentially to extend the lease through the end of 2016.  We are also exploring possible alternatives that could enable longer-term utilization of the Totowa Facility for the manufacture of SURFAXIN drug product, and potentially lyophilized KL4expired on June 30, 2015 surfactant.  The total aggregate payments over the term of the lease are $1.4 million.  See, “Item 1 – Business – Business Operations – Manufacturing and Distribution,” and “Item 2 – Properties.”

Rent expense under the foregoingthese leases was $1.0 million and $1.2 million for each of the years ended December 31, 2013, 20122015 and 2011,2014, respectively.

Battelle Collaboration
79
In October 2014, we entered into a collaboration agreement with Battelle providing for the further development of our ADS for potential use in our planned phase 3 clinical program for AEROSURF for the treatment of RDS in premature infants and, if AEROSURF is approved for commercial sale by the FDA or other regulatory authority, initial commercial supply.  Under our agreement, we and Battelle plan to design, develop, and complete the testing, verification, and documentation of an improved AEROSURF system, and share equally in the related development costs.  If this development project is successfully completed, based upon our current estimates, we expect to incur development costs of approximately $6.6 million through 2016.  See, “Item 8 – Notes to consolidated financial statements – Note 12 – Corporate Partnership, Licensing and Research Funding Agreements.”

Severance Arrangements

Effective February 1, 2016, we terminated the Employment Agreement of our President and Chief Executive Officer (the Former CEO).  In connection therewith, upon execution by the Former CEO of a plenary release in form satisfactory to us, he became entitled under his Employment Agreement to the following severance and other benefits, in addition to any vested benefits under our company plans or policies: (i) a pro rata bonus equal to a percentage of his Annual Bonus Amount determined by dividing the aggregate bonuses paid to other contract executives for the year 2016 by the aggregate target bonuses of such other contract executives for 2016, and further prorated for the number of days the Former CEO was employed during 2016, payable at the time that other contract executives are paid bonuses with respect to 2016; (ii) a severance amount equal to the sum of the Former CEO’s base salary then in effect and his Annual Bonus Amount, payable in equal installments through August 1, 2017 (the Severance Period); and (iii) all stock options held by the Former CEO will continue to vest during the Severance Period, and continue to be exercisable for up to 36 months after the date of termination.  From and after the end of the Severance Period, the Former CEO will forfeit all of his unvested stock options in accordance with the terms of the 2011 Plan.  The Former CEO also is subject to non-competition and non-solicitation restrictions for 12 months and 18 months, respectively, after the date of termination under a separate confidentiality agreement.  All of our obligations under the Employment Agreement will cease if at any time during the Severance Period the Former CEO engages in a material breach of the Employment Agreement and fails to cure such breach within five business days after receipt from us of notice of such breach.

In April 2015, we implemented a restructuring plan to voluntarily cease manufacturing and commercial activities for SURFAXIN and focus our resources on the development of our aerosolized KL4 surfactant pipeline for respiratory diseases, beginning with AEROSURF.  As part of a restructuring plan, we closed our Totowa Facility upon expiration of the lease on June 30, 2015.  The total severance cost for all impacted employees is $2.9 million, of which $1.0 million was accrued as of December 31, 2014 for Totowa employees.  The remaining $1.9 million was charged to expense during 2015 ($1.0 million to research and development expenses and $0.9 million to selling, general and administrative expenses).  We paid $2.6 million of the severance and retention benefits during 2015.  The remaining $0.3 million will be paid through June 30, 2016.

In April 2015, we terminated the Employment Agreement of our Senior Vice President and Chief Operating Officer (the Former COO).  In connection therewith, upon execution by the Former COO of a plenary release in form satisfactory to us, he became entitled under his Employment Agreement to the following severance and other benefits, in addition to any vested benefits under our company plans or policies: (i) a pro rata bonus in the amount of $31,000, paid in January 2016 at the time that current executives were paid bonuses for 2015; (ii) a severance amount equal to the sum of the Former COO’s base salary then in effect and his Annual Bonus Amount, payable in equal installments through April 17, 2016 (the Severance Period); and (iii) all vested stock options held by the Former COO have continued to be exercisable during the Severance Period.  The Former COO’s unvested stock options were forfeited in accordance with the terms of our 2011 Long-Term Incentive Plan.  In addition, the Former COO is subject to non-competition and non-solicitation restrictions for 12 months and 18 months, respectively, after the date of termination under a separate confidentiality agreement.  All of our obligations under the Employment Agreement will cease if at any time during the Severance Period the Former COO engages in a material breach of the Employment Agreement and fails to cure such breach within five business days after receipt from us of notice of such breach.
Severance Arrangements

On September 13,Effective November 30, 2014 we and our Senior Vice President, Research and Development (the Former Development Officer) agreed to terminate his employment under his existing Employment Agreement dated April 1, 2013 our Board(Employment Agreement).  In connection therewith, upon execution by the Former Development Officer of Directors approved an employeea plenary release in form satisfactory to us, he became entitled under his Employment Agreement to the following severance and retention plan for employees at the Totowa Facilityother benefits, in addition to take effect in the event that we are unable to secure long-term utilization of the Totowa Facility beyond the scheduled lease expiration on June 30, 2015.  The retention plan is intended to minimize employee turnover by providingany vested benefits under our company plans or policies: a severance and retention bonuses that encourage employees to stay with us through facility closing date (and beyond for certain employees).  The plan has two components: (1) plant management (three individuals) has received an award of stock options that will vest in full, and will be eligible for a retention bonus payable in June 2016, provided that they remain employed with us in June 2016; and (2) provided that they remain employed with us through the successful closure of the Totowa Facility, non-union employees (nine individuals) will be eligible to receive both severance and a retention bonus payable upon such closure.  The total cash amount expected to be paid for severance and retention through June 2016 is approximately $1.0 million.  The plan-related expense incurred during 2013 is $0.1 million and is included in research and development expense.  The related liability is $0.1 million as of December 31, 2013.

In addition, there are 14 employees at the Totowa Facility who are subject to a collective bargaining agreement and will be eligible to receive severance upon closure of the Totowa Facility.  The plan-related expense incurred during 2013 is $30,000 and is included in research and development expense.  The related liability is $0.5 million as of December 31, 2013.
In December 2012, we entered into a separation agreement (CEO Agreement) with our former Chief Executive Officer and Chairman of the Board of Directors.  Pursuant to the CEO Agreement, the executive resigned his positions with us effective December 31, 2012, and was entitled to (i) on December 31, 2012, a cash payment equal to the sum of (a) all unpaid compensation accrued through December 31, 2012, less any applicable withholding, any unreimbursed employee business expenses (subjectthe Former Development Officer’s base salary then in effect and his Annual Bonus Amount, payable in equal installments from November 30, 2014 to submission of appropriate documentation),November 30, 2015 (the Severance Period); and a severance payment in the amount of $1,250,000, less any applicable withholding; (ii) the accelerated vesting of all outstandingvested stock options which remainheld by the Former Development Officer continued to be exercisable tothrough the end of their respective stated terms;a consultancy ending on May 31, 2016.  The Former Development Officer’s unvested stock options were forfeited in accordance with the terms of our 2011 Long-Term Incentive Plan.  In addition, the Former Development Officer was made subject to non-competition and (iii) through July 31, 2013, reimbursement of $2,000 per month, plus a tax-gross up adjustment,non-solicitation restrictions for temporary living expenses.  We also agreed to pay the executive’s attorneys’ fees incurred in connection with negotiating the CEO Agreement.

In July 2011, we entered into a separation agreement (EVP Agreement) with a former executive who served as our Executive Vice President, General Counsel12 months and Corporate Secretary.  Pursuant to the EVP Agreement, the executive resigned his positions with us effective July 31, 2011, and was entitled to (i) payment of accrued vacation pay, (ii) the right to continue to hold a restricted stock award for 15,000 shares (RSA) without any continuing service obligation (as defined in the RSA), (iii) extended health benefits for up to 18 months, and, (iv) depending onrespectively, after the circumstances, outplacement services.  In addition, we paid the former executive, in 2012, severance in the amountdate of $400,000, which amount was reduced by any outstanding amount duetermination under a promissory note that the former execute had issued to us in 2001. The EVP Agreement also contained a general release by both parties and a 12-month non-competition covenant by the former executive.separate confidentiality agreement.

Off-Balance Sheet Arrangements

We did not have any material off-balance sheet arrangements at December 31, 2013, 20122015 or 2011,2014, or during the periods then ended.
 
ITEM 7A.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not applicable.
 
ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

See, Index to Consolidated Financial Statements on Page F-1 attached hereto.
80
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

Not applicable.
 
ITEM 9A.CONTROLS AND PROCEDURES.

(a) Evaluation of disclosure controls and procedures

Our management, including our President and Chief Executive Officer (principal executive officer) and our Senior Vice President and Chief Financial Officer (principal executive officer and principal financial officer), doesdo not expect that our disclosure controls or our internal control over financial reporting will prevent all error and all fraud.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.  These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake.  Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls.  The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.  Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.  Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.  In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer hashave evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K.  Based on this evaluation, our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer, to allow for timely decisions regarding required disclosures, and recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

(b) Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) promulgated under the Exchange Act.  Our internal control system is designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements.  All internal control systems, no matter how well designed, have inherent limitations.  Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer, our management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2013.2015.  In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated 19922013 Framework.  Based on our assessment, our management believes that our internal control over financial reporting is effective based on those criteria, as of December 31, 2013.2015.

Our independentThis annual report does not include an attestation report of our registered public accounting firm has audited ourregarding internal control over financial reporting,reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and issued an unqualified opinion dated March 17, 2014 on our internal control over financial reporting, which opinion is included herein.Exchange Commission that permit us to provide only management’s report in this annual report.

(c)Changes in internal controls

There were no changes in our internal control over financial reporting identified in connection with the evaluation described above that occurred during the quarter ended December 31, 20132015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

81
Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Discovery Laboratories, Inc.

We have audited Discovery Laboratories, Inc. and subsidiary’s internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (1992 framework) (the COSO criteria). Discovery Laboratories, Inc. and subsidiary’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Discovery Laboratories, Inc. and subsidiary maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Discovery Laboratories, Inc. and subsidiary as of December 31, 2013 and 2012, and the related consolidated statements of operations, changes in stockholders' equity, and cash flows for the three years in the period ended December 31, 2013 and our report dated March 17, 2014 expressed an unqualified opinion thereon.
/s/ Ernst & Young
Philadelphia, Pennsylvania
March 17, 2014
ITEM 9B.OTHER INFORMATION.

Not applicable.
PART III

Except as set forth below, the information required by Items 10 through 14 of Part III is incorporated herein by reference to our definitive proxy statement or an amendment to this annual report on Form 10-K, in either case, to be filed with the Securities and Exchange Commission within 120 days after the end of our 20122015 fiscal year.
 
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

We have adopted a Code of Business Conduct and Ethics that applies to our officers, including our principal executive, financial and accounting officers, and our directors and employees.  We have posted the Code of Business Conduct and Ethics on our Internet website at “http://www.DiscoveryLabs.com” under the “Company” tab in the Corporate Governance section.  We intend to make all required disclosures on a Current Report on Form 8-Kour website concerning any amendments to, or waivers from, our Code of Business Conduct and Ethics with respect to our executive officers and directors.  Our website and the information contained therein or connected thereto are not incorporated into this Annual Report on Form 10-K.
 
PART IV
 
ITEM 15.
EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.

The consolidated financial statements required to be filed in this Annual Report on Form 10-K are listed on the Index to Consolidated Financial Statements on page F-1 hereof.

Exhibits are listed on the Index to Exhibits at the end of this Annual Report on Form 10-K.  The exhibits required to be filed pursuant to Item 601 of Regulation S-K, which are listed on the Index in response to this Item, are incorporated herein by reference.
SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

DISCOVERY LABORATORIES, INC.
Date: March 17, 201428, 2016By:/s/ John G. CooperCraig Fraser
John G. Cooper,Craig Fraser, Director, President, and Chief Executive Officer and Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

Signature
Name & Title
Date
/s/ John G. CooperCraig Fraser
John G. Cooper
Craig FraserMarch 28, 2016
Director, President,  and Chief Executive Officer and     Chief Financial OfficerMarch 17, 2014
(Principal Executive and Principal Financial Officer)Executive)
/s/ John Tattory
John Tattory
March 28, 2016
Senior Vice President Finance, and Chief AccountingFinancial OfficerMarch 17, 2014
(Principal Financial and Accounting Officer)
/s/ John R. Leone
John R. Leone
March 28, 2016
Director (Chairman of the Board)March 17, 2014
/s/ Joseph M. Mahady
Joseph M. Mahady
Director
March 17, 2014
 
March 28, 2016
Director
/s/ Bruce A. Peacock
Bruce A. Peacock
Director
March 17, 201428, 2016
Director
/s/ Marvin E. Rosenthale
Marvin E. Rosenthale, Ph.D.
Director
March 17, 201428, 2016
Director

INDEX TO EXHIBITS

The following exhibits are included with this Annual Report on Form 10-K.

Exhibit No.
Description
Description
Method of Filing
3.1Amended and Restated Certificate of Incorporation filed as ofon August 1, 2013 including amendments reflected in a Certificate of Amendment to the Restated Certificate of Incorporation of Discovery filed on December 27, 2010, and in a Certificate of Amendment to the Restated Certificate of Incorporation of Discovery filed on October 3, 2011Incorporated by reference to Exhibit 3.1 to Discovery’s Quarterly Report on Form 10-Q, as filed with the SEC on August 8, 2013.
3.2Certificate of Amendment to Amended and Restated Certificate of Incorporation filed on June 10, 2014Incorporated by reference to Exhibit 3.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on June 10, 2014.
3.3Certificate of Amendment to Amended and Restated Certificate of Incorporation, as amended, filed on January 21, 2016Incorporated by reference to Exhibit 3.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on January 21, 2016.
3.4Certificate of Designations, Preferences and Rights of Series A Junior Participating Cumulative Preferred Stock of Discovery, dated February 6, 2004Incorporated by reference to Exhibit 2.2 to Discovery’s Form 8-A, as filed with the SEC on February 6, 2004.
3.33.5Amended and Restated By-Laws of Discovery, as amended effective September 3, 2009Incorporated by reference to Exhibit 3.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on September 4, 2009.
4.1Shareholder Rights Agreement, dated as of February 6, 2004, by and between Discovery and Continental Stock Transfer & Trust CompanyIncorporated by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on February 6, 2004.
4.2Warrant Agreement dated December 12, 2008 by and between Kingsbridge Capital Limited and DiscoveryIncorporated by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on December 15, 2008.
4.3Form of Warrant to Purchase Common Stock issued in May 2009Incorporated by reference to Exhibit 10.3 to Discovery’s Current Report on Form 8-K, as filed with the SEC on May 8, 2009.
4.4Form of Warrant to Purchase Common Stock issued in February 2010Incorporated by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on February 18, 2010.
4.5Warrant Agreement, dated as of April 30, 2010, by and between Discovery and PharmaBioIncorporated by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on April 28, 2010.
4.6Warrant Agreement dated June 11, 2010 by and between Kingsbridge Capital Limited and DiscoveryIncorporated by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on June 14, 2010.
Exhibit No.
DescriptionMethod of Filing
4.7Form of Series I Warrant to Purchase Common Stock issued on June 22, 2010 (Five-Year Warrant)Incorporated by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on June 17, 2010.
4.8
Warrant Agreement, dated as of October 12, 2010, by and between Discovery and PharmaBio
Incorporated by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on October 13, 2010.
4.9Form of Series I Warrant to Purchase Common Stock issued on February 22, 2011 (Five-Year Warrant)Incorporated by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on February 16, 2011.
4.10Form of Warrant dated February 13, 2013, issued to affiliates of Deerfield Management Co., LLP (Deerfield) under a Facility Agreement dated as of February 13, 2012 between Discovery and DeerfieldIncorporated by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on June 14, 2013.
4.114.2Form of Warrant dated December 3, 2013, issued to affiliates of Deerfield Management Co., LLP (Deerfield) on December 3, 2013 under a Facility Agreement dated as of February 13, 2012 between Discovery and DeerfieldIncorporated by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on December 6, 2013.
4.3Form of Warrant to Purchase Common Stock dated October 10, 2014, by and between Discovery and Battelle Memorial InstituteIncorporated by reference to Exhibit 4.11 to Discovery’s Quarterly Report on Form 10-Q, as filed with the SEC on November 7, 2014.
4.4Form of Warrant to Purchase Common Stock dated October 10, 2014, by and between Discovery and Battelle Memorial InstituteIncorporated by reference to Exhibit 4.12 to Discovery’s Quarterly Report on Form 10-Q, as filed with the SEC on November 7, 2014.
4.5Form of Series A Warrant dated July 22, 2015Incorporated by reference to Exhibit 4.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on July 17, 2015.
4.6Form of Pre-Funded Series B Warrant dated July 22, 2015Incorporated by reference to Exhibit 4.2 to Discovery’s Current Report on Form 8-K, as filed with the SEC on July 17, 2015.
 
Exhibit No.
Description
Method of Filing
4.7Form of Series B Warrant dated July 22, 2015Incorporated by reference to Exhibit 4.3 to Discovery’s Current Report on Form 8-K, as filed with the SEC on July 17, 2015.
10.1+
 
Sublicense Agreement, dated as of October 28, 1996, between Johnson & Johnson, Ortho Pharmaceutical Corporation and Acute Therapeutics, Inc.Incorporated by reference to Exhibit 10.6 to Discovery’s Registration Statement on Form SB-2/A, as filed with the SEC on April 18, 1997 (Commission File Number 333-19375).
10.2 +Amended and Restated License Agreement by and between Discovery and Philip Morris USA Inc., d/b/a/ Chrysalis Technologies, dated March 28, 2008Incorporated by reference to Exhibit 10.4 to Discovery’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008, as filed with the SEC on May 9, 2008.
10.3 +License Agreement by and between Discovery and Philip Morris Products S.A., dated March 28, 2008Incorporated by reference to Exhibit 10.5 to Discovery’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2008, as filed with the SEC on May 9, 2008.
10.4+
 
Amended and Restated Sublicense and Collaboration Agreement made as of December 3, 2004, between Discovery and Laboratorios del Dr. Esteve, S.A.Incorporated by reference to Exhibit 10.28 to Discovery’s Annual Report on Form 10-K for the year ended December 31, 2004, as filed with the SEC on March 16, 2005.
10.5+Amended and Restated Supply Agreement, dated as of December 3, 2004, by and between Discovery and Laboratorios del Dr. Esteve, S.A.Incorporated by reference to Exhibit 10.29 to Discovery’s Annual Report on Form 10-K for the year ended December 31, 2004, as filed with the SEC on March 16, 2005.
 
