UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to ___________
Commission file number 000-26422
DISCOVERY LABORATORIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-3171943
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
350 South Main Street, Suite 307
Doylestown, Pennsylvania 18901
(Address of principal executive offices) (Zip Code)
(215) 340-4699
(Registrants' telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
As of May 13, 2003, 32,856,526 shares of Common Stock, par value $.001 per
share, were outstanding.
Table of Contents
Page
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS --
As of March 31, 2003 (unaudited) and December 31, 2002 ...................................... Page 4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
-- For the Three Months Ended March 31, 2003 and 2002; and
for the Period from May 18, 1993 (Inception) through March 31, 2003 ......................... Page 5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
-- For the Three Months Ended March 31, 2003 and 2002; and
for the Period from May 18, 1993 (Inception) through March 31, 2003 ......................... Page 6
Notes to Condensed Consolidated Financial Statements
- March 31, 2003 (unaudited) ................................................................ Page 7
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations ..................................................................................... Page 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk ...................................... Page 21
Item 4. Controls and Procedures ......................................................................... Page 21
PART II - OTHER INFORMATION
Item 1. Legal Proceedings. .............................................................................. Page 23
Item 2. Changes in Securities and Use of Proceeds. ...................................................... Page 23
Item 3. Defaults Upon Senior Securities. ................................................................ Page 23
Item 4. Submission of Matters to a Vote of Security Holders. ............................................ Page 23
Item 5. Other Information. .............................................................................. Page 23
Item 6. Exhibits and Reports on Form 8-K. ............................................................... Page 23
Signatures ............................................................................................... Page 25
Unless the context otherwise requires, all references to "we," "us," "our," and
the "Company" include Discovery Laboratories, Inc. ("Discovery"), and its
wholly-owned, presently inactive subsidiary, Acute Therapeutics, Inc.
Safe Harbor Statement Under the Private Securities Litigation Act of 1996
Certain statements set forth in this report and any that are incorporated by
reference herein which are not historical, including, without limitation,
statements concerning our research and development programs and clinical trials,
the possibility of submitting regulatory filings for our products under
development, the seeking of collaboration arrangements with pharmaceutical
companies or others to develop, manufacture and market products, the research
and development of particular compounds and technologies and the period of time
for which our existing resources will enable us to fund our operations,
constitute "Forward Looking Statements" within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
We intend that all forward-looking statements be subject to the safe-harbor
provisions of the Private Securities Litigation Reform Act of 1995. These
forward-looking statements are only predictions and reflect our views as of the
date they are made with respect to future events and financial performance.
Forward-looking statements are subject to many risks and uncertainties which
could cause our actual results to differ materially from any future results
expressed or implied by the forward-looking statements.
Examples of the risks and uncertainties include, but are not limited to: the
inherent risks and uncertainties in developing products of the type we are
developing; possible changes in our financial condition; the progress of our
research and development (including the risk that our lead product candidate,
Surfaxin(R), will not prove to be safe or useful for the treatment of certain
indications); the impact of development of competing therapies and/or
technologies by other companies; our ability to obtain additional required
financing to fund our research programs; our ability to enter into agreements
with collaborators and the failure of collaborators to perform under their
agreements with us; the results of clinical trials being conducted by us; the
progress of the FDA approvals in connection with the conduct of our clinical
trials and the marketing of our products; the additional cost and delays which
may result from requirements imposed by the FDA in connection with obtaining the
required approvals; and the other risks and uncertainties detailed in Item 2:
"Management's Discussion and Analysis" and in any documents incorporated by
reference in this report.
Except to the extent required by applicable laws or rules, we do not undertake
to update any forward-looking statements or to publicly announce revisions to
any of the forward-looking statements, whether as a result of new information,
future events or otherwise.