10.6*Discovery’s 2007 Long Term Incentive PlanIncorporated by reference to Exhibit 1.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on June 28, 2007.
Exhibit No.
DescriptionMethod of Filing
 
10.7*Form of 2007 Long-Term Incentive Plan Stock Option AgreementIncorporated by reference to Exhibit 10.3 to Discovery’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2007, as filed with the SEC on August 9, 2007.
10.8*
 
Discovery’s 2011 Long-Term Incentive PlanIncorporated by reference to Appendix II to Discovery’s Definitive Proxy Statement on Form DEF 14A, as filed with the SEC on August 15, 2011 (Commission File Number 000-26422).
10.9*Form of Employee Option Agreement under Discovery’s 2011 Long-Term Incentive PlanIncorporated by reference to Exhibit 10.2 to Discovery’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, as filed with the SEC on May 15, 2012.
10.10*Form onof Non-Employee Director Option Agreement under Discovery’s 2011 Long-Term Incentive PlanIncorporated by reference to Exhibit 10.3 to Discovery’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, as filed with the SEC on May 15, 2012.
Exhibit No.
Description
Method of Filing
10.11*Form of Restricted Stock Unit Award Agreement for Non-Employee Directors under Discovery’s 2011 Long-Term Incentive PlanIncorporated by reference to Exhibit 10.11 to Discovery’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the SEC on March 16, 2015.
10.12*
Discovery’s Amended and Restated 2011 Long-Term Incentive Plan effective as of January 22, 2016Filed herewith.
10.13*Employment Agreement by and between the Company and Craig Fraser dated as of May 4, 2012 between Discovery and John G. CooperFebruary 1, 2016.Incorporated by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on May 10, 2012.February 3, 2016
10.12*10.14*EmploymentInducement Stock Option Award Agreement dated as of AprilFebruary 1, 2013,2016 between Craig Fraser and Discovery Laboratories, Inc. and John G. Cooperunder Discovery’s 2011 Long-Term Incentive PlanIncorporated by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on April 2, 2013.
10.13*Employment Agreement dated as of May 4, 2012 between Discovery and Thomas F. MillerIncorporated by reference to Exhibit 10.3 to Discovery’s Current Report on Form 8-K, as filed with the SEC on May 10, 2012February 3, 2016.
10.15*Employment Agreement dated as amendedof December 19, 2014, by and between Discovery and Steven G. Simonson, M.D.Incorporated by reference to Exhibit 10.110.4 to Discovery’s CurrentQuarterly Report on Form 8-K/A,10-Q, as filed with the SEC on May 11, 2012.2015.
10.14*10.16*Amendment dated December 29, 2014 to Employment Agreement dated as of December 19, 2014, effective as of April 1, 2015, by and between Discovery and Steven G. Simonson, M.D.Incorporated by reference to Exhibit 10.5 to Discovery’s Quarterly Report on Form 10-Q, as filed with the SEC on May 11, 2015.
10.17*Employment Agreement dated as of April 1, 2013,March 21, 2014, by and between Discovery Laboratories, Inc. and Thomas F. Miller, Ph.D., MBAJohn A. TattoryIncorporated by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on April 2, 2013.
10.15*
Employment Agreement dated as of April 1, 2013, between Discovery Laboratories, Inc. and Russell G. ClaytonFiled herewith.
 
10.16*
Employment Agreement dated as of April 1, 2013, between Discovery Laboratories, Inc. and Mary B. TempletonFiled herewith.
Exhibit No.
DescriptionMethod of Filing
10.17
Assignment of Lease and Termination and Option Agreement, dated as of December 30, 2005, between Laureate Pharma, Inc. and DiscoveryIncorporated by reference to Exhibit 10.1 to Discovery’s Annual Report on Form 10-K for the year ended December 31, 2005, as filed with the SEC on March 16, 2006.
10.18Extension, dated as of July 16, 2013, of Lease dated as of December 3, 2004, between Discovery, as successor-in-interest to Laureate Pharma, Inc., and Norwell Land Company, with respect to property at 710 Union Blvd., Totowa, NJ 07512
Incorporated by reference to Exhibit 10.1 to Discovery’s Quarterly Report on Form 10-Q, as filed with the SEC on August 8, 2013.
May 12, 2014.
10.18*Amendment dated December 29, 2014 to Employment Agreement dated as of March 21, 2014, by and between Discovery and John A. TattoryIncorporated by reference to Exhibit 10.19 to Discovery’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the SEC on March 16, 2015.
10.19Form of Indemnification Agreement between the Company and its named executive officers, including Craig Fraser, and directors.Incorporated by reference to Exhibit 10.4 to Discovery’s Current Report on Form 8-K, as filed with the SEC on February 3, 2016
10.20Lease Agreement dated May 26, 2004, and First Amendment to Lease Agreement, dated April 2, 2007, by and between TR Stone Manor Corp. and Discovery
Incorporated by reference to Exhibits 10.1 and 10.2 to Discovery’s Current Report on Form 8-K, as filed with the SEC on April 6, 2007.
 
10.2010.21Second Amendment  to Lease Agreement, dated January 3, 2013 by and between TR Stone Manor Corp. and DiscoveryIncorporated by reference to Exhibits 10.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on January 8, 2013.
Exhibit No.
Description
Method of Filing
10.21
10.22+Master Services Agreement dated October 24, 2013 between Discovery and DSM Pharmaceuticals, Inc. (now known as Patheon Manufacturing Services LLC)Incorporated by reference to Exhibit 10.2 to Discovery’s Quarterly Report on Form 10-Q, as filed with the SEC on November 12, 2013.
10.23+Supply Agreement dated as of December 22, 2010 between by and between Corden Pharma (formerly Genzyme Pharmaceuticals LLC, now known as Corden Pharma) and DiscoveryIncorporated by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on December 29, 2010.
10.2210.24+Product DevelopmentCollaboration Agreement made as of October 10, 2014, by and Supply Agreement between Discovery and Lacey Manufacturing Company, a Division of Precision Engineered Products, LLCBattelle Memorial InstituteIncorporated by reference to Exhibit 10.1 to Discovery’s Quarterly Report on Form 10-Q, for the quarter ended March 31, 2012, as filed with the SEC on May 15, 2012.November 7, 2014.
10.2310.25Research and Development ServicesAmendment dated as of August 4, 2015 to Collaboration Agreement dated as of October 14, 2014 between Discovery and Battelle Memorial Institute, dated June 22, 2012Institute.Incorporated by reference to Exhibit 10.4 of10.3 to Discovery’s Quarterly Report on Form 10-Q, as filed with the SEC on August 14, 2012.10, 2015.
10.2410.30+Facility Agreement dated as of February 13, 2013, between Discovery and DeerfieldIncorporated by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K/A, as filed with the SEC on March 15, 2013.
10.2510.31Amendment dated July 9, 2015 to Facility Agreement dated February 13, 2013 by and between the Company and DeerfieldIncorporated by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on July 9, 2015.
10.32Second Amendment dated July 22, 2015 to Facility Agreement dated February 13, 2013 by and between the Company and DeerfieldIncorporated by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on July 24, 2015.
10.33Registration Rights Agreement dated as of February 13, 2013, between Discovery and DeerfieldIncorporated by reference to Exhibit 10.2 to Discovery’s Current Report on Form 8-K/A, as filed with the SEC on March 15, 2013.
Exhibit No.
DescriptionMethod of Filing
 
10.2610.34Security Agreement dated as of February 13, 2013, between Discovery and DeerfieldIncorporated by reference to Exhibit 10.3 to Discovery’s Current Report on Form 8-K/A, as filed with the SEC on March 15, 2013.
10.2710.35At-the-Market Equity Offering Sales Agreement dated February 11, 2013 between Discovery and Stifel Nicolaus & Company, IncorporatedIncorporated by reference to Exhibit 10.1 to Discovery’s Current Report on Form 8-K, as filed with the SEC on February 13, 2013.
10.2810.36Pharmaceutical Manufacturing and SupplyAmendment No. 1 dated February 11, 2016, to the At-the-Market Equity Offering Sales Agreement dated August 7,February 11, 2013 between Discovery and DSM Pharmaceuticals, Inc.Stifel Nicolaus & Company, IncorporatedIncorporated by reference to Exhibit 10.210.1 to Discovery’s QuarterlyCurrent Report on Form 10-Q,8-K, as filed with the SEC on August 8, 2013.February 16, 2016.
10.29Master Services Agreement dated October 24, 2013 between Discovery and DSMIncorporated by reference to Exhibit 10.2 to Discovery’s Quarterly Report on Form 10-Q, as filed with the SEC on November 12, 2013.
21.1
Subsidiaries of DiscoveryFiled herewith.
Exhibit No.
Description
Method of Filing
23.1
Consent of Ernst & Young LLP, independent registered public accounting firmFiled herewith.
31.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange ActFiled herewith.
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002Filed herewith.
101.1The following consolidated financial statements from the Discovery Laboratories, Inc. Annual Report on Form 10-K for the year ended December 31, 2013,2015, formatted in Extensive Business Reporting Language (“XBRL”): (i) Balance Sheets as of December 31, 2013, December 31, 20122015 and December 31, 2011,2014, (ii) Statements of Operations for the years ended December 31, 2013, December 31, 2012,2015 and December 31, 2011,2014, (iii) Statements of Changes in Equity for the years ended December 31, 2013, December 31, 2012,2015 and December 31, 2011,2014, (iv) Statements of Cash Flows for the years ended December 31, 2013, December 31, 2012,2015 and December 31, 2011,2014, and (v) Notes to consolidated financial statements.
101.INSInstance DocumentFiled herewith.
101.SCHXBRL Taxonomy Extension Schema DocumentFiled herewith.
Exhibit No.
DescriptionMethod of Filing
 
101.CALXBRL Taxonomy Extension Calculation Linkbase DocumentFiled herewith.
101.DEFXBRL Taxonomy Extension Definition Linkbase DocumentFiled herewith.
101.LABXBRL Taxonomy Extension Label Linkbase DocumentFiled herewith.
101.PREXBRL Taxonomy Extension Presentation Linkbase DocumentFiled herewith.

+Confidential treatment requested as to certain portions of these exhibits.  Such portions have been redacted and filed separately with the Commission.
+          Confidential treatment requested as to certain portions of these exhibits.  Such portions have been redacted and filed separately with the Commission.

*          A management contract or compensatory plan or arrangement required to be filed as an exhibit to this annual report pursuant to Item 15(b) of Form 10-K.
 
*A management contract or compensatory plan or arrangement required to be filed as an exhibit to this annual report pursuant to Item 15(b) of Form 10-K.
81
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY

Contents

Contents
Page
Consolidated Financial Statements
Report of Independent Registered Public Accounting FirmF-2
Balance Sheets as of December 31, 20132015 and December 31, 20122014F-3
Statements of Operations for the years ended December 31, 2013, 2012,2015 and 20112014F-4
Statements of Changes in Stockholders’ Equity for the years ended December 31, 2013, 2012,2015 and 20112014F-5
Statements of Cash Flows for the years ended December 31, 2013, 2012,2015 and 20112014F-6
Notes to consolidated financial statementsF-7
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
 
Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Discovery Laboratories, Inc.

We have audited the accompanying consolidated balance sheets of Discovery Laboratories, Inc. and subsidiary(the Company) as of December 31, 20132015 and 2012,2014, and the related consolidated statements of operations, changes in stockholders'stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013.then ended. These financial statements are the responsibility of the Company'sCompany’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includesstatements, assessing the accounting principles used and significant estimates made by management, as well asand evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Discovery Laboratories, Inc. and subsidiary at December 31, 20132015 and 2012,2014, and the consolidated results of theirits operations and theirits cash flows for each of the three years in the periodthen ended, December 31, 2013, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Discovery Laboratories, Inc. and subsidiary's internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission  (1992 framework) and our report dated March 17, 2014 expressed an unqualified opinion thereon.
/s/ Ernst and Young LLP
Philadelphia, Pennsylvania
March 28, 2016
 
Philadelphia, Pennsylvania
F-2
March 17, 2014
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY

Consolidated Balance Sheets
(in thousands, except share and per share data)

 December 31,  December 31,  
December 31,
2015
  
December 31,
2014
 
 2013  2012       
ASSETS 
  
       
Current Assets: 
  
       
Cash and cash equivalents $86,283  $26,892  $38,722  $44,711 
Accounts receivable  67   – 
Inventory, net  112   195   –   27 
Prepaid interest, current portion  1,710   – 
Prepaid expenses and other current assets  777   719   362   821 
Total current assets  87,239   27,806   40,794   45,559 
                
Property and equipment, net  1,656   1,737   1,039   1,637 
Restricted cash  325   400   225   225 
Prepaid interest, non-current portion  2,319   – 
Other assets  97   –   –   78 
Total assets  89,317   29,943  $44,377  $47,499 
                
LIABILITIES & STOCKHOLDERS’ EQUITY                
Current Liabilities:                
Accounts payable $1,433  $1,166  $3,263  $350 
Accrued expenses  4,785   4,159   7,582   6,116 
Deferred revenue  139   –   –   43 
Common stock warrant liability  5,425   6,305   223   1,258 
Equipment loans, current portion  73   69   –   62 
Total current liabilities  11,855   11,699   11,068   7,829 
                
Long-term debt, net of discount of $11,646 at December 31, 2013 and $0 at December 31, 2012  18,354   – 
Equipment loans, non-current portion  69   148 
Long-term Debt:        
Long-term debt, gross  25,000   30,000 
Discount on long-term debt  –   (9,698)
Long-term debt, net  25,000   20,302 
        
Other liabilities  538   443   43   169 
Total liabilities $30,816  $12,290   36,111   28,300 
                
Stockholders’ Equity:                
Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued or outstanding  –   –   –   – 
Common stock, $0.001 par value; 150,000,000 and 100,000,000 shares authorized at December 31, 2013 and 2012, respectively; 84,659,111 and 43,673,636 shares issued at December 31, 2013 and 2012, respectively; 84,638,219 and 43,652,744 shares outstanding at December 31, 2013 and 2012, respectively  85   44 
Common stock, $0.001 par value; 36,000,000 shares authorized; 8,196,011 and 6,114,843 shares issued at December 31, 2015 and 2014, respectively; 8,194,519 and 6,113,351 shares outstanding at December 31, 2015 and 2014, respectively
  8   6 
Additional paid-in capital  541,420   455,398   590,490   546,255 
Accumulated deficit  (479,950)  (434,735)  (579,178)  (524,008)
Treasury stock (at cost); 20,892 shares at December 31, 2013 and 2012  (3,054)  (3,054)
Treasury stock (at cost); 1,492 shares  (3,054)  (3,054)
Total stockholders’ equity $58,501  $17,653   8,266   19,199 
Total liabilities & stockholders’ equity $89,317  $29,943  $44,377  $47,499 

See notes to consolidated financial statements
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
 
Consolidated Statements of Operations
(in thousands, except per share data)

 Year Ended December 31,  Year Ended December 31, 
 
  
  2015  2014 
 2013  2012  2011       
Revenues:      
Product sales $7  $312 
Grant revenue  980   2,523 
 
  
  
   987   2,835 
Grant revenue
 $388  $195  $582 
Expenses:                    
Cost of product sales517--  929   2,671 
Research & development  27,661   21,570   17,230 
Selling, general & administrative  16,718   16,444   7,864 
Total expenses  44,896   38,014   25,094 
Research and development  28,888   26,690 
Selling, general, and administrative  11,004   16,732 
  40,821   46,093 
Operating loss  (44,508)  (37,819)  (24,512)  (39,834)  (43,258)
                    
Change in fair value of common stock warrant liability  761   555   3,560   851   3,791 
                    
Other income / (expense):                    
Loss on debt extinguishment  (11,758)  – 
Interest and other income  3   6   13   237   6 
Interest and other expense  (1,471)  (57)  (26)  (4,666)  (4,597)
Other income / (expense), net  (1,468)  (51)  (13)  (16,187)  (4,591)
                    
Net loss $(45,215) $(37,315) $(20,965) $(55,170) $(44,058)
Net loss per common share – basic and diluted $(0.82) $(0.95) $(0.93)
Weighted average number of common shares outstanding – basic and diluted  55,258   39,396   22,660 
Net loss per common share        
Basic $(7.98) $(7.28)
Diluted $(7.98) $(7.84)
        
Weighted average number of common shares outstanding
        
Basic  6,967   6,078 
Diluted  6,967   6,145 

See notes to consolidated financial statements
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders’ Equity

(In thousands)
 
Common Stock
  
    Treasury Stock   
 
 Shares  Amount  
Additional
Paid-in
Capital
  
Accumulated
Deficit
  Shares  Amount  Total 
 
 
  
  
  
  
  
  
 
Balance – January 1, 2011  13,822  $14  $385,521  $(376,455)  (21) $(3,054) $6,026 
Net loss  –   –   –   (20,965)  –   –   (20,965)
Issuance of common stock, restricted stock awards  1   –   –   –   –   –   – 
Issuance of common stock, 401(k) Plan employer match  265   –   497   –   –   –   497 
Issuance of common stock, February 2011 financing  10,000   10   13,513   –   –   –   13,523 
Issuance of common stock, CEFF financings  515   1   1,315   –   –   –   1,316 
Stock-based compensation expense  –   –   867   –   –   –   867 
Balance – December 31, 2011  24,603  $25  $401,713  $(397,420)  (21) $(3,054) $1,264 
Net loss  –   –   –   (37,315)  –   –   (37,315)
Issuance of common stock, March 2012 financing  16,072   16   42,074   –   –   –   42,090 
Issuance of common stock, ATM financing  350   1   1,460   –   –   –   1,461 
Issuance of common stock, 401(k) Plan employer match  317   –   763   –   –   –   763 
Exercise of common stock warrants  2,289   2   6,875   –   –   –   6,877 
Exercise of stock options for cash  3   –   6   –   –   –   6 
Issuance of common stock, consultants  40   –   96   –   –   –   96 
Stock-based compensation expense  –   –   2,411   –   –   –   2,411 
Balance – December 31, 2012  43,674  $44  $455,398  $(434,735)  (21) $(3,054) $17,653 
Net loss  –   –   –   (45,215)  –   –   (45,215)
Issuance of common stock, May 2013 financing  10,847   11   15,102   –   –   –   15,113 
Issuance of common stock, November 2013 financing  28,750   29   53,836   –   –   –   53,865 
Issuance of common stock, ATM financing  714   1   1,795   –   –   –   1,796 
Issuance of common stock warrants, Deerfield  –   –   11,729   –   –   –   11,729 
Issuance of common stock, 401(k) Plan employer match  510   –   959   –   –   –   959 
Exercise of common stock warrants  114   –   290   –   –   –   290 
Exercise of stock options for cash  18   –   34   –   –   –   34 
Issuance of common stock, consultants  32   –   67   –   –   –   67 
Stock-based compensation expense  –   –   2,210   –   –   –   2,210 
Balance – December 31, 2013  84,659  $85  $541,420  $(479,950)  (21) $(3,054) $58,501 
Consolidated Statements of Changes in Stockholders’ Equity 
 
(In thousands)
 
Common Stock
        Treasury Stock   
  Shares  Amount  
Additional
Paid-in
Capital
  