Page 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
(a development stage company)
Condensed Consolidated Balance Sheets
March 31, December 31,
2003 2002
----------- -----------
Current assets: (unaudited)
Cash and cash equivalents 6,884,000 8,538,000
Available -for-sale marketable securities 7,286,000 10,652,000
Note receivable - current 2,000 2,000
Prepaid expenses and other current assets 257,000 325,000
----------- -----------
Total current assets 14,429,000 19,517,000
Property and equipment, net of accumulated depreciation 1,409,000 1,231,000
Note receivable, net of current portion 194,000 195,000
Other assets 108,000 119,000
----------- -----------
Total Assets 16,140,000 21,062,000
=========== ===========
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accured expenses 2,567,000 3,013,000
Capitalized lease - current 238,000 189,000
----------- -----------
Total current liabilities 2,805,000 3,202,000
Deferred revenue 1,213,000 1,393,000
Credit facility with corporate partner 1,648,000 1,450,000
Capitalized lease, net of current portion 348,000 256,000
----------- -----------
Total Liabilities 6,014,000 6,301,000
Shareholders' equity:
Common stock, $.001 par value; 60,000,000 authorized;
32,856,526 issued and outstanding at March 31, 2003
and December 31, 2002 33,000 33,000
Additional paid-in capital 87,397,000 87,463,000
Unearned portion of compensatory stock options (96,000) (95,000)
Deficit accumulated during development stage (77,083,000) (72,578,000)
Treasury stock (at cost; 38,243 shares common) (239,000) (239,000)
Accumulated other comprehensive income 114,000 177,000
----------- -----------
Total stockholders' equity 10,126,000 14,761,000
----------- -----------
Total Liabilities & Equity 16,140,000 21,062,000
=========== ===========
See notes to condensed consolidated financial statements Page 4
DISCOVERY LABORATORIES, INC. AND SUBSIDIARY
(a development stage company)
Condensed Consolidated Statements of Operations
(Unaudited)
May 18, 1993
Three Months Ended (Inception)
March 31, through
2003 2002 March 31, 2003
------------ ------------ ------------
Revenues:
Research and delvelopment
collaborative agreements $ 393,000 $ 237,000 $ 4,233,000
------------ ------------ ------------
Expenses:
Research & development 3,844,000 2,605,000 46,560,000
General & administrative 1,167,000 1,132,000 24,592,000
Write-off of acquired in-process
research and development
and supplies -- -- 13,508,000
------------ ------------ ------------
Total expenses 5,011,000 3,737,000 84,660,000
------------ ------------ ------------
Operating loss (4,618,000) (3,500,000) (80,427,000)
Other income and expenses:
Interest income, dividends, realized
gains, and other income 169,000 160,000 4,245,000
Minority interest in net loss of subsidiary -- -- 26,000
Interest expense (56,000) (30,000) (244,000)
------------ ------------ ------------
Net loss $ (4,505,000) $ (3,370,000) $(76,400,000)
============ ============ ============
Net loss per common share - $ (0.14) $ (0.13)
basic and diluted
Weighted average number of common
shares outstanding -
basic and diluted 32,856,526 25,833,880
See notes to condensed consolidated financial statements Page 5
Condensed Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended May 18, 1993
March 31, (Inception)
--------------------------- through
2003 2002 March 31, 2003
----------- ----------- --------------
Cash flows from operating activities:
Net loss (4,505,000) (3,370,000) (76,401,000)
Adjustments to reconcile net loss to net cash used
in operating activities:
Write-off of acquired in-process research and
development and supplies -- -- 13,508,000
Write-off of licenses -- -- 683,000
Depreciation and amortization 86,000 61,000 915,000
Compensatory stock options (1,000) 54,000 3,576,000
Expenses paid using treasury stock and
common stock -- 26,000 230,000
Loss on sale of property -- -- 4,000
Changes in:
Prepaid expenses and other current assets 68,000 308,000 904,000
Accounts payable and accrued expenses (446,000) (275,000) 2,434,000
Other assets (2,000) 28,000 (25,000)
Proceeds from research and development
collaborative agreements -- 1,833,000 3,474,000
Amortization of deferred revenue (180,000) (237,000) (2,816,000)
Expenses paid on behalf of company -- -- 18,000
Employee stock compensation -- -- 42,000
Reduction of research and development supplies -- -- (161,000)
----------- ----------- -----------
Net cash used in operating activities (4,980,000) (1,572,000) (53,615,000)
----------- ----------- -----------
Cash Flows from Investing Activities:
Purchase of property and equipment (61,000) (137,000) (2,039,000)
Proceeds from sale of property and equipment -- -- 575,000
Loan to related party -- -- (200,000)
Related party loan payments received 1,000 -- 4,000
Acquisition of licenses -- -- (711,000)
Purchase of marketable securities (133,000) (2,136,000) (52,637,000)
Proceeds from sale or maturity of marketable securities 3,436,000 3,000,000 45,870,000
Net cash payments on merger -- -- (1,670,000)
----------- ----------- -----------
Net cash provided by (used in) investing activities 3,243,000 727,000 (10,808,000)
----------- ----------- -----------
Cash Flows from Financing Activities:
Proceeds from issuance of securities, net of expenses (66,000) 2,613,000 69,943,000
Proceeds from credit facility 198,000 -- 1,648,000
Purchase of treasury stock -- -- (121,000)
Principal payments under capital lease obligation (49,000) (11,000) (163,000)
----------- ----------- -----------
Net cash provided by financing activities 83,000 2,602,000 71,307,000
----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents (1,654,000) 1,757,000 6,884,000
Cash and cash equivalents - beginning of period 8,538,000 3,758,000 --
----------- ----------- -----------
Cash and cash equivalents - end of period 6,884,000 5,515,000 6,884,000
=========== =========== ===========
Supplementary disclosure of cash flows information:
Interest paid 13,000 30,000 145,000
Noncash transactions:
Class H warrants issued/revalued -- (326,000) 150,000
Accrued dividends on Series C preferred stock -- -- 682,000
Series C preferred stock dividends paid using common stock -- -- 204,000
Preferred Stock issued for inventory -- -- 575,000
Equipment acquired through capitalized lease 190,000 -- 749,000
Unrealized gain (loss) on marketable securities (63,000) (121,000) 114,000
See notes to condensed consolidated financial statements Page 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NOTE 1 - THE COMPANY AND BASIS OF PRESENTATION
The Company
Discovery Laboratories, Inc. (the "Company"), is a specialty pharmaceutical
company developing its proprietary surfactant technology as Surfactant
Replacement Therapies for respiratory diseases including Respiratory Distress
Syndromes, Acute Lung Injury, asthma, Chronic Obstructive Pulmonary Disease
(COPD), and upper airway disorders. The Company believes that this proprietary
surfactant technology is the only surfactant technology presently available to
potentially treat a broad range of respiratory diseases.