Accumulated
Deficit
  Shares  Amount  Total 
                      
Balance – January 1, 2014  6,047  $6  $541,499  $(479,950)  (1) $(3,054) $58,501 
Net Loss  –   –   –   (44,058)  –   –   (44,058)
Issuance of common stock, 401(k) Plan employer match  43   –   944   –   –   –   944 
Exercise of common stock warrants  20   –   803   –   –   –   803 
Exercise of stock options for cash  1   –   30   –   –   –   30 
Issuance of common stock, consultants  1   –   38   –   –   –   38 
Stock-based compensation expense  3   –   2,941   –   –   –   2,941 
Balance – December 31, 2014  6,115  $6  $546,255  $(524,008)  (1) $(3,054) $19,199 
Net Loss  –   –   –   (55,170)  –   –   (55,170)
Issuance of common stock, July 2015 financing  1,792   2   37,626   –           37,628 
Issuance of common stock, 401(k) Plan employer match  94   –   539   –   –   –   539 
Issuance of common stock warrants  –   –   4,053   –   –   –   4,053 
Exercise of common stock warrants  194   –   320   –   –   –   320 
Stock-based compensation expense  1   –   1,697   –   –   –   1,697 
Balance – December 31, 2015  8,196  $8  $590,490  $(579,178)  (1) $(3,054) $8,266 
 
See notes to consolidated financial statements

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY

Consolidated Statements of Cash Flows
(In thousands)

 Year Ended December 31,  Year Ended December 31, 
 
  
  
       
 2013  2012  2011  2015  2014 
Cash flows from operating activities: 
  
  
       
Net loss $(45,215) $(37,315) $(20,965) $(55,170) $(44,058)
Adjustments to reconcile net loss to net cash used in operating activities:                    
Depreciation and amortization  707   1,150   1,234   712   818 
Provision for excess inventory  514   –   – 
Stock–based compensation and 401(k) Plan employer match  3,236   3,270   1,364 
Change in provision for excess inventory  (174)  1,873 
Stock–based compensation and 401(k) plan employer match  2,235   3,923 
Fair value adjustment of common stock warrants  (761)  (555)  (3,560)  (851)  (3,791)
Amortization of discount of long-term debt  534   –   –   1,287   1,948 
Loss on disposal of equipment  –   42   45 
Loss on debt extinguishment  11,758   – 
Debt discount write-off  707   – 
Loss on sale of equipment  84   – 
Reduction in required restricted cash under lease agreement75––  –   100 
Amortization of prepaid interest  971   – 
Changes in:                    
Inventory  (431)  (195)  –   201   (1,788)
Accounts receivable  (67)  –  –
Accounts receivables  –   67 
Prepaid expenses and other current assets(58)(277)(157)  459   (44)
Accounts payable  267   55   (574)  2,913   (1,083)
Accrued expenses  626   1,187   (314)  1,466   1,331 
Deferred revenue  139   –   –   (43)  (96)
Other assets  (115)  –   174   67   – 
Other liabilities  95   (246)  55   (126)  (369)
Net cash used in operating activities  (40,454)  (32,884)  (22,698)  (33,504)  (41,169)
                    
Cash flows from investing activities:                    
Purchase of property and equipment(608)(636)(106)  (458)  (780)
Proceeds from sale of property and equipment  270   – 
Net cash used in investing activities  (608)  (636)  (106)  (188)  (780)
                    
Cash flows from financing activities:                    
Proceeds from issuance of securities, net of expenses  70,774   43,551   22,927   32,629   – 
Proceeds from issuance of long-term debt  30,000   –   – 
Payment of debt issuance costs  (450)  –   – 
Proceeds from exercise of common stock warrants and options  204   6,747   –   136   457 
Principal payments under equipment loans  (75)  (75)  (145)
Principal payments on long-term debt  (5,000)  – 
Repayment of equipment loans  (62)  (80)
Net cash provided by financing activities  100,453   50,223   22,782   27,703   377 
Net increase / (decrease) in cash and cash equivalents  59,391   16,703   (22)
Net decrease in cash and cash equivalents  (5,989)  (41,572)
Cash and cash equivalents – beginning of year  26,892   10,189   10,211   44,711   86,283 
Cash and cash equivalents – end of year $86,283  $26,892  $10,189  $38,722  $44,711 
                    
Supplementary disclosure of cash flows information:                    
Interest paid $920  $13  $20  $1,468  $2,630 
 
See notes to consolidated financial statements

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Note 1 – The Company and Description of Business

Discovery Laboratories, Inc. (referred to as “we,” “us,” or the “Company”) is a specialty biotechnology company focused on creating life-saving productsdeveloping novel KL4 surfactant therapies for critical-care patients with respiratory diseasediseases and improvingother potential applications.  Surfactants are produced naturally in the standard of care in pulmonary medicine.lung and are essential for normal respiratory function and survival.  Our proprietary drug technology producesplatform includes a synthetic, peptide-containing surfactant (KL4 surfactant) that is structurally similar to endogenous pulmonary surfactant, a substance produced naturally in the lung and essential for normal respiratory function and survival.  We are developing our KL4 surfactant in liquid, lyophilized and aerosolized dosage forms.  We are also developing novel drug delivery technologies potentiallybeing developed to enable efficient deliverynoninvasive administration of our aerosolized KL4 surfactant.  We believe that our proprietary technologiestechnology platform may make it possible for the first time, to develop a significant pipeline of surfactant products to address a variety of respiratory diseases for which there frequently are few or no approved therapies.

We are initiallyOur core development program, AEROSURF® (lucinactant for inhalation), is focused on improving the management of respiratory distress syndrome (RDS) in premature infants.  RDS isinfants, a serious respiratory condition caused by insufficientthat can result in long-term respiratory problems, developmental delay and death.  Premature infants born prior to 37 weeks gestational age may not have fully developed natural lung surfactant production in underdeveloped lungsand therefore may need surfactant therapy to sustain life.  Higher incidence and severity of RDS are correlated with younger gestational ages; however, RDS can occur at any premature infants.gestational age.  RDS is the most prevalent respiratory disease in the Neonatal Intensive Care Unitneonatal intensive care unit (NICU).  Surfactant therapy is a life-saving treatment for RDS and canthe primary therapy to address an underlying surfactant deficiency.  Surfactants currently available in the U.S. are animal-derived and must be administered using invasive endotracheal intubation and mechanical ventilation, each of which may result in long-termserious respiratory problems, developmental delayconditions and death.other complications.  Intubation is associated with airway trauma and clinical instability that can extend beyond the respiratory system such as increased intracranial pressure and risk for brain injury.  Mechanical ventilation is associated with ventilator-associated lung injury, chronic lung disease and increased risk of infection.  To avoid these risks, many premature infants are initially treated with noninvasive respiratory support, such as nasal continuous positive airway pressure (nCPAP).  Unfortunately, since nCPAP does not address the underlying surfactant deficiency, many premature infants respond poorly to nCPAP (typically within the first 72 hours of life) and may require intubation and delayed surfactant therapy (an outcome referred to as nCPAP failure).  In addition, many premature infants with RDS who receive surfactant therapy as initial therapy are capable of breathing without mechanical ventilation, but require surfactant therapy for RDS.  Because surfactant therapy requires intubation, these infants generally are supported with mechanical ventilation for either a limited or extended period of time.  If surfactant therapy could be administered noninvasively, neonatologists would be able to provide surfactant therapy to these premature infants without exposing them to the risks associated with intubation and mechanical ventilation.

Our firstAEROSURF is an investigational combination drug/device product that combines our proprietary KL4surfactant with our novel aerosol delivery system (ADS), which is based primarily on our capillary aerosol generator technology.  We are developing AEROSURF to enable administration of aerosolized KL4 surfactant to premature infants receiving nCPAP, without invasive intubation and mechanical ventilation.  We believe that, if approved, AEROSURF will have the potential to transform the treatment of RDS, allow for earlier treatment of those premature infants who currently receive surfactants later in their course of treatment, decrease the morbidities and complications currently associated with surfactant administration, and reduce the number of premature infants who are subjected to invasive intubation and delayed surfactant therapy as a result of nCPAP failure.  By enabling delivery of our aerosolized KL4 surfactant using noninvasive methods, we believe that AEROSURF, if approved, will address a serious unmet medical need and potentially provide transformative clinical and pharmacoeconomic benefits.

The drug product component of our AEROSURF product candidate is a lyophilized (freeze-dried) dosage form of our KL4 surfactant liquid instillate drug product that was approved by the U.S. Food and Drug Administration (FDA) in 2012 under the name SURFAXIN® (lucinactant) Intratracheal Suspension for the prevention of RDS in premature infants at high risk for RDS, was approved byRDS.  In the United States Foodsecond quarter of 2015, we determined to cease commercial and Drug Administration (FDA) in 2012.manufacturing activities for SURFAXIN isto focus our KL4 surfactant in liquid formlimited resources on advancing the AEROSURF clinical development program and is the first synthetic, peptide-containing surfactant approved by the FDA and the only alternative to animal-derived surfactants currently used in the United States (U.S.).  Since November 2013, SURFAXIN has been commercially available in the U.S.

Premature infants with severe RDS currently are treated with surfactants that can only be administered by endotracheal intubation supported with mechanical ventilation, both invasive procedures that may each result in serious respiratory conditions and other complications.  To avoid such complications, many neonatologists treat infants with less severe RDS by less invasive means, typically nasal continuous positive airway pressure (nCPAP).  Unfortunately, a significant number of premature infants on nCPAP will not respond well (an outcome referred to as nCPAP failure) and thereafter may require delayed surfactant therapy.  Since neonatologists currently cannot predict which infants will experience nCPAP failure, neonatologists are faced with difficult choices in treating infants with less severe RDS.  This is because the medical outcomes for those infants who experience nCPAP failure and receive delayed surfactant therapy may be less favorable than the outcomes for infants who receive surfactant therapy in the first hours of life.

AEROSURF® is an investigational combination drug/device product that combines our KL4 surfactant with our proprietary capillary aerosol generator (CAG).  With AEROSURF, neonatologists potentially will be able to administer aerosolized KL4 surfactant pipeline.  We believe that gaining the approval of SURFAXIN provided us valuable experience to premature infants supported with nCPAP, without having to use invasive intubation and mechanical ventilation.  By enabling deliverysupport the further development of our KL4 surfactant using less invasive procedures, we believe that AEROSURF will address a serious unmet medical need and potentially enable the treatment of a significantly greater number of premature infantsproduct candidates, beginning with RDS who could benefit from surfactant therapy but are currently not treated.AEROSURF. 

We are also developing a lyophilized (freeze-dried) dosage form of our KL4 surfactant that is stored as a powder and reconstituted to liquid form prior to use with the objective of improving ease of use for healthcare practitioners, as well as potentially to prolong shelf life and eliminate the need for cold-chain storage.  We are initially developing this dosage form for use in our AEROSURF development program.  We are also planning to seek regulatory advice to determine if we could gain marketing authorization for a lyophilized dosage form of SURFAXIN under a development plan that would be both capital efficient and capable of implementation within a reasonable time.  If feasible, we would likely implement such a development plan and would plan to introduce it commercially as a life-cycle extension of SURFAXIN under the name SURFAXIN LS™, in the U.S. and potentially in other markets.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARYNote 2 – Basis of Presentation

To support the commercial introduction of SURFAXIN in the U.S. and our other KL4 surfactant pipeline products, if approved, we have established our own specialty respiratory critical care commercial and medical affairs team.  This team includes medical professionals with experience in neonatal/pediatric respiratory critical care, and has focused on products that address neonatal indications, beginning with SURFAXIN.  We believe that this team will be positioned to efficiently introduce our other KL4 surfactant products under development, if approved, including AEROSURF and potentially SURFAXIN LS and future applicationsThe accompanying consolidated financial statements reflect a 1-for-14 reverse split of our aerosolized KL4 surfactant.

In addition, we recognize that our commercialcommon stock and medical affairs team could potentially support introductions of other synergistic pipeline products, including products  owned or developed by third parties for the NICU/PICU.  To that end, we would consider potential transactions focused on securing commercial rights to such synergistic products, includinga change in the form of product acquisitions, in-licensing agreements or distribution, marketing or co-marketing arrangements.

In the future, we expect that we may be able to leverage the information, data and know-how that we gain from our development efforts with SURFAXIN and AEROSURF to support development of a potential product pipeline to address serious critical care respiratory conditions in larger children and adults in pediatric and adult intensive care units (PICUS and ICUs), including Acute Lung Injury (ALI), Chronic Obstructive Pulmonary Disorder (COPD) and Cystic Fibrosis (CF).  At the present time, however, we are focusing our resources primarily on the commercial introduction of SURFAXIN and development of AEROSURF through phase 2 clinical trials.  Once we have achieved these objectives, we believe we would be in a better position to assess the potential of other development programs to address the critical care needs of patients in the PICU and ICU.

We also have developed a disposable aerosol-conducting airway connector for infants that is intended to simplify the delivery of aerosolized medications (including our aerosolized KL4 surfactant) and other inhaled therapies to critical-care patients requiring ventilatory support.  This device introduces aerosolized medications directly at the patient interface and minimizes the number of connectionsshares of common stock authorized for issuance under our Amended and Restated Certificate of Incorporation, as amended (Certificate of Incorporation), that was approved by our Board of Directors and stockholders and made effective on January 22, 2016.  All share and per share information herein that relates to our common stock has been retroactively restated to reflect the reverse stock split and reduction in the ventilator circuit.  We have registered this device as a Class I, exempt medical device in the U.S. under the name AFECTAIR® and it is currently commercially available in the U.S.authorized shares.

The reader is referred to, and encouraged to read in its entirety “Item 1 – Business” of this Annual Report on Form 10-K for the year ended December 31, 2013, which contains a discussion of our Business and Business Strategy, as well as information concerning our proprietary technologies and our current and planned KL4 pipeline programs.

Note 23 – Liquidity Risks and Management’s Plans

As of December 31, 2015, we had cash and cash equivalents of approximately $38.7 million, current accounts payable and accrued expenses of $10.8 million, and $25 million of long-term debt under a secured loan (Deerfield Loan) with affiliates of Deerfield Management, L.P. (Deerfield).  The principal portion of the debt is payable in two equal installments in February 2018 (subject to potential deferral in certain circumstances) and February 2019.  Before any additional financings or other transactions, we anticipate that we will have sufficient cash available to support our development programs, business operations and debt service obligations through the first quarter of 2017.

We have incurred substantial losses since inception, due to investments in research and development, manufacturing, and, more recently,the commercialization of SURFAXIN, including marketing, commercial and medical affairs activities, and we expect to continue to incur substantial losses over the next severalfour to five years.  Historically,To secure the significant additional capital that we will need, we expect to utilize all or a combination of potential strategic alliances, collaboration agreements and other strategic transactions, public or private equity offerings (including our ATM Program), or through debt arrangements.  We also believe that our success in these efforts will be largely dependent upon our ability to successfully and timely complete the AEROSURF phase 2b clinical trial.  Failure to complete the clinical trial within the expected time line in the fourth quarter of 2015 and obtain acceptable and promising results could have fundeda material adverse effect on our business operationsability to secure the additional capital that we will require, through various sources, includingstrategic transactions or otherwise, and our ability to continue as a going concern.

Our ability to secure capital under our ATM Program or pursuant to public offerings under our 2014 Universal Shelf will be constrained by the value of our equity securities held by nonaffiliated persons and privateentities (public float), which as of March 18, 2016 is approximately $13.4 million.  Our 2014 Universal Shelf was filed on Form S-3, which limits the size of primary securities offerings debt facilities, strategic alliances,conducted by companies that have a public float of less than $75 million in any 12-month period to no more than one-third of their public float.  Based on the use of committed equity financing facilities (CEFFs) and at-the-market equity programs, and capital equipment financings.

As of December 31, 2013, we had cash and cash equivalents of $86.3 million and $30 million ($18.4 million net of discount) of long-term debt under our Deerfield Loan with affiliates of Deerfield Management  Company, L.P. (Deerfield).  See, “Note 9 – Deerfield Loan.”  During 2013, we raised aggregate gross proceeds of $75.8 million through public offeringsclosing market price of our common stock includingon March 18, 2016 ($1.65) we could raise up to approximately $4.5 million under our ATM Program.2014 Universal Shelf.  To raise capital, we may be required to seek other forms of transactions, including, for example, under a registration statement on Form S-1, the preparation and maintenance of which would be more time consuming and costly, or private placements, potentially with registration rights or priced at a discount to the market value of our stock, or other transactions, any of which could result in substantial equity dilution of stockholders’ interests.  In February 2013,addition, although we entered intohave regained compliance with the Deerfield Loan and, upon executionMinimum Bid Price Requirement of the agreement, Deerfield advancedNasdaq Listing Rules, there can be no assurance that we will be able to maintain continued compliance, including with certain other Nasdaq listing requirements that require us $10to maintain a market capitalization of at least $35 million ($9.85 million netor stockholders’ equity of transaction fee).at least $2.5 million.  If we fail to meet both of these requirements, we would receive another delisting notice from the Nasdaq Capital Market, which could further depress the value of our stock. In May 2013,addition, to be able to raise sufficient capital to support our activities in the near term through public or private equity offerings, given our current per share market price, we completed a public offeringmay have to seek approval from our stockholders to increase the number of 10.847 million shares of common stock including 1.347 million sharesauthorized for issuance under an option grantedour Certificate of Incorporation.  Moreover, if any such offering were to and exercised byinvolve the underwriters, at an offering price of $1.50 per share, resulting in gross proceeds of $16.3 million ($15.1 million net of commissions, discounts and expenses).  In October 2013, we completed an offering under the ATM Program and issued 713,920 shares of our common stock resulting in net proceeds to us of approximately $1.8 million (net of  commissions).  In November 2013, we completed a public offering of 28.75 million sharesissuance of common stock including 3.75 million sharesin excess of 20% of our outstanding common stock, we may be required under an option grantedNasdaq Listing Rules to and exercised byseek stockholder approval before we can proceed.  There can be no assurance that we would be successful in obtaining such approvals.  Failure to secure the underwriters for over-allotments, at an offering price of $2.00 per share resulting in gross proceeds of $57.5 million ($53.9 million net of commissions, discounts and expenses).  In December 2013, we received an additional $20 million under the Deerfield Loan ($19.7 million net of transaction fee), which became due under the Deerfield Loan upon the first commercial sale of SURFAXIN.  Before any additional financings, including under our ATM Program, we anticipatecapital that we will need, whether from non-dilutive sources or from equity offerings, would have sufficient cash availablea material adverse impact on our business and our ability to fund our operations and debt service obligations through the third quarter of 2015.continue as a going concern.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Our future capital requirements depend upon many factors, primarilyWe have in the successpast collaborated with research organizations and universities to assess the potential utility of our effortsKL4 surfactant in studies funded in part through non-dilutive grants issued by U.S. Government-sponsored drug development programs, including grants in support of initiatives related to (i) execute the commercial introduction of SURFAXIN in the U.S.; (ii) advance theour AEROSURF development program to completion of the phase 2 clinical program as planned in the second halfand medical and biodefense-related initiatives under programs that encourage private sector development of 2015;medical countermeasures against chemical, biological, radiological, and (iii) secure one or more strategic alliances or other collaboration arrangements to support the developmentnuclear terrorism threat agents, and if approved, commercial introductionpandemic influenza, and provide a mechanism for federal acquisition of AEROSURF and potentially SURFAXIN in markets outside the U.S.  We believe that, if we are able to complete the AEROSURF phase 2 clinical program on a timely basis and obtain encouraging results, and if we are able to successfully advance the commercial introduction of SURFAXIN, our ability to enter into a significant strategic alliance will be enhanced.  Theresuch countermeasures.  Although there can be no assurance, however, that our efforts will be successful, orwe continue to pursue such funding opportunities and expect that we will be ablemay qualify for similar programs in the future.

An important priority for us is to obtainidentify potential strategic transactions, including without limitation strategic alliances and collaboration arrangements that would potentially provide additional capital to support our AEROSURF development activities when needed on acceptable terms,and strategic resources to support the registration and commercial introduction of AEROSURF.  We seek a significant strategic alliance partner that has broad experience, including local regulatory and product-development expertise and, if at all.

Even if we succeed withAEROSURF is approved, an ability to support the commercial introduction of SURFAXIN, given the time required to secure formulary acceptance at our target hospitals, we expect our revenues from SURFAXIN to be modestAEROSURF in the first 12-24 monthsEU and then increase slowly over time.  For the next several years, we expect that our cash outflows for marketing, commercial and medical activities, development programs, operations and debt service will far outpace the rate at which we may generate revenues.  Therefore, to execute our business strategy and fund our operations over the long term, we will require significant additional infusions of capital until such time as the net revenues from the sale of approved products, from potential strategic alliances and from other sources are sufficient to offset our cash flow requirements.  To secure the necessary capital to fund our development programs, we would prefer to enter into strategic alliances or collaboration arrangements with partners having broad experience inselected markets outside the U.S., including regulatory and product-development expertise as well as an ability to commercialize our products, if approved.  Such alliances typically would also provide financial resources, in the form of upfront payments, milestone payments, commercialization royalties and a sharing of research and development expenses.  Collaboration, co-marketingWe have engaged in discussions with potential counterparties and other similar arrangements would provide,a number of these entities have expressed interest in additionAEROSURF and our KL4 surfactant and drug delivery technologies.

Our future capital requirements will depend upon many factors, including our efforts to an ability(i) advance the AEROSURF development program to introduce our products in markets outside the U.S., a sharing of revenues.  Under our ATM Program (see, “Note 11 – Stockholders' Equity – At-the-Market Program (ATM Program)”), subject to market conditions, we may sell up to approximately $23 million of common stock at such times and in such amounts that we deem appropriate, subject to a 3% commission.  However, usecompletion of the ATM Program is subjectphase 2b clinical trials as planned; (ii) assure near- and long-term continuity of supply for our lyophilized KL4 surfactant and ADS and related components with CMOs to marketsupport our clinical activities, (iv) develop our ADS for use in a planned phase 3 clinical program and, other conditionsif approved, early commercial activities, (v) prepare for and the ATM Program couldconduct an AEROSURF phase 3 clinical program, which likely will be cancelled at any time by either party.  We also may consider publicdesigned to enroll significantly more premature infants than our phase 2 clinical trials, and private equity offerings(vi) secure one or more strategic alliances or other financing transactions, including potentially secured equipment financing facilities or other similar transactions.collaboration arrangements to support our development programs and commercialization of our approved products, if any.  There can be no assurance however, that our AEROSURF and other research and development projectsprogram will be successful thatwithin our products under development will obtain necessary regulatory approval in the U.S. and other markets, that any approved product, including SURFAXIN, will be commercially viable, that the ATM Program will be available when needed,anticipated time frame, if at all, orall; that we will be able to obtainsecure regulatory approval for AEROSURF and our other potential KL4 surfactant product candidates in the U.S. and other markets; or that we will be successful in securing the capital we will require when needed.  Failure to secure the necessary additional capital when needed could have a material adverse effect on acceptable terms, if at all.  our business, financial condition and results of operations and could compel us to pace, delay or cease our new product development and clinical trial activities and ultimately cease operations.  Even if we succeed in raising additional capital and developingour efforts and subsequently commercializing product candidates,commercialize our products, we may never achieve sufficient sales revenue to achieve or maintain profitability.

As of December 31, 2015, we had outstanding warrants to purchase approximately 8.5 million shares of our common stock that are exercisable at various prices on different dates into 2024.  This includes 4.8 million warrants issued in a July 2015 public offering with an exercise price of $9.80 per share, and 2.9 million pre-funded warrants, of which the entire purchase price was pre-paid upon issuance.  Upon exercise of the pre-funded warrants, we would issue the shares to the holders and receive no additional proceeds.

The accompanying financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.  ForIn the next several years,future, our ability to continue as a going concern will beis dependent on our ability to raise additional capital to fund our research and development and commercial programs and meet our obligations including debt service, on a timely basis.  If we are unable to successfully raise sufficientsecure the required additional capital, when needed, we will likely not have sufficient cash flows and liquidity to fund our business operations, which could significantly limit our ability to continue as a going concern.  In that event, we may be forced to further limit our development programs and consider other means of creating value for our stockholders, such as licensing the development andand/or commercialization of products that we consider valuable and wouldmight otherwise likelyplan to develop ourselves.  If we are unable to raise the necessary capital, we may be forced to curtail all of our activities and, ultimately, potentially cease operations.  Even if we are able to raisesecure additional capital, such financings may only be available on unattractive terms, or could result in significant dilution of stockholders’ interests and, in such event, the market price of our common stock may decline.  The balance sheetsMoreover, if we fail in the future to make any required payment under our Deerfield Loan or fail to comply with any commitments contained in the loan documents, Deerfield would be able to declare us in default regarding that indebtedness, which could result in the acceleration of the payment obligations under all or a portion of our indebtedness.  Since we have pledged substantially all of our assets to secure our obligations under the Deerfield Loan, a debt default would enable the lenders to foreclose on our assets securing the debt and could significantly diminish the market value and marketability of our common stock.  Our December 31, 2015 financial statements do not include any adjustments relating to recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue in existence.

As of December 31, 2013, 1502015, 36 million shares of common stock and 5 million shares of preferred stock were authorized under our Amended and Restated Certificate of Incorporation and approximately 42.1 18.3 million shares of common stock and 5 million shares of preferred stock were available for issuance and not otherwise reserved.reserved.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
In addition, as of December 31, 2013, we had outstanding warrants to purchase approximately 14.8 million shares of our common stock at various prices, exercisable on different dates into 2019.  Of these warrants, 7 million warrants were issued to Deerfield in connection with the Deerfield Loan at an exercise price of $2.81 per share.  The Deerfield Warrants may be exercised for cash or on a cashless basis.  In lieu of paying cash upon exercise, the holders also may elect to reduce the principal amount of the Deerfield loan in an amount sufficient to satisfy the exercise price of the Deerfield Warrants.  In addition to the Deerfield Warrants, we have outstanding warrants to purchase approximately 4.8 million shares of common stock that were issued in February 2011, are exercisable for five-years, and contain anti-dilution provisions that adjust the exercise price if we issue any common stock, securities convertible into common stock, or other securities (subject to certain exceptions) at a value below the then-existing exercise price of the warrants.  These warrants were originally issued with an exercise price of $3.20 per share and thereafter adjusted downward, first to $2.80 per share in March 2012 and then to $1.50 per share following a public offering in May 2013.  If the market price of our common stock should exceed $1.50 at any time prior to the expiration date of these warrants (February 2016) and if the holders determine in their discretion to exercise these warrants (and we have an effective registration statement covering the warrant shares to be issued upon exercise of the warrants), we potentially could receive up to $7.3 million. Although we believe that, in the future, we will secure additional capital from the exercise of at least a portion of our outstanding warrants, there can be no assurance that the market price of our common stock will equal or exceed price levels that make exercise of outstanding warrants likely or that holders of outstanding warrants will choose to exercise any or all of their warrants prior to the warrant expiration date.  Moreover, if our outstanding warrants are exercised, such exercises likely will be at a discount to the then-market value of our common stock and have a dilutive effect on the value of our shares of common stock at the time of exercise.

Although we currently believe that we will be able to successfully execute our business strategy, there can be no assurance that we will be successful.  We will require significant additional capital to satisfy debt obligations and sustain operations, and to complete the development and support the commercial introduction of our products.  Failure to secure the necessary additional capital would have a material adverse effect on our business, financial condition and results of operations.

Note 34 – Accounting Policies and Recent Accounting Pronouncements

The consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States.U. S.

Consolidation

The consolidated financial statements include all of the accounts of Discovery Laboratories, Inc. and its inactive subsidiary, Acute Therapeutics, Inc.  All intercompany transactions and balances have been eliminated in consolidation.

Use of estimates

The preparation of financial statements, in conformity with accounting principles generally accepted in the United States,U. S., requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Cash and cash equivalents

Cash and cash equivalents are held in U.S. banks and consist of liquid investments and money market funds with a maturity from date of purchase of 90 days or less that are readily convertible into cash.

Fair value of financial instruments

Our financial instruments consist principally of cash and cash equivalents and restricted cash.  The fair values of our cash equivalents are based on quoted market prices.  The carrying amount of cash equivalents is equal to their respective fair values at December 31, 20132015 and 2012,2014, respectively.  Warrants classified as liabilities are recorded at their fair market value.  Other financial instruments, including long-term debt, accounts payable and accrued expenses, are carried at cost, which we believe approximates fair value.
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Accounts receivable
Trade accounts receivable are recorded net of allowances for prompt payment discounts and doubtful accounts.

Inventory

Inventories, which are recorded at the lower of cost or market, include materials, labor, and other direct and indirect costs and are valued at cost using the first-in, first-out method. The Company capitalizes inventories produced in preparation for commercial launches when the related product candidates receive regulatory approval and that the related costs will be recoverable through the commercial sale of the product.  Costs incurred prior to FDA approval of SURFAXIN drug product and registration of our initial AFECTAIR device have been recorded in our statement of operations as research and development expense.  Inventory is evaluated for impairment through consideration of factors such as the net realizable value, lower of cost or market, obsolescence, and expiry. Inventories do not have carrying values that exceed either cost or net realizable value.

We evaluate our expiry risk by evaluating current and future product demand relative to product shelf life. We build demand forecasts by considering factors such as, but not limited to, overall market potential, market share, market acceptance and hospital ordering practices.

Property and equipment

Property and equipment are recorded at cost and depreciated using the straight-line method over the estimated useful lives of the assets (generally three to ten years).  Leasehold improvements are amortized over the shorter of the estimated useful lives or the remaining term of the lease.  Repairs and maintenance costs are charged to expense as incurred.

Restricted cash

Restricted cash consists of a certificate of deposit held by our bank as collateral for a letter of credit in the same notional amount held by our landlord to secure our obligations under our Lease Agreement dated May 26, 2004 and amended January 3, 2013 for our headquarters location in Warrington, Pennsylvania (See, Note 1413 – Commitments, for further discussion on our leases).  Under terms
F-10
Long-lived assets

Our long-lived assets, primarily consisting of equipment, are reviewed for impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable, or its estimated useful life has changed significantly.  When the undiscounted cash flows of an asset are less than its carrying value, an impairment is recorded and the asset is written down to estimated value.  No impairment was recorded during the years ended December 31, 2013, 2012,2015 and 20112014 as management believes there are no circumstances that indicate the carrying amount of the assets will not be recoverable.
Financing costs related to long-term debt
Costs associated with obtaining long-term debt, including  In the fair valuesecond quarter of warrants issued2015, we closed the Totowa Facility and sold manufacturing equipment for total cash proceeds of $0.3 million, resulting in connection witha $0.1 million loss from the debtsale and transaction fees, are amortized over the termdisposal of the related debt using the effective interest method.these assets.

F - 11
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
DeferredGrant revenue
Deferred revenue reflects amounts related to SURFAXIN sales to our specialty distributor, which are deferred and recognized as revenue once product has been sold through to the hospital and all revenue recognition criteria have been met.

Product Sales

Revenues from product sales are recognized when (1) persuasive evidence of an arrangement exists, (2) delivery has occurred or services have been rendered, (3) the price is fixed or determinable and (4) collectability is reasonably assured.   

Our products are distributed in the U.S. using a specialty distributor.  Under this model, the specialty distributor purchases and takes physical delivery and title of product, and then sells to hospitals.  We began the commercial introduction of SURFAXIN in the fourth quarter of 2013 and, for that reason, we currently cannot make a reasonable estimate of future product returns when product is delivered to the specialty distributor.  Therefore, we currently do not recognize revenue upon product shipment to the specialty distributor, even though the distributor is invoiced upon product shipment.  Instead, we recognize revenue once product has been sold through to the hospital and all revenue recognition criteria have been met.  Once product has been delivered to the hospital, the risk of material returns is significantly mitigated. As of December 31, 2013, we have deferred revenue recognition on all product sales since the inception of the commercial launch of SURFAXIN in November 2013.  We will recognize those revenues at the point in time when all revenue recognition criteria have been met.

We will begin to recognize revenue at the time of shipment of product to our specialty distributor when we can reasonably estimate expected distributor sales deductions and returns. In developing estimates for sales returns we consider the shelf life of the product, expected demand based on market data and return rates of other surfactant products. 

Product sales are recorded net of accruals for estimated chargebacks, discounts, specialty distributor deductions and returns.

·Chargebacks.  Chargebacks are discounts that occur when contracted customers purchase directly from our specialty distributor.  Contracted customers, which currently consist primarily of member hospitals of Group Purchasing Organizations, generally purchase the product at a discounted price.  Our specialty distributor, in turn, charges back the difference between the price initially paid by the specialty distributor and the discounted price paid to the specialty distributor by the customer.  The allowance for specialty distributor chargebacks is based on known sales to contracted customers.

·Sales discounts:  Sales discounts are offered to certain contracted customers based upon a customer’s historical volume of surfactant product purchases.  Customers must enter into a Letter of Participation (LOP) with us to receive sales discounts.  Sales discounts are calculated on a quarterly basis based upon the customer’s quarterly purchases of SURFAXIN, as provided in the LOP.  The allowance for sales discounts is based on known sales to contracted customers.

·Specialty distributor deductions. Our specialty distributor is offered various forms of consideration including allowances, service fees and prompt payment discounts. Specialty distributor allowances and service fees are provided in our contractual agreement and are generally a percentage of the purchase price paid by the specialty distributor. The specialty distributor is offered a prompt pay discount for payment within a specified period.

·Returns.  Sales of our products are not subject to a general right of return; however, we will accept product that is damaged or defective when shipped or for expired product up to 6 months subsequent to its expiry date.  Product that has been administered to patients is no longer subject to any right of return.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Grant Revenue

We recognize grant revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable, and collectability is reasonably assured.

We recognized $0.4 million and $0.2 million of grant revenue for the years ended December 31, 2013 and 2012, respectively, for funds received and expended under a $0.6 million Small Business Innovation Research (SBIR) Phase I award to Discovery Labs from National Institute of Health’s (NIH) National Institute of Allergy and Infectious Diseases (NIAID) Center for Medical Counter Measures Against Radiation and Nuclear Threats to assess the ability of KL4 surfactant to mitigate the effects of acute radiation exposure to the lung, including acute pneumonitis and delayed lung injury.

For the year ended December 31, 2011, grant revenue represents funds received and expended under a $0.6 million Fast Track SBIR from the NIH to support the development of aerosolized KL4 surfactant for RDS.

Research and development

We trackaccount for research and development expense by activity, as follows:the following categories: (a) product development and manufacturing, (b) medical and regulatory operations, and (c) direct preclinical and clinical programs.   Research and development expense includes personnel, facilities, manufacturing and quality operations, pharmaceutical and device development, research, clinical, regulatory, other preclinical and clinical activities and medical affairs.  Research and development costs are charged to operations as incurred.

Stock-based compensation

Stock-based compensation is accounted for under the fair value recognition provisions of Accounting Standards Codification (ASC) Topic 718, “Stock Compensation” Compensation(ASC (ASC Topic 718).  See, Note 1211 – Stock Options and Stock-based Employee Compensation, for a detailed description of our recognition of stock-based compensation expense.  The fair value of stock option grants is recognized evenly over the vesting period of the options or over the period between the grant date and the time the option becomes non-forfeitable by the employee, whichever is shorter. Stock option expense is generally included in research and development and selling, general and administrative expenses in the accompanying Consolidated Statements of Operations.

Warrant accounting

We account for common stock warrants in accordance with applicable accounting guidance provided in ASC Topic 815, “Derivatives and Hedging – Contracts in Entity’s Own Equity”Equity (ASC Topic 815), as either derivative liabilities or as equity instruments depending on the specific terms of the warrant agreement.  We classify derivative warrant liabilities on the consolidated balance sheet as current liabilities, which are revalued at each balance sheet date subsequent to the initial issuance.  WeDepending on the terms of a warrant agreement, we use the Black-Scholes or trinomial pricing models depending on the applicable terms of the warrant agreement, to value the related derivative warrant liabilities.  Changes in the fair value of the warrants are reflected in the consolidated statement of operations as “Change in the fair value of common stock warrant liability.”  See, “Item 8 – Notes to consolidated financial statements – Note 8 – Common Stock Warrant Liability,” for a detailed description of our accounting for derivative warrant liabilities.

Collaborative arrangements

We account for collaborative arrangements in accordance with applicable accounting guidance provided in ASC Topic 808, Collaborative Arrangements (ASC Topic 808).  See, “ – Note 12 – Corporate Partnership, Licensing and Research Funding Agreements – Battelle Memorial Institute,” for a description of our accounting for the Battelle collaboration Agreement.
Income taxes

We account for income taxes in accordance with ASC Topic 740, “Accounting for Income Taxes.”Taxes ASC(ASC Topic 740740), which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between financial statement carrying amounts and the tax basis of assets and liabilities.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
We use a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  Because we have never realized a profit, management has fully reserved the net deferred tax asset since realization is not assured.