Surfactants are substances that are produced naturally in the lungs and are
essential to the lungs' ability to absorb oxygen and to maintain proper airflow
through the respiratory system. The absence or depletion of surfactant is
involved in a number of respiratory diseases. The Company's surfactant
technology produces an engineered version of natural human lung surfactant that
is designed to precisely mimic the essential properties of human lung
surfactant.
The Company's lead product, Surfaxin(R), is being developed initially for
critical care patients with life-threatening respiratory disorders where there
are few, if any, approved therapies. Surfaxin is currently in two Phase 3
clinical trials for Respiratory Distress Syndrome in premature infants, a Phase
3 and a Phase 2 clinical trial for Meconium Aspiration Syndrome in full-term
infants, and a Phase 2 clinical trial for Acute Respiratory Distress Syndrome in
adults. Inhalable aerosolized formulations of the Company's humanized surfactant
are presently being developed to potentially treat patients suffering from
severe acute asthma and Acute Lung Injury, the Company's lead preclinical
programs, as well as COPD, sinusitis, and upper airway disorders such as sleep
apnea and otitis media (inner ear infection).
The Company is presently developing a dedicated sales and marketing capability
through a collaboration with Quintiles Transnational Corp. ("Quintiles"), to
commercialize Surfaxin in neonatal indications in the United States. The Company
has also entered into a strategic alliance with Laboratorios del Dr. Esteve
("Esteve") to commercialize Surfaxin in Europe and Latin America. The Company
intends to establish strategic alliances, where appropriate, for the development
and commercialization of the Company's products in other indications and
markets.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information in accordance with the
instructions to Form 10-Q. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the opinion of
management, all adjustments (consisting of normally recurring accruals)
considered for fair presentation have been included. Operating results for the
three-month period ended March 31, 2003, are not necessarily indicative of the
results that may be expected for the year ended December 31, 2003. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K, as amended, for
the year ended December 31, 2002.
The Company is a development stage company and has incurred substantial losses
since inception. To date, the Company has funded its operations primarily
through the issuance of equity. The Company expects to continue to expend
substantial amounts for continued product research, development, and initial
commercialization activities for the foreseeable future. Management's plans with
respect to funding these development and commercialization activities are to use
its secured revolving credit facility with Quintiles to secure additional
capital through the issuance of equity, if possible, and to secure collaborative
arrangements that will provide available cash funding for operations.
Continuation of the Company is dependent on its ability to obtain additional
financing and, ultimately, on its ability to achieve profitable operations.
There is no assurance, however, that such financing will be available or that
the Company's efforts ultimately will be successful.
All of the Company's current products under development are subject to license
agreements that will require the payment of future royalties.
Page 7
Certain prior year balances have been reclassified to conform with the current
presentation. The reclassification had no effect on net income.
NOTE 2 - NET LOSS PER SHARE
Net loss per share is computed based on the weighted average number of common
shares outstanding for the periods. Common shares issuable upon the exercise of
options and warrants and the conversion of convertible securities are not
included in the calculation of the net loss per share as their effect would be
antidilutive.
NOTE 3 - COMPREHENSIVE LOSS
Total comprehensive loss was approximately $4,568,000 for the three months ended
March 31, 2003, and approximately $3,491,000 for the three months ended March
31, 2002.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Overview
Since our inception, we have incurred significant losses and, as of March 31,
2003, had a deficit accumulated during the development stage of approximately
$77 million (including historical results of predecessor companies). The
majority of our expenditures to date have been for research and development
activities. Research and development expenses represent costs incurred for
scientific and clinical personnel, clinical trials, regulatory filings and
manufacturing efforts (including raw material costs). We expense our research
and development costs as they are incurred. General and administrative expenses
consist primarily of executive management, financial, business development,
legal and general corporate activities and related expenses.