Net loss per common share

Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period.  Diluted net loss per common share is computed by giving effect to all potentially dilutive securities outstanding for the period.  For the years ended December 31, 2013, 2012,2015 and 2011,2014, the number of shares of common stock potentially issuable upon the exercise of certain stock options and warrants was 20.2 million, 11.99.1 million and 15.41.6 million shares, respectively.  As a result of the net losses for all periods presented,December 31, 2015, all potentially dilutive securities were anti-dilutive and therefore have been excluded from the computation of diluted net loss per share. As of December 31, 2014, there were 1.2 million shares of common stock potentially issuable upon the exercise of stock options and warrants excluded from the computation of diluted net loss per common share because their impact would have been anti-dilutive.
In accordance with ASC Topic 260, “Earnings per Share,” when calculating diluted net loss per common share, a gain associated with the decrease in the fair value of warrants classified as derivative liabilities results in an adjustment to the net loss; and the dilutive impact of the assumed exercise of these warrants results in an adjustment to the weighted average common shares outstanding.  We utilize the treasury stock method to calculate the dilutive impact of the assumed exercise of warrants classified as derivative liabilities.  For the year ended December 31, 2015, the effect of the adjustments for warrants classified as derivative liabilities was anti-dilutive.  For the year ended December 31, 2014, the effect of the adjustments for warrants classified as derivative liabilities was dilutive.
The table below provides information pertaining to the calculation of diluted net loss per common share for the periods presented:

(in thousands) December 31, 
  2015  2014 
       
Numerator:      
Net loss as reported $(55,170) $(44,058)
Less: income from change in fair value of warrant liability  (851)  (3,791)
Numerator for diluted net loss per common share $(56,021) $(47,849)
         
Denominator:        
Basic weighted average common shares outstanding  6,967   6,078 
Dilutive common shares from assumed warrant exercises  –   67 
Diluted weighted average common shares outstanding  6,967   6,145 

We do not have any components of other comprehensive income (loss).
 
Concentration of Suppliers

We currently obtain the active pharmaceutical ingredients (APIs) of our KL4surfactant drug products from single-source suppliers.  In addition, we rely on a number of third-party institutions and laboratories that perform various studies as well as quality control release and stability testing and other activities related to our KL4 surfactant development and manufacturing activities.  At the present time, several of these laboratories are single-source providers.  The loss of one or more of our single-source suppliers or testing laboratories could have a material adverse effect upon our operations.

Major customer and concentration of credit risk

We currently sell our products to one exclusive pharmaceutical specialty distributor in the U.S.  We periodically assess the financial strength of our specialty distributor and establish allowances for anticipated uncollectible amounts, if necessary.  As of December 31, 2013, we have not recorded an allowance for doubtful accounts.

Business segments

We currently operate in one business segment, which is the research and development of products focused on surfactant replacement therapies for respiratory disorders and diseases, and the manufacture and commercial sales of approved products.  We are managed and operated as one business.  A single management team that reports to the Chief Executive Officer comprehensively manages the entire business.  We do not operate separate lines of business with respect to our product candidates.

Recent Accounting Pronouncements
 
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize revenue at an amount that reflects the consideration to which the entity expects to be entitled in exchange for transferring goods or services to customers.  The Company didASU will replace most existing revenue recognition guidance in U.S. generally accepted accounting principles (GAAP) when it becomes effective.  The new standard is effective for us in the annual period ending December 31, 2017, including interim periods within that annual period.  Early application is not adopt anypermitted.  We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures.  The standard permits the use of either the retrospective or cumulative effect transition method.  We have not yet selected a transition method nor determined the effect of the standard on our financial reporting.
In August 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-15, Presentation of Financial Statements – Going Concern, which requires management to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern and, if so, disclose that fact.  Management will also be required to evaluate and disclose whether its plans alleviate that doubt.  The standard defines substantial doubt as when it is probable (i.e., likely) that the entity will be unable to meet its obligations as they become due within one year of the date the financial statements are issued (or available to be issued, when applicable). The ASU is effective for the annual period ending December 31, 2016 and interim periods thereafter.  Early application is permitted.  We are evaluating the effect that ASU 2014-15 will have on our consolidated financial statements and related disclosures.  The standard permits the use of either the retrospective or cumulative effect transition method.  We have not yet selected a transition method nor determined the effect of the standard on our financial reporting.

In April 2015, the FASB issued ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires an entity to present debt issuance costs in the balance sheet as a direct deduction from the carrying amount of the corresponding debt liability, consistent with debt discounts. The guidance would not address situations in which debt issuance costs do not have an associated debt liability or exceed the carrying amount of the associated debt liability (e.g., an undrawn or partially drawn line of credit).  The new accounting pronouncements during 2013standard is effective for us in the annual period ending December 31, 2016, including interim periods within that hadannual period.  Early adoption is permitted and the standard is to be applied retrospectively.  We are evaluating the effect that ASU 2015-03 will have on our consolidated financial statements and related disclosures.

In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes, which requires an entity to classify all deferred tax assets and liabilities as noncurrent on the balance sheet instead of separating deferred taxes into current and noncurrent amounts. Also, companies will no longer allocate valuation allowances between current and noncurrent deferred tax assets because those allowances also will be classified as noncurrent.  The new standard is effective for fiscal years beginning after December 15, 2016, with early adoption permitted.  We have adopted ASU 2015-17 as of December 31, 2015, and the adoption of this update is not expected to have a material effect on the Company’sour consolidated financial statements.statements and related disclosures.

Note 45 – Fair Value Measurements

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.  The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, as follows:

·Level 1 – Quoted prices in active markets for identical assets and liabilities.
·Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
·Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

F - 14
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Fair Value on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are categorized in the table below as of December 31, 20132015 and 2012:2014:

 Fair Value  Fair value measurement using  Fair Value  Fair value measurement using 
(in thousands) December 31, 2013  Level 1  Level 2  Level 3  
December 31,
2015
  Level 1  Level 2  Level 3 
 
  
  
  
             
Assets: 
  
  
  
             
Cash and cash equivalents $86,283  $86,283  $–  $–  $38,722  $38,722  $–  $– 
Certificate of deposit  325   325   –   –   225   225   –   – 
Total Assets $86,608  $86,608  $–  $–  $38,947  $38,947  $–  $– 
Liabilities:                                
Common stock warrants $5,425  $$ –  $–  $5,425  $223  $ –  $–  $223 

 Fair Value  Fair value measurement using  Fair Value  Fair value measurement using 
(in thousands) December 31, 2012  Level 1  Level 2  Level 3  
December 31,
2014
  Level 1  Level 2  Level 3 
            
Assets: 
  
  
  
             
Cash and cash equivalents $26,892  $26,892  $–  $–  $44,711  $44,711  $–  $– 
Certificate of deposit  400   400   –   –   225   225   –   – 
Total Assets $27,292  $27,292  $–  $–  $44,936  $44,936  $–  $– 
Liabilities:                                
Common stock warrants $6,305  $$ –  $–  $6,305  $1,258  $ –  $–  $1,258 

The following table summarizes changes in the fair value of the common stock warrants measured on a recurring basis using Level 3 inputs for 20122015 and 2013:2014:

(in thousands)     
     
Balance at January 1, 2012 $6,996 
Issuance of common stock warrants  (136)
Change in fair value of common stock warrant liability  (555)
Balance at December 31, 2012 $6,305 
Balance at January 1, 2014 $5,425 
Exercise of warrants (1)
  (119)  (376)
Change in fair value of common stock warrant liability  (761)  (3,791)
Balance at December 31, 2013 $5,425 
Balance at December 31, 2014 $1,258 
Exercise of warrants (1)
  (184)
Change in fair value of common stock warrant liability  (851)
Balance at December 31, 2015 $223 

(1) See, Note 8 – Common Stock Warrant Liability.
 
(1)
See,
F-14 Note 8 – Common Stock Warrant Liability.

The significant unobservable inputs used in the fair value measurement of the common stock warrants measured on a recurring basis are the historical volatility of our common stock market price, expected term of the applicable warrants, and the risk-free interest rate based on the U.S. Treasury yield curve in effect at the measurement date.  In addition to the significant unobservable inputs noted above, certain fair value measurements also take into account an assumption of the likelihood and timing of the occurrence of an event that would result in an adjustment to the exercise price in accordance with the anti-dilutive pricing provisions in certain of the warrant.warrants.  Any significant increases or decreases in the unobservable inputs, with the exception of the risk-free interest rate, may result in significantly higher or lower fair value measurements.

F - 15
Significant Unobservable Input December 31, 
Assumptions of Level 3 Valuations 2015  2014 
       
Historical volatility  159%  55% – 84%
Expected term (in years)  0.2   0.1 – 1.1 
Risk-free interest rate  0.15%  0.03% – 0.31%
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
 December 31, 
Significant Unobservable Input Assumptions of Level 3 Valuations 2013  2012 
 
  
 
Historical volatility  62% -76%  56% -80%
Expected term (in years)  0.4 – 2.1   1.4 – 3.2 
Risk-free interest rate  0.08% - 0.44%  0.16% - 0.36%

Fair Value of Long-Term Debt

At December 31, 2013,2015, the estimated fair value of the Company'sDeerfield Loan (see, Note 9 – Deerfield Loan) approximated the carrying value of $25.0 million.  At December 31, 2014, the estimated fair value of the Deerfield Loan was $23.6$22.2 million compared to a carrying value, net of discounts, of $18.4$20.3 million.  We had no long-term debt as ofAt December 31, 2012.  The2014, the estimated fair value of the Deerfield Loan was based on discounting the future contractual cash flows to the present value.value at the valuation date.  This analysis utilizes certain Level 3 unobservable inputs, including current cost of capital.  Considerable judgment is required to interpret market data and to develop estimates of fair value.  The estimates presented are not necessarily indicative of amounts we could realize in a current market exchange.  The use of alternative market assumptions and estimation methodologies could have a material effect on these estimates of fair value.
Note 5 – Inventory

Inventory  Fair value is comprised ofdefined as the following:

 December 31, 
(in thousands) 2013  2012 
    
Raw materials $52  $195 
Finished goods  60   – 
 $112  $195 

Raw materials costs in inventory of $52,000 as of December 31, 2013 consisted of the portion of raw materials anticipatedexchange price that would be received for an asset or paid to be usedtransfer a liability in the manufacture of commercial product that were purchased after October 4, 2013,principal or most advantageous market for the dateasset or liability in an orderly transaction between market participants on the FDA agreed to our updated product specifications for SURFAXIN that allowed us to proceed with the commercial introduction of SURFAXIN.  Raw materials on hand as of December 31, 2013 that were purchased prior to October 4, 2013 were $1.6 million.  These raw materials have a carrying value of zero, as the costs to purchase this material were expensed as research and development expense in the period purchased, and accordingly are not reflected in the inventory balances shown above.  The majority of these raw materials are anticipated to be used in manufacturing development and research and development activities.  The remaining portion of these raw materials  are anticipated to be used in the manufacture of commercial product.

Raw materials costs in inventory of $195,000 as of December 31, 2012 consisted of the portion of raw materials anticipated to be used in the manufacture of commercial product that were purchased after the FDA agreed granted us marketing approval for SURFAXIN (March 2012).  Due to a delay in commercial availability of SURFAXIN drug product until the fourth quarter of 2013, previously capitalized raw material costs of $195,000 as of December 31, 2012 were charged to research and development expense in the first quarter of 2013, as these raw materials were no longer expected to be used in the manufacture of commercial product.
Inventory reserves were $0.5 million as of December 31, 2013 and $0 as of December 31, 2012. The inventory reserves in 2013 primarily reflect costs of SURFAXIN related finished goods inventories that are not anticipated to be recoverable through the commercial sale of the product during the initial launch period due to product expiration.  These reserves ensure that the inventory carrying values do not exceed net realizable value.measurement date.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Note 6 – Property and Equipment

Property and equipment is comprised ofcomprises the following:

 
 December 31, 
(in thousands) 2013  2012 
 
    
Manufacturing, laboratory & office equipment $8,383  $7,775 
Furniture & fixtures  816   816 
Leasehold improvements  2,711   2,711 
Subtotal  11,910   11,302 
Accumulated depreciation and amortization  (10,254)  (9,565)
Property and equipment, net $1,656  $1,737 

Leasehold improvements primarily consist of construction of an analytical and development laboratory in our Warrington, Pennsylvania headquarters, which was completed in 2007.  The activities conducted in our laboratory include release and stability testing of raw materials as well as preclinical, clinical and commercial drug product supply.  We also perform development work with respect to our aerosolized and lyophilized dosage forms of our KL4 surfactant.  In addition, in 2007, we built a microbiology laboratory at our manufacturing facility in Totowa, New Jersey, to support production of our drug product candidates.  The microbiology laboratory will be amortized through the end of the lease term for our Totowa, New Jersey facility in June 2015.
  December 31, 
(in thousands) 2015  2014 
       
Manufacturing, laboratory & office equipment $6,290  $9,154 
Furniture & fixtures  778   817 
Leasehold improvements  2,437   2,718 
Subtotal  9,505   12,689 
Accumulated depreciation and amortization  (8,466)  (11,052)
Property and equipment, net $1,039  $1,637 

Depreciation expense on property and equipment for the years ended December 31, 2013, 2012,2015 and 20112014 was $0.7 million $0.9 million, and $1.3$0.8 million, respectively.

Note 7 – Accrued Expenses

Accrued expenses are comprised of the following:

 December 31,  December 31, 
(in thousands) 2013  2012  2015  2014 
          
Salaries, bonus & benefits $1,849  $1,206  $2,387  $2,332 
Research and development  3,254   1,641 
Manufacturing operations  1,707   926   1,097   876 
Research and development  270   734 
Professional fees  393   428   326   376 
Sales and marketing  161   279   –   318 
All other  405   586 
Other  518   573 
Total accrued expenses $4,785  $4,159  $7,582  $6,116 

Note 8 – Common Stock Warrant Liability

We account for common stock warrants in accordance with applicable accounting guidance provided in ASC Topic 815, Derivatives and Hedging – Contracts in Entity’s Own Equity (ASC 815), either as derivative liabilities or as equity instruments depending on the specific terms of the warrant agreement.

The form of warrant agreement for theOn February 22, 2011, we issued registered warrants (2011 Warrants) that we issued in our May 2009expired on February 22, 2016 and February 2010 public offerings generally provide that, in the eventhad a related registration statement or an exemption from registration is not available for thefair value at issuance or resale of the$8.0 million.  As of December 31, 2015, there were 0.3 million warrant shares potentially issuable upon exercise of the warrant, the holder may exercise the warrant onthese warrants, with a cashless basis.  Notwithstanding the availability of cashless exercise, generally accepted accounting principles (GAAP) provide that these registered warrants are deemed to be subject to potential net cash settlement and must be classified as derivative liabilities because (i) under federal securities laws, providing freely-tradable shares upon exercise of the warrants may not be within our control in all circumstances, and (ii) the warrant agreements do not expressly provide that there is no circumstance in which we may be required to effect a net cash settlement of the warrants.  The accounting guidance expressly precludes an evaluation of the likelihood that cash settlement could occur.  Accordingly, the May 2009 and February 2010 warrants have been classified as derivative liabilities and reported, at each balance sheet date, at estimated fair value determined using the Black-Scholes option-pricing model.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
The form of warrant agreement for the registered five-year$0.2 million.  These warrants that we issued in the February 2011 public offering (February 2011 five-year warrants) contain anti-dilutivecontained anti-dilution provisions that in certain circumstances would adjust the exercise price if we issue any common stock, securities convertible into common stock, or other securities (subject to certain exceptions) at a value below the then-existing exercise price of the February 2011 five-year warrants.  Although by their express terms, these warrants are not subject to potential cash settlement, due to the nature of the anti-dilution provisions, these warrants have been classified as derivative liabilities and reported, at each balance sheet date, at estimated fair value determined using a trinomial pricing model.

Selected terms and estimated fair value of warrants accounted for as derivative are as follows:

 
  
 
   
 
Fair Value of Warrants
(in thousands)
Issuance
Date
 Number of Warrant Shares Issuable  
Exercise
Price
 
Warrant
Expiration
Date
 
Value at
Issuance
Date
  December 31,
 2013  2012 
 
 
  
 
 
 
  
  
 
5/13/2009  466,667  $17.25 5/13/2014 $3,360  $–  $– 
2/23/2010  916,669   12.75 2/23/2015  5,701   6   104 
2/22/2011  4,834,950   1.50 2/22/2016  8,004   5,419   6,201 
 
        
 
     $5,425  $6,305 

In addition, the February 2011 five-year warrants contain anti-dilution provisions that adjust the exercise price if we issueissued any common stock, securities convertible into common stock, or other securities (subject to certain exceptions) at a value below the then-existing exercise price of the warrants.  Accordingly,Although by their express terms, these warrants were not subject to potential cash settlement, due to the nature of the anti-dilution provisions, they were classified as derivative liabilities and reported, at each balance sheet date, at estimated fair value determined using a trinomial pricing model. The exercise price of these warrants at issuance of $3.20 was adjusted downward to $2.80$2.66 per share at the time of the March 2012 public offering and to $1.50 per share at the time of the May 2013July 2015 public offering.

During the year ended December 31, 2013,2015, holders of the February 2011 five-year warrantsWarrants exercised warrants to purchase 113,80051,193 shares of our common stock for totalat an exercise price of $2.66 per share, resulting in proceeds to us of $170,700.$0.1 million.  During the year ended December 31, 2012,2014, holders of the February 2011 five-year warrantsWarrants exercised warrants to purchase 51,25020,346 shares of our common stock for totalat an exercise price of $21.00 per share, resulting in proceeds to us of $162,000.$0.4 million.

Changes in the estimated fair value of warrants classified as derivative liabilities are reported in the accompanying Consolidated Statement of Operations as the “Change in fair value of common stock warrants.”

Note 9 –Note 9 – Deerfield Loan

On February 13, 2013, we entered intoLong-term debt consists solely of amounts due under a secured loan facility (Deerfield Loan) with affiliates of Deerfield Management Company, L.P. (Deerfield) for up to $30 million in secured financing in 2013.  As of December 31, 2013, long-term debt consists solely of amounts due under this facility as follows:

(in thousands)
Note Payable $30,000 
Unamortized discount  (11,646)
Long-term debt, net of discount $18,354 

Under the terms of the related agreement, Deerfield advanced funds to us in two separate disbursements.  Deerfield made the first disbursement, in the amount of $10 million, on February 13, 2013, upon execution of the related agreement (First Disbursement).  Deerfield made the second disbursement, in the amount of $20 million, on December 3, 2013 (Second Disbursement), following the first commercial sale of SURFAXIN.periods presented:

(in thousands) December 31, 
  2015  2014 
       
Note payable $25,000  $30,000 
Unamortized discount  –   (9,698)
Long-term debt, net of discount $25,000  $20,302 
F - 18
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
The loan may be prepaid in whole or in part without penalty at any time.  In addition,Under the principal amount of the loan may be reduced to the extent that holders of the notes elect to apply all or a portion of the principal amount outstanding under the loan to satisfy the exercise price of all or a portionterms of the Deerfield Warrants (discussed below)loan agreement, Deerfield made two advances, the first upon exercise.  The principalexecution of the agreement in February 2013 in the amount of $10 million, and the loan is payablesecond upon the first commercial sale of SURFAXIN in equal annual installments on the fourth, fifth and sixth anniversaries of the Deerfield Loan agreement, provided thatDecember 2013 in the amount payable on the fourth anniversary shall be deferred for one year if either (i) our “Net Sales” (defined below) for the immediately preceding 12-month period are at leastof $20 million, or (ii) our “Equity Value” (defined below) is at least $200 million; and provided further, that the amount payable on the fifth anniversary (together with any amount deferred on the fourth anniversary) shall be deferred until the sixth anniversary if either (i) our “Net Sales” for the immediately preceding 12-month period are at least $30 million, or (ii) our “Equity Value” is at least $250 million.  For the purposes of the foregoing deferrals of principal, “Net Sales” means, without duplication, the gross amount invoiced by us or on our behalf, any of our subsidiaries or any direct or indirect assignee or licensee for products, sold globally in bona fide, arm’s length transactions, less customary deductions determined without duplication in accordance with generally accepted accounting principles; and “Equity Value” means, with respect to each measurement date, the product of (x) the number of issued and outstanding shares of our common stock on such measurement date multiplied by (y) the per share closing price of our common stock on such measurement date.  Accordingly, if the milestones are achieved in each year, payment of the principal amount could be deferred until the sixth anniversary date of the loan, on February 13, 2019.

The amount received and outstanding under the Deerfield Loan will accrue interest at an annual rate of 8.75%, payable quarterly in cash.  The Deerfield Loan agreement contains customary terms and conditions but does not require us to meet minimum financial and revenue performance covenants.  In connection with each advance, we paid Deerfield a transaction fee equal to 1.5% of the amount disbursed.  The outstanding principal accrued interest at a rate of 8.75%, payable quarterly in cash.  The Deerfield Loan agreement also contains variouscustomary terms and conditions, representations and warranties and affirmative and negative covenants, customary for financings of this type, including restrictions on our ability to incur additional indebtedness and grant additional liens on our assets.assets, but it does not require us to meet minimum financial and revenue performance covenants.  In addition, all amounts outstanding under the Deerfield Loan may become immediately due and payable upon (i) an “Event of Default,” as defined in the Deerfield Loan agreement, in which case Deerfield would have the right to require us to repay the outstanding principal amount of the loan, plus any accrued and unpaid interest thereon, or (ii) the occurrence of certain events as defined in the facility agreement, including, among other things, the consummation of a change of control transaction or the sale of more than 50% of our assets (a Major Transaction).

In connection with theUpon execution of the Deerfield Loan, and receipt of the First Disbursement, we issued to Deerfield warrants to purchase approximately 2.30.2 million shares of our common stock at an exercise price of $2.81$39.34 per share.  Upon receipt of the Second Disbursement,second advance in December 2013, we issued to Deerfield warrants to purchase an additional 4.70.3 million shares of our common stock at an exercise price of $2.81$39.34 per share (together with the warrants issued in connection with the First Disbursement,execution of the agreement, the Deerfield Warrants).  The number of shares of common stock into which the Deerfield Warrants are exercisable and the exercise price of any Deerfield Warrant will be, and have been, adjusted to reflect any stock splits, recapitalizations or similar adjustments in the number of outstanding shares of common stock.

The Deerfield Warrants will expire on the sixth anniversary of the facilityDeerfield Loan agreement, February 13, 2019, and contain certain limitations that generally preventon the ability of a holder from acquiring shares uponto exercise of the Deerfield Warrants or any part thereof thatif after such exercise, the holder would result in the number of shares beneficially owned by such holder to exceedown more than 9.985% of the total number of shares of our common stock then issued and outstanding.  A holder of theThe Deerfield Warrants may exercise allbe exercised in whole or a portion of such Deerfield Warrantsin part either for cash or on a cashless basis.  In connection with a Major Transaction, as defined in the Deerfield Warrants, to the extent of consideration payable to stockholders in cash in connection with such Major Transaction, the holder may have the option to redeem the Deerfield Warrants or that portion of the Deerfield WarrantWarrants for cash in an amount equal to the Black-Scholes value (as defined in the Deerfield Warrants) of the Deerfield Warrants or that portion of the Deerfield Warrants redeemed.  In addition, in connection with a Major Transaction, to the extent of any consideration payable to stockholders in securities, or in the event of an Event of Default, the holder may have the option to exercise the Deerfield Warrants and receive therefor that number of shares of Common Stockcommon stock that equals the Black-Scholes value of the Deerfield Warrants or that portion of the Deerfield Warrants exercised.  Prior to a holder exercising the Deerfield Warrants for shares in such transactions, the Company may elect to terminate the Deerfield Warrants or that portion of the Deerfield Warrants being exercised and pay the holder cash in an amount equal to the Black-Scholes value of the Deerfield Warrants.

We haveinitially recorded the loan as long-term debt at its face value of $30.0 million less debt discounts and issuance costs consisting of (i) $11.7 million fair value of the Deerfield Warrants issued upon the First Disbursementfirst advance and the Second Disbursement (7second advance (0.5 million warrants in total), and (ii) a $450,000 transaction fee.  The discount iswas being accreted to the $30 million loan over its term using the effective interest method.  The Deerfield Warrants are derivatives that qualify for an exemption from liability accounting as provided for in ASC Topic 815 “Derivatives and Hedging – Contracts in Entity’s Own Equity” (ASC 815) and have been classified as equity.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
The fair value of the Deerfield Warrants at issuance was calculated using the Black-Scholes option-pricing model.  The significant Level 3 unobservable inputs used in valuing the Deerfield Warrants are the historical volatility of our common stock market price, expected term of the warrants, and the risk-free interest rate based on the U.S. Treasury yield curve in effect at the measurement date.  Any significant increases or decreases in the unobservable inputs, with the exception of the risk-free interest rate, would have resulted in a significantly higher or lower fair value measurement.

Significant Unobservable Input
Assumptions of Level 3 Valuations
   
  
Historical volatility  101101%%
Expected term (in years)  5.2 – 6.0 
Risk-free interest rate  1.2% – 1.51.5%%

On July 9, 2015, we entered into an amendment to our Deerfield Loan agreement and related notes (Deerfield Notes) to better align our Deerfield Loan principal repayment obligations with anticipated milestones under our clinical development program for AEROSURF.  Under the terms of the amendment, (i) upon execution, we prepaid in cash $2.5 million of the principal amounts outstanding, (ii) on July 22, 2015, upon the occurrence of the July 2015 public offering, we prepaid in cash an additional $2.5 million of the principal amounts outstanding, (iii) the principal installment originally due in February 2017 was eliminated and (iv) each of the principal payments due in February 2018 and February 2019 was increased to $12.5 million.  We also paid Deerfield’s expenses (including reasonable counsel fees and expenses) incurred in connection with the amendment.  Under the Deerfield Loan agreement, the $12.5 million principal installment due in February 2018 may be deferred one year if we achieve the market capitalization milestone set forth in the Deerfield Loan agreement.

On July 22, 2015, we entered into a second amendment to our Deerfield Loan agreement and Deerfield Notes, pursuant to which (a) upon closing the July 2015 public offering on July 22, 2015, we prepaid in cash $2.5 million of the principal amounts outstanding, as contemplated by the first amendment, and (b) Deerfield purchased and accepted $5 million Series A and Series B units offered in our July 2015 public offering in satisfaction of $5 million of future interest payments due under the Deerfield Notes.  In addition, (i) we paid in cash when due on September 30, 2015, all accrued and unpaid interest under the Deerfield Notes for the period from June 30, 2015 to July 22, 2015 at the original rate of 8.75%; (ii) Deerfield agreed to apply the $5 million prepaid interest accruing from and after July 23, 2015, as and when such payments are due and payable, as follows; first, to interest accruing on the $12.5 million principal installment due on February 13, 2019, and second, to interest accruing on the $12.5 million principal installment due on February 13, 2018, until fully allocated, which is scheduled to occur at the end of the second quarter of 2016; (iii) after the full allocation of the $5 million interest prepayment, any remaining interest due on the principal amount of the Deerfield Notes will accrue at a rate of 8.25% per annum; and (iv) no credit will be given with respect to prepaid interest on principal under the Deerfield Notes that is prepaid, in whole or in part, except for a prepayment at our election or a prepayment required under the Deerfield Loan agreement in connection with a Major Transaction that qualifies as a “Qualified Major Transaction.”  A “Qualified Major Transaction” means a change of control transaction (as defined in the Deerfield Warrants), in which (i) we are not the surviving entity and (ii) our common stock valuation (as defined in the Deerfield Warrants) immediately prior to the change of control transaction equals or exceeds $100 million.  In addition, we paid Deerfield’s expenses (including reasonable counsel fees and expenses) incurred in connection with the second amendment.

The restructuring of the Deerfield Loan was accounted for as an extinguishment of debt in accordance with ASC Topic 470, Debt – Modifications and Extinguishments, and as a result, we have incurred an $11.8 million non-cash loss on debt extinguishment consisting of the difference between the reacquisition price of the Deerfield Loan and the net carrying amount of the extinguished Deerfield Loan, which includes $4.1 million in fair value of the Series A and Series B warrants issued to Deerfield as part of the $5 million of Series A and Series B units Deerfield agreed to purchase and accept in our July 2015 public offering in satisfaction of $5 million of future interest payments due under the Deerfield Notes.
The following amounts comprise the Deerfield Loan interest expense for the periods presented:

(in thousands) December 31,  December 31, 
 2013  2012  2011  2015  2014 
            
Cash interest expense $911  $–  $–  $1,451  $2,625 
Non-cash amortization of debt discounts  534   –   –   1,287   1,948 
Debt discount write-off  707   – 
Amortization of prepaid interest expense  971   – 
Amortization of debt costs  18   –   –   12   19 
Write-off of debt costs  66   – 
Total Deerfield Loan interest expenses $1,463  $–  $–   4,494  $4,592 

Cash interest expense represents interest at an annual rate of 8.75% on the outstanding principal amount for the period, paid in cash on a quarterly basis.  Non-cash amortization of debt discount represents the amortization of transaction fees and the fair value of the warrants issued in connection withDeerfield Warrants.  Debt discount write-off represents the proportional write-off of unamortized debt discount at the time of a $2.5 million pre-payment of principal amount outstanding under the Deerfield Loan.  Amortization of prepaid interest expense represents non-cash amortization of the $5 million of Series A and Series B units Deerfield agreed to purchase and accept in our July 2015 public offering in satisfaction of $5 million of future interest payments due under the Deerfield Notes.  The amortization of debt costs represents legal costsprofessional fees incurred in connection with the Deerfield Loan.Loan, and the write-off of debt costs represents the write-off of the remaining costs at the time of the debt restructuring.

Note 10 – Equipment Loan

Our equipment loan comprises the following:

(in thousands) December 31, 
 2013  2012 
    
Short-term  73   69 
Long-term  69   148 
 
 $142  $217 

In September 2008, we entered into a Loan Agreement and Security Agreement with the Commonwealth of Pennsylvania, Department of Community and Economic Development (Department), pursuant to which the Department made a loan to us from the Machinery and Equipment Loan Fund in the amount of $500,000 (MELF Loan) to fund the purchase and installation of new machinery and equipment and the upgrade of existing machinery and equipment at our analytical and development laboratory in Warrington, Pennsylvania.  Principal and interest on the MELF Loan is payable in equal monthly installments over a period of seven years.  Interest on the principal amount accrues at a fixed rate of five percent (5.0%) per annum.  We may prepay the MELF Loan at any time without penalty.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
In addition to customary terms and conditions, the MELF Loan requires us to meet certain job retention and job creation goals in Pennsylvania within a three-year period (Jobs Covenant).  If we fail to comply with the Jobs Covenant, the Department, in its discretion, may change the interest rate on the Promissory Note to a fixed rate equal to two percentage points above the current prime rate for the remainder of the term.  As of September 30, 2011, the end of the three-year Jobs Covenant period, due to our efforts to conserve resources while we focused on securing approval for SURFAXIN, we had not complied with the Jobs Covenant.  In response to a request that we filed with the Department in November 2013 for a waiver, the Department granted us an extension through December 31, 2014 to come into compliance with the Jobs Covenant and has waived any interest adjustment until that date.

For the years ended December 31, 2013, 2012, and 2011, we incurred interest expense of $9,000, $13,000 and $20,000, respectively, on our outstanding equipment loan.

Note 1110 – Stockholders’ Equity

Registered Public Offerings

On November 5, 2013,July 22, 2015, we completed a registered public offering of 25,000,000 shares of our common stock,1,791,667 Series A units and 3,000,000 Series B units each at a price per unit of $2.00 per share$8.40, resulting in gross proceeds of $50.0$40.25 million ($46.837.6 million net proceeds).  We also grantedafter underwriting discount and expenses), including the exercise in full by the underwriters a 30-dayof their option to purchase up to an additional 3,750,000 shares of common stock at an offering price of $2.00 per share.  On November 8, 2013, the underwriters exercised their option in full, resulting in additional gross proceeds of $7.5 million ($7.1 million net proceeds).

On May 10, 2013, we completed a registered public offering of 9,500,000 shares of our common stock,625,000 Series A units at a price per unit of $1.50 per share resulting$8.40 to cover over-allotments.  The proceeds included $5.0 million in gross proceedsnon-cash consideration from Deerfield in the form of $14.3 million ($13.2 million net proceeds)a reduction in future interest payments due under the Deerfield Loan (see, Note 9, “Deerfield Loan”).  We also granted the underwriters a 30-day option to purchase up to an additional 1,425,000 shares of common stock at an offering price of $1.50 per share.  On May 28, 2013, the underwriters exercised their option to purchase 1,347,000 shares of common stock at a price of $1.50 per share, resulting in additional gross proceeds of $2.0 million ($1.9 million net proceeds).

On March 21, 2012, we completed a registered public offering of 16,071,429 shares of our common stock, at a price of $2.80 per share resulting in gross proceeds of $45.0 million ($42.1 million net proceeds).  We also granted the underwriters a 30-day option to purchase up to an additional 2,410,714 shares of common stock at an offering price of $2.80 per share, which expired unexercised in April 2012.

On February 22, 2011, we completed a registered public offering of 10,000,000 shares of our common stock, 15‑month warrants to purchase five million shares of our common stock, and five-year warrants to purchase five million shares of our common stock.  The securities were sold as units, with eachEach Series A unit consistingconsists of one share of common stock and a 15-monthSeries A warrant to purchase one half share of common stock, and a five-year warrant to purchase one half share of common stock at a public offering price of $2.35 per unit, resulting in gross proceeds to us of $23.5 million ($21.6 million net).  The 15-month warrants had an exercise price of $9.80 per share.  Each Series B unit consists of a fully paid pre-funded Series B warrant to purchase one share of $2.94 and expired in May 2012.  The five-year warrants expire in February 2016 and were initially exercisablecommon stock at a price per share of $3.20.  Thean exercise price of the five-year warrants is subject$8.40 per share, and a Series B warrant to adjustment if we issue or sellpurchase one share of common stock or securities convertible into common stock (in each case, subject to certain exceptions) at a price (determined as set forth in the warrant) that is less than thean exercise price of the warrant.  In connection with the closing of our public offerings in March 2012 and May 2013, the exercise price of the five-year warrants was adjusted downward to a price$9.80 per share of $2.80 and $1.50, respectively.

In addition, with respect to the warrants issued in connection with the foregoing offerings, the exercise price and number ofshare.  The shares of common stock issuable upon exercise are subject to adjustment in the event of any stock split, reverse stock split, stock dividend, recapitalization, reorganization or similar transaction.  The exercise price and the amount and/or type of property to be issued upon exercise of the warrants are also subject to adjustment if we engage in a “Fundamental Transaction” (such as consolidation or merger, sale or disposal of substantially all of our assets, and among others as defined in the form of the warrant).  were immediately separable such that no units were issued.  The warrants are exercisable immediately at the election of the holder for cash only, exceptor through a net cashless exercise, provided that ifa holder may not exercise a warrant to the related registration statement or an exemption from registration is not otherwise available for the resaleextent that after giving effect to such exercise, such holder would beneficially own in excess of 9.99% (or 4.99% as may be elected by such holder) of the warrant shares of our common stock outstanding immediately after such exercise.  All warrants will expire on the holder may exercise onseventh anniversary of the issue date.  The net proceeds will be used primarily (i) to advance the AEROSURF development program, and (ii) for general corporate purposes.  The offering was made pursuant to a cashless basis.preliminary prospectus supplement dated July 16, 2015 to the 2014 Universal Shelf.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
At-the-Market Program (ATM Program)

Stifel ATM Program

On February 11, 2013, we entered into an At-the-Market Equity Sales Agreement (ATM Agreement) with Stifel, Nicolaus & Company, Incorporated (Stifel), under which Stifel, as our exclusive agent, at our discretion and at such times that we may determine from time to time, may sell over a three-year period up to a maximum of $25,000,000 of shares of our common stock (ATM Program). We are not required to sell any shares at any time during the term of the ATM Program.

If we issue a sale notice to Stifel, we may designate the minimum price per share at which shares may be sold and the maximum number of shares that Stifel is directed to sell during any selling period.  As a result, prices are expected to vary as between purchasers and during the term of the offering.  Stifel may sell the shares by any method deemed to be an “at-the-market” equity offering as defined in Rule 415 promulgated under the Securities Act of 1933, as amended, which may include ordinary brokers’ transactions on The Nasdaq Capital Market®, or otherwise at market prices prevailing at the time of sale or prices related to such prevailing market prices, or as otherwise agreed by Stifel and us.  Either party may suspend the offering under the ATM Agreement by notice to the other party.

The ATM Agreement, as amended on February 11, 2016, will terminate upon the earliest of: (1) the sale of all shares subject to the ATM Agreement, (2) February 11, 20162019 or (3) the termination of the ATM Agreement in accordance with its terms.  Either party may terminate the ATM Agreement at any time upon written notification to the other party in accordance with the ATM Agreement, and upon such termination, the offering will terminate.

We agreed to pay Stifel a commission equal to 3.0% of the gross sales price of any shares sold pursuant to the ATM Agreement. With the exception of expenses related to the shares, Stifel will be responsible for all of its own costs and expenses incurred in connection with the offering.

On October 15, 2013, we completed an offering under the ATM Program and issued 713,920 shares of our common stock for an aggregate purchase price of approximately $2.0 million, resulting in net proceeds to us of approximately $1.8 million, after deducting commissions.  As of December 31, 2013, approximately $23 million remained available under the ATM Program.

Lazard ATM Program

On December 14, 2011, we entered into a Sales Agency Agreement (Agency Agreement) with Lazard Capital Markets LLC (Lazard), under which Lazard, as our exclusive agent, at our discretion and at such times that we may determine from time to time, could sell over a two-year period up to a maximum of $15,000,000 of shares of our common stock through an “at-the-market” program (Lazard ATM Program).

We agreed to pay Lazard a commission equal to 3.0% of the gross proceeds of any sales under the Lazard ATM Program.  We also agreed to reimburse Lazard for certain expenses incurred in connection with entering into the Agency Agreement and provided Lazard with customary representations, warranties and indemnification rights.  In connection with initiation of coverage of our stock by an analyst affiliated with Lazard, we agreed with Lazard to terminate the Lazard ATM Program effective August 6, 2012.

On March 12, 2012, we completed an offering of 350,374 shares of our common stock for an aggregate purchase price of approximately $1.6 million, resulting in net proceeds to us of approximately $1.5 million, after deducting commissions.

Committed Equity Financing Facility (CEFF)

From 2004 through June 2013, we maintained one or more Committed Equity Financing Facilities (CEFFs) with Kingsbridge Capital Limited (Kingsbridge), a private investment group, under which Kingsbridge was committed to purchase, subject to certain conditions, newly-issued shares of our common stock.  The CEFFs allowed us, at our discretion, to raise capital, at the time and in amounts deemed suitable to us, to support our business plans.  We were not obligated to utilize any of the funds available under any CEFF and our ability to access funds at any time was subject to certain conditions, including stock price and volume limitations.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
As of December 31, 2013, we did not have an active CEFF.  Three CEFF agreements, dated May 22, 2008, December 12, 2008, and June 11, 2010 (2010 CEFF) expired in June 2011, February 2011, and June 2013, respectively.  There were no financings under the May 2008 CEFF or December 2008 CEFF during 2013, 2012 and 2011.  The 2010 CEFF Agreement originally provided for the purchase of the lesser of up to 2.1 million shares or a maximum of $35 million, and expired in June 2013.  There were no financings completed under the 2010 CEFF in 2012 and 2013.  In 2011, we received $1.3 million of gross proceeds from the issuance of 514,990 shares at an average discounted price of $2.56 per share under the 2010 CEFF.

401(k) Plan Employer Match

We have a voluntary 401(k) savings plan (401(k) Plan) covering eligible employees that allows for periodic discretionary company matches equal to a percentage of each participant’s contributions (up to the maximum deduction allowed, excluding “catch up” amounts).  We currently provide for the company match by issuing shares of common stock that are registered pursuant to a registration statement on Form S-8 filed with the U.S. Securities and Exchange Commission (SEC).  For the years ended December 31, 2013, 20122015 and 2011,2014, the match resulted in the issuance of 510,047, 316,543,94,114 and 265,185,42,371 shares of common stock, respectively.  Expenses associated with the 401(k) match for the years ended December 31, 2013, 2012,2015 and 2011 2014 were $1.0 million, $0.8$0.5 million and $0.5$1.0 million, respectively.

Common Shares Reserved for Future Issuance

Common shares reserved for potential future issuance upon exercise of warrants

The chart below summarizes shares of our common stock reserved for future issuance upon the exercise of warrants:

(in thousands, except  price per share data) December 31,  Exercise Price Expiration Date
  2015  2014      
Battelle – 2014 collaboration agreement(1)
  107   107  $70.00 10/10/2024
Investors – July 2015 financing  4,792   –  $9.80 07/22/2022
Investors – July 2015 financing (prefunded)  2,857   –   – 07/22/2022
Deerfield – 2013 loan  500   500  $39.34 2/13/2019
Former employee  2   2  $44.80 3/18/2016
Investors – February 2011 financing  274   325  $2.66 2/22/2016
PharmaBio – October 2010 financing  –   6  $57.40 10/13/2015
Investors – June 2010 financing  –   85  $84.00 6/22/2015
Kingsbridge – June 2010 CEFF  –   6  $93.66 12/11/2015
PharmaBio – April 2010 financing  –   10  $148.26 4/30/2015
Investors – February 2010 financing  –   66  $178.50 2/23/2015
Total  8,532   1,107       
(in thousands, except  price per share data) December 31,  Exercise Expiration
 
 2013  2012  Price Date
 
       
Deerfield – 2013 loan  7,000   –  $2.81 2/13/2019
Former employee  30   30  $3.20 3/18/2016
Investors – February 2011 financing  4,835   4,949  $1.50 2/22/2016
PharmaBio – October 2010 financing  79   79  $4.10 10/13/2015
Investors – June 2010 financing  1,190   1,190  $6.00 6/22/2015
Kingsbridge – June 2010 CEFF  83   83  $6.69 12/11/2015
PharmaBio – April 2010 financing  135   135  $10.59 4/30/2015
Investors – February 2010 financing  917   917  $12.75 2/23/2015
Investors – May 2009 financing  467   467  $17.25 5/13/2014
Kingsbridge – December 2008 CEFF  45   45  $22.70 6/12/2014
Kingsbridge – May 2008 CEFF  -   55  $37.59 11/22/2013
Total  14,781   7,950     

(1)See Note 12 for further details on the Battelle collaboration agreement
Common shares reserved for potential future issuance upon exercise of stock options or granting of additional equity incentive awards

In October 2011, our stockholders approved the adoptionAs of December 31, 2015 and 2014, we had 0.4 million and 0.5 million shares, respectively, available for potential future issuance under the 2011 Long-Term Incentive Plan (the 2011 Plan).  TheOn January 21, 2016, at a Special Meeting of Stockholders, our stockholders authorized the issuance of an additional 1.1 million shares under the 2011 Plan provides for the grant of long-term equity and cash incentive compensation awards and replaced the 2007 Long-Term Incentive Plan, (the 2007 Plan).  The 2011 Plan continues many of the features of the 2007 Plan, but is updated to reflect changes to The Nasdaq Capital Market rules regarding equity compensation, other regulatory changes and market and corporate governance developments.  Awards outstanding under the 2007 and our previous, expired plan (1998 Plan) will continue to be governed by the terms of the respective plans and the agreements under which theyshares were granted, although any shares returnable to the 2007 Plan as a result of cancellations, expirations and forfeitures will be returned to, and become available for issuance under, the 2011 Plan.  Shares returnable to the 1998 Plan as a result of cancellations, expirations and forfeitures will not become available for issuance under the 1998 Plan or the 2011 Plan.registered on Form S-8 on January 27, 2016.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Stock options and awards outstanding and available for future issuance as of December 31, 2013 and 2012 are as follows:

 As of December 31, 
 2013  2012 
    
Stock Options Outstanding    
2011 Plan(1)
  4,919   3,365 
2007 Plan  258   277 
1998 Plan  251   355 
Total Outstanding  5,428   3,997 
Available for Future Grants under 2011 Plan  2,894   2,966 
Total  8,322   6,963 

(1)  See, Note 12 – Stock Options and Stock-based Employee Compensation – Long-Term Incentive Plans.
Common shares reserved for potential future issuance under our 401(k) Plan

As of December 31, 20132015 and 2012,2014, we had 166,2434,567 and 26,290,438, respectively, reserved for potential future issuance under the 401(k) Plan.  On October 27, 2015 the Board of Directors approved the issuance of 78,571 shares of common stock that may be issued pursuant to our 401(k) Plan.  These shares were registered on Form S-8 on January 6, 2016.

Note 1211 – Stock Options and Stock-based Employee Compensation

Long-Term Incentive Plans

In October 2011, our stockholders approvedWe have the 2011 Plan whichthat provides for the grant of long-term equity and cash incentive compensation awards and replaced thea 2007 Plan.  (See, Note 11 – Common shares reserved for potential future issuance upon exercise of stock options or granting of additional equity incentive awards.)  The 2011Long-Term Incentive Plan continues many of the features of the(the 2007 Plan, but is updated to reflect changes to The Nasdaq Capital Market rules regarding equity compensation, other regulatory changes and market and corporate governance developments.Plan).  Awards outstanding under the 2007 Plan and an earlier 1998 Plan (expired) will continue to be governed by the terms of thosethe plans and the applicable award agreements.agreements under which they were granted.

Under the 2011 Plan, we may grant awards for up to 7.82.0 million shares of our common stock.  Additionally, any shares returnable to the 2007 Plan as a result of cancellations, expirations and forfeitures will be returned to, and become available for issuance under, the 2011 Plan.  Shares returnable to the 1998 Plan as a result of cancellations, expirations and forfeitures will not become available for issuance under the 1998 Plan or the 2011 Plan.  Awards under the Plan may include stock options, stock appreciation rights (SARs), restricted stock awards (RSAs), restricted stock units, other performance and stock-based awards, and dividend equivalents.

An administrative committee (the Committee – currently the Compensation Committee of the Board of Directors) or Committee delegates may determine the types, the number of shares covered by, and the terms and conditions of, such awards.  Eligible participants may include any of our employees, directors, advisors or consultants.

As of December 31, 2013, under the 2011 Plan, there were 4,919,333 stockStock options outstanding, 18,936and restricted stock units (“RSUs”) that vest in June 2014(RSUs) outstanding and 2,894,374 shares available for grant.  future issuance are as follows:

 December 31, 
  2015  2014 
       
Stock Options and RSUs Outstanding      
2011 Plan  493   437 
2007 Plan  17   18 
1998 Plan  12   13 
Total Outstanding  522   468 
         
Available for Future Grants under 2011 Plan  420   476 

No SARs, RSAs, other performance and stock-based awards, or dividend equivalents have been granted under the 2011 Plan.  Although individual grants may vary, option awards generally are exercisable upon vesting, vest based upon threetwo years of continuous service, and have a 10-year term.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
A summary of activity under our long-term incentive plans is presented below:

(in thousands, except for weighted-average data)           
Stock Options Shares  
Weighted-
Average
Exercise
Price
 
Weighted-
Average
Remaining
Contractual
Term (In Yrs)
 Shares  
Weighted-
Average
Exercise
Price
  
Weighted-
Average
Remaining
Contractual
Term (In Yrs)
 
             
Outstanding at December 31, 2010  943  $56.06 
 
Outstanding at January 1, 2015  467  $63.04    
           
Granted  1,771   1.84 
 
  185   15.64    
Forfeited or expired  (276)  44.95 
 
  (135)  42.81    
Outstanding at December 31, 2011  2,438  $17.97 
 
Granted  1,724   2.63 
 
Exercised  (3)  1.83 
 
Forfeited or expired  (162)  24.39 
 
Outstanding at December 31, 2012  3,997  $11.11 
 
Granted  1,928   2.30 
 
Exercised  (18)  1.85 
 
Forfeited or expired  (479)  28.09 
 
Outstanding at December 31, 2013  5,428  $6.51 8.0
Outstanding at December 31, 2015  517  $51.35   6.6 
        
    
            
Exercisable at December 31, 2013  2,346  $12.01 6.9
Vested and exercisable at December 31, 2015  294  $74.84   4.9 

(in thousands, except for weighted-average data)          
Restricted Stock Units Shares  
Weighted-
Average
Exercise
Price
  
Weighted-
Average
Remaining
Contractual
Term (In Yrs)
  Shares  
Weighted-
Average
Grant
Date Fair
 Value
 
            
Outstanding at December 31, 2012  –  $–  
 
Unvested at January 1, 2015  1  $23.94 
Awarded  19   –  
   5  $6.72 
Outstanding at December 31, 2013  19  $–   0.4 
            
Exercisable at December 31, 2013  –  $–   0.0 
Vested  (1) $23.94 
Unvested at December 31, 2015  5  $6.72 

Based upon application of the Black-Scholes option-pricing formula described below, the weighted-average grant-date fair value of options and awards granted during the years ended December 31, 2013, 2012,2015 and 20112014 was $1.79, $2.02,$10.48 and $1.45,$25.48, respectively.  The weighted-average grant-date fair value of RSUs granted during the year ended December 31, 2013 was $1.69.  There were no RSUs granted during the years ended December 31, 20122015 and 2011.  For the year ended December 31, 2013, there were 18,208 options exercised, resulting in approximately $34,000 in proceeds.  For the year ended December 31, 2012, there were 3,334 options exercised, resulting in approximately $6,000 in proceeds.  There were no options exercised during the year ended December 31, 2011.2014 was $6.72 and $23.94, respectively.  The total intrinsic value of options outstanding, vested, and exercisable as of December 31, 2013 is $0.8 million, $0.5 million, and $0.5 million, respectively.2015 are each $0.
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY

The following table provides detail with regard to options outstanding, vested and exercisable at December 31, 2013:
(shares in thousands)  Outstanding Vested and Exercisable
Price per share  Shares  
Weighted-
Average Price
per Share
 
Weighted-
Average
Remaining
 Contractual Life
 Shares  
Weighted-
Average Price
per Share
 
Weighted-
Average
Remaining
Contractual Life
$1.58 - $156.45   5,428  $6.51 8.0 Years  2,346  $12.01 6.9 Years

Stock-Based Compensation

We recognized stock-based compensation expense in accordance ASC Topic 718 for the years ended December 31, 2013, 2012,2015 and 2011,2014 of $2.2 million, $2.4$1.7 million and $0.9$2.9 million, respectively.

Stock-based compensation expense was classified as follows:

 December 31, 
(in thousands) 2013  2012  2011 
      
Research and development $784  $487  $289 
Selling, general and administrative  1,426   1,924   578 
Total $2,210  $2,411  $867 
On December 31, 2012, our former Chief Executive Officer resigned from his position and as a member of our Board.  Under the terms of a separation agreement that we entered into with the former CEO, all of the former CEO’s outstanding options vested immediately and all such options shall remain exercisable to the end of their stated terms.  We recognized $0.8 million in stock option modification costs related to these items.
  December 31, 
(in thousands) 2015  2014 
       
Research and development $642  $1,014 
Selling, general and administrative  1,054   1,927 
Total $1,696  $2,941 

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing formula that uses assumptions noted in the following table.  Expected volatilities are based upon the historical volatility of our common stock and other factors.  We also use historical data and other factors to estimate option exercises, employee terminations and forfeiture rates within the valuation model.  The risk-free interest rates are based upon the U.S. Treasury yield curve in effect at the time of the grant.

 December 31, 
 2013  2012  2011 
      
Weighted average expected volatility  109%  111%  113%
Weighted average expected term 4.7 years  4.6 years  4.8 years 
Weighted average risk-free interest rate  0.73%  0.74%  1.08%
Expected dividends  –   –   – 
  December 31, 
  2015  2014 
       
Weighted average expected volatility  83%  100%
Weighted average expected term 5.5 years  5.4 years 
Weighted average risk-free interest rate  1.50%  1.65%
Expected dividends  –   – 

The total fair value of the underlying shares of the options vested during 2013, 2012,2015 and 2011,2014 equals $1.9 million, $2.2$2.7 million and $0.6$3.1 million, respectively.  As of December 31, 2013,2015, there was $4.0$1.9 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the 2011 Plan.  That cost is expected to be recognized over a weighted-average vesting period of 1.71.8 years.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Note 1312 – Corporate Partnership, Licensing and Research Funding Agreements

Laboratorios del Dr. Esteve, S.A.

We have a strategic alliance with Laboratorios del Dr. Esteve, S.A. (Esteve) for the development, marketing and sales of a broad portfolio of potential KL4 surfactant products in Andorra, Greece, Italy, Portugal, and Spain.  Antonio Esteve, Ph.D., a principal of Esteve, served as a member of our Board of Directors from May 2002 until January 2013.  Esteve will pay us a transfer price on sales of our KL4 surfactant products.  We will be responsible for the manufacture and supply of all of the covered products and Esteve will be responsible for all sales and marketing in the territory.  Esteve is obligated to make stipulated cash payments to us upon our achievement of certain milestones, primarily upon receipt of marketing regulatory approvals for the covered products.  In addition, Esteve has agreed to contribute to phase 3 clinical trials for the covered products by conducting and funding development performed in the territory.  As part of a 2004 restructuring in which Esteve returned certain rights to us in certain territories (Former Esteve Territories), we agreed to pay Esteve 10% of any cash up front and milestone fees (up to a maximum aggregate of $20 million) that we receive in connection with any strategic collaborations for the development and/or commercialization of certain of our KL4 surfactant products in the Former Esteve Territories.

Licensing and Research Funding Agreements

Battelle Memorial Institute

In October 2014, we entered into a collaboration agreement with Battelle providing for the further development of our ADS for potential use in our planned phase 3 clinical program for AEROSURF for the treatment of RDS in premature infants and, if AEROSURF is approved for commercial sale by the FDA or other regulatory authority, initial commercial supply.  Under our agreement, we and Battelle plan to design, develop, and complete the testing, verification, and documentation of an improved AEROSURF system, and share equally in the related development costs.  These costs are recognized in research and development expense as incurred and were $3.1 million and $0.3 million for the years ended December 31, 2015 and 2014, respectively.

In connection with the collaboration agreement, we issued to Battelle two warrants to purchase shares of our common stock, each having an exercise price of $70.00 per share and a term of 10 years, subject to earlier termination under certain circumstances set forth therein, including (i) a warrant to purchase up to 71,429 shares of our common stock, exercisable upon successful completion by Battelle of development activities described above (Initial Warrant), and (ii) a warrant to purchase up to 35,714 shares of our common stock (Additional Warrant; and together with the Initial Warrant, the Battelle Warrants), exercisable if and only if Battelle successfully completes the development activities no later than July 15, 2016, which date  was adjusted, and may be further adjusted, as provided in the Collaboration Agreement.  We and Battelle have agreed to execute a registration rights agreement providing for the registration of the resale of shares underlying the Battelle Warrants.  The Battelle Warrants may be exercised for cash only, except that, in the event a registration statement is not effective at the time of exercise and if an exemption from registration is otherwise available at that time, the Battelle Warrants may be exercised on a cashless basis.  The Battelle Warrants were issued pursuant to an exemption from registration contained in Regulation D, Rule 506.  The Battelle Warrants are accounted for as equity instruments under the applicable accounting guidance of ASC Topic 815.

If Battelle successfully completes their activities under the agreement, we have agreed to pay Battelle royalties equal to a low single-digit percentage of the worldwide net sales and license royalties on sales of AEROSURF for the treatment of RDS in premature infants, up to an aggregate limit of $25 million.

Philip Morris USA Inc. and Philip Morris Products S.A.

Under license agreements with Philip Morris USA Inc. (PMUSA) and Philip Morris Products S.A. (PMPSA), we hold exclusive worldwide licenses to the CAGADS technology for use with pulmonary surfactants (alone or in combination with any other pharmaceutical compound(s)) for all respiratory diseases and conditions (the foregoing uses in each territory, the Exclusive Field), and an exclusive license in the U.S. for use with certain non-surfactant drugs to treat a wide range of pediatric and adult respiratory indications in hospitals and other health care institutions.  We generally are obligated to pay royalties at a rate equal to a low single-digit percent of sales of products sold in the Exclusive Field (as defined in the license agreements) in the territories, including sales of aerosol devices and related components that are not based on the capillary aerosolization technology (unless we exercise our right to terminate the license with respect to a specific indication).  We also agreed to pay minimum royalties quarterly beginning in 2014, but are entitled to a reduction of future royalties in an amount equal to the excess of any minimum royalty paid over royalties actually earned in prior periods.  We paid the minimum royalty of $400,000 and $300,000 in 2015 and 2014, respectively, related to these license agreements.

Johnson & Johnson and Ortho Pharmaceutical Corporation

We, Johnson & Johnson (J&J) and its wholly-owned subsidiary, Ortho Pharmaceutical Corporation, are parties to a license agreement granting to us an exclusive worldwide license to the J&J proprietary KL4 surfactant technology.  Under the license agreement, we are obligated to pay fees of up to $2.5 million in the aggregate upon our achievement of certain milestones, primarily upon receipt of marketing regulatory approvals for certain designated products.  We have paid $950,000 to date for milestones that have been achieved including a $500,000 milestone payment in 2012 that became due as a result of the FDA’s approval of SURFAXIN. In addition, we are required to make royalty payments at different rates, depending upon type of revenue and country, in amounts in the range of a high single-digit percent of net sales (as defined in the license agreement) of licensed products sold by us or sublicensees, or, if greater, a percentage of royalty income from sublicensees in the low double digits.

F - 27
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Note 14 – CommitmentsLaboratorios del Dr. Esteve, S.A.

FutureWe have a strategic alliance with Laboratorios del Dr. Esteve, S.A. (Esteve) for the development, marketing and sales of a broad portfolio of potential KL4 surfactant products in Andorra, Greece, Italy, Portugal, and Spain.  Antonio Esteve, Ph.D., a principal of Esteve, served as a member of our Board of Directors from May 2002 until January 2013.  Esteve will pay us a transfer price on sales of our KL4 surfactant products.  We will be responsible for the manufacture and supply of all of the covered products and Esteve will be responsible for all sales and marketing in the territory.  Esteve is obligated to make stipulated cash payments due under contractual obligations at December 31, 2013 are as follows:to us upon our achievement of certain milestones, primarily upon receipt of marketing regulatory approvals for the covered products.  In addition, Esteve has agreed to contribute to phase 3 clinical trials for the covered products by conducting and funding development performed in the territory.  As part of a 2004 restructuring in which Esteve returned certain rights to us in certain territories (Former Esteve Territories), we agreed to pay Esteve 10% of any cash up front and milestone fees (up to a maximum aggregate of $20 million) that we receive in connection with any strategic collaborations for the development and/or commercialization of certain of our KL4 surfactant products in the Former Esteve Territories.

(in thousands) 2014  2015  2016  2017  2018  
There-
after
  Total 
Operating lease obligations  1,087   1,024   934   936   158   –   4,139 
Equipment loan obligations (1)
  79   69   –   –   –   –   148 
Total
 $1,166  $1,093  $934  $936  $158  $–  $4,287 
(1)
See, Note 10 – Equipment Loan
Note 13 – Commitments

Operating Leases

Our operating leases consist primarily of facility leases for our operations in Pennsylvania and New Jersey.

We maintain our headquarters in Warrington, Pennsylvania.  The facility is 39,594 square feet and serves as the main operating facility for drug and device development, regulatory, analytical technical services, research and development, and administration.  In January 2013, the lease was amended to extend the term an additional five years through February 2018.  The total aggregate base rental payments under the lease prior to the extension were approximately $7.2 million and the total aggregate base rental paymentsremaining under the extended portion of the lease are approximately $4.9$2.0 million.

We leaseUntil June 30, 2015, we leased approximately 21,000 square feet of space for our manufacturing operations in Totowa, New Jersey (Totowa Facility), at an annual rent of $150,000.  This space is specifically designed$525,000.  The lease for the manufacture and filling of sterile pharmaceuticals in compliance with cGMP and is our only manufacturing facility.  We have secured an extension of the lease,this facility, which was scheduledused to expire in December 2014, until tomanufacture SURFAXIN drug product, expired on June 30, 2015 for aggregate base rental payments of $306,250 under the extension period.  For a discussion of our manufacturing strategy, See, “Item 1 – Business – Business Operations – Manufacturing and Distribution,” in our Annual Report on Form 10-K.

Rent expense under these leases was $1.0 million and $1.2 million for each of the years ended December 31, 2013, 2012,2015 and 2011,2014, respectively.

Retention Plan

On September 13, 2013, our Board of Directors approved an employee severance and retention plan for employees at the Totowa Facility to take effect in the event that we are unable to secure long-term utilization of the Totowa Facility beyond the scheduled lease expiration on June 30, 2015.  The retention plan is intended to minimize employee turnover by providing severance and retention bonuses that encourage employees to stay with us through facility closing date (and beyond for certain employees).  The plan has two components: (1) plant management (three individuals) has received an award of stock options that will vest in full, and will be eligible for a retention bonus payable in June 2016, provided that they remain employed with us in June 2016; and (2) provided that they remain employed with us through the successful closure of the Totowa Facility, non-union employees (nine individuals) will be eligible to receive both severance and a retention bonus payable upon such closure.  The total cash amount expected to be paid for severance and retention through June 2016 is approximately $1.0 million.  The plan-related expense incurred during 2013 is $0.1 million and is included in research and development expense.  The related liability is $0.1 million as of December 31, 2013.

In addition, there are 14 employees at the Totowa Facility who are subject to a collective bargaining agreement and will be eligible to receive severance upon closure of the Totowa Facility.  The plan-related expense incurred during 2013 is $30,000 and is included in research and development expense.  The related liability is $0.5 million as of December 31, 2013.

DISCOVERY LABORATORIES, INC.  AND SUBSIDIARYBattelle Collaboration

In accordance with terms of the Battelle agreement (See, – Note 1512 – Corporate Partnership, Licensing and Research Funding Agreements), we and Battelle plan to design, develop, and complete the testing, verification, and documentation of an improved AEROSURF system, and share equally in the development plan costs.  If this project is successfully completed in accordance with the development plan, based upon current estimates, we expect to incur development costs of approximately $6.6 million through 2016.

Restructuring Plan

In April 2015, we implemented a restructuring plan to voluntarily cease the commercialization of SURFAXIN and focus our resources on the development of our aerosolized KL4 surfactant pipeline for respiratory diseases, beginning with AEROSURF.  As part of the restructuring plan, we ceased manufacturing activities at our Totowa Facility, which we closed upon the expiration of our lease on June 30, 2015.

The total severance cost for all impacted employees is $2.9 million, of which $1.0 million was accrued as of December 31, 2014 for Totowa employees.  The remaining $1.9 million was charged to expense during 2015 ($1.0 million to research and development expenses and $0.9 million to selling, general and administrative expenses).  We paid $2.6 million of the severance and retention benefits during 2015.  The remaining $0.3 million will be paid through June 30, 2016.

Note 14 – Litigation

We are not aware of any pending or threatened legal actions that would, if determined adversely to us, have a material adverse effect on our business and operations.

We have from time to time been involved in disputes and proceedings arising in the ordinary course of business, including in connection with the conduct of our clinical trials.  In addition, as a public company, we are also potentially susceptible to litigation, such as claims asserting violations of securities laws.  Any such claims, with or without merit, if not resolved, could be time-consuming and result in costly litigation.  There can be no assurance that an adverse result in any future proceeding would not have a potentially material adverse effect on our business, results of operations and financial condition.

Note 1615 – Income Taxes

Since our inception, we have never recorded a provision or benefit for Federal and state income taxes.

The reconciliation of the income tax benefit computed at the Federal statutory rates to our recorded tax benefit for the years ended December 31, 2013, 2012,2015 and 20112014 is as follows:

(in thousands) December 31,  December 31, 
 2013  2012  2011  2015  2014 
Income tax benefit, statutory rates $15,373  $12,687  $7,128  $18,758  $14,980 
State taxes on income, net of Federal benefit  2,922   2,288   1,633   3,760   2,871 
Research and development tax credit  517   332   662   1,047   1,472 
Employee related  (766)  (988)  (1,758)  (340)  (2,131)
Warrant valuation related  259   189   1,210   289   1,289 
Income tax benefit  18,305   14,508   8,875   23,514   18,481 
Valuation allowance  (18,305)  (14,508)  (8,875)  (23,514)  (18,481)
Income tax benefit $–  $–  $–  $–  $– 
The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities, at December 31, 20132015 and 2012,2014, are as follows:

(in thousands) December 31, 
 
 2013  2012 
Long-term deferred tax assets: 
  
 
Net operating loss carryforwards (Federal and state) $175,258  $160,522 
Research and development tax credits  10,604   9,412 
Compensation expense on stock  3,276   3,154 
Charitable contribution carryforward  7   7 
Inventory reserve  198   – 
Deferred revenue  53   – 
Other accrued  1,024   524 
Depreciation  2,714   2,665 
Capitalized research and development  1,326   1,516 
Total long-term deferred tax assets  194,460   177,800 
Less:  valuation allowance  (194,460)  (177,800)
Deferred tax assets, net of valuation allowance $–  $– 

(in thousands) December 31, 
  2015  2014 
Long-term deferred tax assets:      
Net operating loss carryforwards (Federal and state) $218,203  $191,643 
Research and development tax credits  13,917   12,927 
Compensation expense on stock  2,776   2,588 
Charitable contribution carryforward  6   7 
Inventory reserve  –   907 
Deferred revenue  –   16 
Other accrued  469   1,088 
Depreciation  482   2,630 
Capitalized research and development  –   1,123 
Total long-term deferred tax assets  235,853   212,929 
Less:  valuation allowance  (235,853)  (212,929)
Deferred tax assets, net of valuation allowance $–  $– 
F - 29
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY

We are in a net deferred tax asset position at December 31, 20132015 and 20122014 before the consideration of a valuation allowance.  Because we have never realized a profit, management has fully reserved the net deferred tax asset since realization is not assured.  It is our policy to classify interest and penalties recognized on uncertain tax positions as a component of income tax expense. There was neither interest nor penalties accrued as of December 31, 20132015 or 2012,2014, nor were any incurred in 2013, 2012,2015 or 2011.2014.

At December 31, 20132015 and 2012,2014, we had available carryforward net operating losses for Federal tax purposes of $432.1$540.2 million and $396.7$473.3 million, respectively, and a research and development tax credit carryforward of $10.6$13.9 million and $9.4$12.9 million, respectively.  The Federal net operating loss and research and development tax credit carryforwards beganwill continue to expire in 2008 and will continue through 2033.2035.

At December 31, 2013,2015, we had available carryforward Federal and State net operating losses of $5.2 million and $0.4 million, respectively, related to stock-based compensation, the tax effect of which will result in a credit to equity as opposed to income tax expense, to the extent these losses are utilized in the future.

At December 31, 20132015 and 2012,2014, we had available carryforward losses of approximately $433.7$527.1 million and $392.6$470.4 million, respectively, for state tax purposes.  Of the $433.7$527.1 million state tax carryforward losses, $399.5$503.7 million is associated with the state of Pennsylvania, with the remainder associated with the other 10 states within which we have established tax nexus.

Utilization of net operating loss (NOL) and research and development (R&D) credit carryforwards may be subject to a substantial annual limitation under Section 382 of the Internal Revenue Code of 1986 due to ownership change limitations that have occurred previously or that could occur in the future.  These ownership changes may limit the amount of NOL and R&D credit carryforwards that can be utilized annually to offset future taxable income and tax, respectively.  There also could be additional ownership changes in the future, which may result in additional limitations in the utilization of the carryforward NOLs and credits.

A full valuation allowance has been provided against our research and development credits and, if a future assessment requires an adjustment, an adjustment would be offset by an adjustment to the valuation allowance.  Thus, there would be no impact to the consolidated balance sheet or statement of operations if an adjustment were required.
DISCOVERY LABORATORIES, INC.  AND SUBSIDIARY
Note 1716 – Selected Quarterly Financial Data (Unaudited)

The following table containstables contain unaudited statement of operations information for each quarter of 20132015 and 2012.2014. The operating results for any quarter are not necessarily indicative of results for any future period.

2013 Quarters Ended:    
(in thousands, except per share data) Mar. 31  June 30  Sept. 30  Dec. 31  Total Year 
Grant revenues $72  $182  $60  $74  $388 
Expenses:                    
Cost of sales  –   –   –   517   517 
Research and development  8,472   6,863   6,574   5,752   27,661 
Selling, General and administrative  4,220   4,129   4,299   4,070   16,718 
Total expenses  12,692   10,992   10,873   10,339   44,896 
Operating loss  (12,620)  (10,810)  (10,813)  (10,265)  (44,508)
Change in fair value of common stock warrant liability  162   2,525   (1,059)  (867)  761 
Other expense, net  (177)  (342)  (352)  (597)  (1,468)
Net loss $(12,635) $(8,627) $(12,224) $(11,729) $(45,215)
Net loss per common share - basic $(0.29) $(0.18) $(0.22) $(0.16) $(0.82)
Net loss per common share - diluted  (0.29)  (0.22)  (0.22)  (0.16)  (0.82)
Weighted average number of common shares outstanding - basic  43,657   49,135   54,792   73,129   55,258 
Weighted average number of common shares outstanding - diluted  43,657   49,866   54,792   73,129   55,258 
2012 Quarters Ended: 
 
(in thousands, except per share data) Mar. 31  June 30  Sept. 30  Dec. 31  Total Year 
Grant Revenues $–  $–  $–  $195  $195 
Expenses:                    
Research and development  4,533   5,206   5,743   6,088   21,570 
General and administrative  2,047   3,610   4,255   6,532   16,444 
Total expenses  6,580   8,816   9,998   12,620   38,014 
Operating loss  (6,580)  (8,816)  (9,998)  (12,425)  (37,819)
Change in fair value of common stock warrant liability  (3,434)  1,680   (3,309)  5,618   555 
Other expense, net  (2)  (2)  (39)  (8)  (51)
Net loss $(10,016) $(7,138) $(13,346) $(6,815) $( 37,315)
Net loss per common share -  basic and diluted $(0.37) $(0.16) $(0.31) $(0.16) $(0.95)
Weighted average number of common shares outstanding  27,162   43,369   43,444   43,521   39,396 
 
2015 Quarters Ended:   
(in thousands, except per share data) Mar. 31  June 30  Sept. 30  Dec. 31  Total Year 
Revenues:               
Product sales $7  $–  $–  $–  $7 
Grant revenues  184   75   66   655   980 
Total revenues  191   75   66   655   987 
Expenses:                    
Cost of sales  929   –   –   –   929 
Research and development  7,082   7,129   6,452   8,225   28,888 
Selling, General and administrative  3,353   3,383   2,057   2,211   11,004 
Total expenses  11,364   10,512   8,509   10,436   40,821 
Operating loss  (11,173)  (10,437)  (8,443)  (9,781)  (39,834)
Change in fair value of common stock warrant liability  (31)  469   139   274   851 
Other expense, net  (975)  (1,358)  (13,252)  (602)  (16,187)
Net loss $(12,179) $(11,326) $(21,556) $(10,109) $(55,170)
Net loss per common share - basic $(1.96) $(1.82) $(2.80) $(1.26) $(7.98)
Net loss per common share - diluted $(1.96) $(1.82) $(2.80) $(1.26) $(7.98)
Weighted average number of common shares outstanding - basic  6,114   6,125   7,550   8,050   6,967 
Weighted average number of common shares outstanding - diluted  6,114   6,125   7,550   8,050   6,967 
F - 31
2014 Quarters Ended:   
(in thousands, except per share data) Mar. 31  June 30  Sept. 30  Dec. 31  Total Year 
Revenues:               
Product sales $28  $42  $106  $136  $312 
Grant revenues  3   1,051   421   1,048   2,523 
Total revenues  31   1,093   527   1,184   2,835 
Expenses:                    
Cost of sales  781   731   257   902   2,671 
Research and development  5,590   6,858   6,471   7,771   26,690 
Selling, General and administrative  4,423   4,446   4,126   3,737   16,732 
Total expenses  10,794   12,035   10,854   12,410   46,093 
Operating loss  (10,763)  (10,942)  (10,327)  (11,226)  (43,258)
Change in fair value of common stock warrant liability  378   1,448   173   1,792   3,791 
Other expense, net  (1,091)  (1,129)  (1,170)  (1,201)  (4,591)
Net loss $(11,476) $(10,623) $(11,324) $(10,635) $(44,058)
Net loss per common share - basic $(1.96) $(1.68) $(1.82) $(1.68) $(7.28)
Net loss per common share - diluted $(1.96) $(1.96) $(1.82) $(2.10) $(7.84)
Weighted average number of common shares outstanding - basic  6,052   6,076   6,086   6,097   6,078 
Weighted average number of common shares outstanding - diluted  6,052   6,134   6,086   6,111   6,145 
Note 17      Subsequent Events

We evaluated all events or transactions that occurred after December 31, 2015 through the date we issued these financial statements.  During this period, we noted two subsequent events as described below:

Share Consolidation

On January 21, 2016, at a Special Meeting of Stockholders, our stockholders approved proposals authorizing the Board of Directors, in its discretion, to implement a reverse split based on an exchange ratio in a designated range and to reduce the number of authorized shares of common stock at one half the exchange ratio implemented for the reverse split.

We filed a Certificate of Amendment to our Certificate of Incorporation to (i) effect a share consolidation, or reverse split, of the common stock, par value $0.001 per share, at a ratio of 1-for-14, effective at 12:01 a.m. on January 22, 2016, and (ii) reduce the number of authorized shares of common stock under our Certificate of Incorporation from 250 million to 36 million.  Because the Amendment did not reduce the number of authorized shares of common stock in the same proportion as the reverse split, the Amendment had the effect of increasing the amount of common stock available for issuance relative to the amount of common stock available for issuance prior to the Amendment.  Further, any warrants, options, restricted stock units and rights outstanding as of the effective date that were subject to adjustment were adjusted in accordance with the terms thereof.  Those adjustments may have included, without limitation, changes to the number of shares of common stock that may be obtained upon exercise or conversion of these securities, and changes to the applicable exercise or purchase price.  The stockholders also approved the issuance of an additional 1.1 million shares under the 2011 Long-Term Incentive Plan.

Executive Severance

On February 1, 2016, the Company announced the appointment of Craig Fraser to serve as our President and Chief Executive Officer, effective February 1, 2016.  Upon recommendation of the Nomination and Governance Committee of our Board of Directors also appointed Mr. Fraser to serve as a member of the Board, effective immediately.

In connection with the foregoing, effective February 1, 2016, we terminated the Employment Agreement of our then President and Chief Executive Officer (the Former CEO).  In connection therewith, upon execution by the Former CEO of a plenary release in form satisfactory to us, he became entitled under his Employment Agreement to the following severance and other benefits, in addition to any vested benefits under our company plans or policies: (i) a pro rata bonus equal to a percentage of his Annual Bonus Amount determined by dividing the aggregate bonuses paid to other contract executives for the year 2016 by the aggregate target bonuses of such other contract executives for 2016, and further prorated for the number of days the Former CEO was employed during 2016, payable at the time that other contract executives are paid bonuses with respect to 2016; (ii) a severance amount equal to the sum of the Former CEO’s base salary then in effect and his Annual Bonus Amount, payable in equal installments through August 1, 2017 (the Severance Period); and (iii) all stock options held by the Former CEO will continue to vest during the Severance Period, and continue to be exercisable for up to 36 months after the date of termination.  From and after the end of the Severance Period, the Former CEO will forfeit all of his unvested stock options in accordance with the terms of the 2011 Plan.  The Former CEO also is subject to non-competition and non-solicitation restrictions for 12 months and 18 months, respectively, after the date of termination under a separate confidentiality agreement.  All of our obligations under the Employment Agreement will cease if at any time during the Severance Period the Former CEO engages in a material breach of the Employment Agreement and fails to cure such breach within five business days after receipt from us of notice of such breach.
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