Plan of Operations
We expect to continue to incur increasing operating losses for the foreseeable
future, primarily due to our continued research and development activities
attributable to new and existing products, manufacturing, initial
commercialization, and general and administrative activities.
We anticipate that during the next 12 to 24 months we will:
(i) significantly increase our research, development and regulatory
activities.
It is anticipated that our research and development activities will
be the clinical trials for Surfaxin indications and related
regulatory filings. We are presently conducting a pivotal,
multinational landmark Phase 3 trial treating up to 1,500 patients
for the treatment of Respiratory Distress Syndrome in premature
infants. This pivotal trial is intended, if successful, to provide
the basis for New Drug Applications with the FDA and other worldwide
regulatory authorities. This pivotal trial is expected to be
completed and data announced early in the fourth quarter of 2003. We
are also conducting another multinational Phase 3 trial treating up
to 500 patients for the treatment of Respiratory Distress Syndrome
in premature infants. This supportive trial was designed to be
completed within the same timeframe as the pivotal Phase 3 trial. We
are currently evaluating whether to conclude this trial early to
conserve financial resources and reallocate clinical resources to
our pivotal Phase 3 trial. For Acute Respiratory Distress Syndrome
in adults, we currently are conducting a Phase 2 dose-ranging safety
and efficacy study of up to 110 patients in the United States. We
expect to complete this trial in the fourth quarter of 2003. For
Meconium Aspiration Syndrome in full-term infants, we currently are
conducting a Phase 3 clinical trial of up to 200 patients in the
United States. Enrollment is ongoing but has been slower than
expected and completion is now anticipated in 2004. Given our belief
in the importance of the pivotal Phase 3 trial for Respiratory
Distress Syndrome in premature infants to our present development
plan, resources have been and may continue to be reallocated from
the Meconium Aspiration Syndrome program to the Respiratory Distress
Syndrome program, as needed. We are conducting a Phase 2 clinical
trial of Surfaxin lavage in up to 60 infant patients for use as a
prophylactic for infants who are at risk for Meconium Aspiration
Syndrome. The clinical trial and regulatory process is lengthy,
expensive and uncertain and subject to numerous risks including,
without limitation, the following risks discussed in the "Risks
Related to Our Business" section: "The clinical trial and regulatory
approval process for our products is expensive and time consuming,
and the outcome is uncertain"; and "Our technology platform
Page 8
is based solely on our proprietary humanized, engineered surfactant
technology and only our lead product candidate, Surfaxin, has been
subject to clinical studies. Our ongoing Phase 3 clinical trials for
Surfaxin for the treatment of Respiratory Distress Syndrome in
premature infants may be delayed, or fail, which will harm our
business."
Aerosolized formulations of our humanized surfactant are presently
being developed to potentially treat hospitalized patients suffering
from severe acute asthma and Acute Lung Injury. In addition, we are
evaluating the development of aerosolized formulations of our
humanized surfactant to potentially treat COPD, sinusitis, sleep
apnea and otitis media (inner ear infection).
(ii) invest in additional manufacturing capability in order to provide
backup for the production of our humanized surfactant drug product
and to scale up to meet clinical and commercial needs as they
expand.
(iii) invest in additional general and administrative resources primarily
to support our business development initiatives, financial systems
and controls and management information technologies.
(iv) invest in marketing and commercialization management infrastructure
to manage the strategic relationships with our collaborative
partners for the launch of Surfaxin, if approved, and the execution
of our "Discovery/Surfaxin" worldwide marketing strategy.
In December 2001, we entered into a collaboration arrangement with Quintiles,
and its affiliate, PharmaBio, Development, Inc., to provide certain
commercialization services in the United States for Surfaxin for the treatment
of Respiratory Distress Syndrome in premature infants and Meconium Aspiration
Syndrome in full-term infants. Quintiles will hire and train a dedicated United
States sales force that will be branded in the market as ours. Quintiles will
make available up to $70 million in post-launch funding to cover the first seven
years of United States sales and marketing costs. In return, Quintiles will
receive a commission on net sales of Surfaxin over a 10-year period. The
Quintiles arrangement allows us to retain product ownership and have sales and
marketing expertise in place for the commercialization of Surfaxin in the United
States, if approved.
In March 2002, we expanded our existing alliance with Esteve to develop, market
and sell Surfaxin throughout Europe and Latin America. Esteve will provide
certain commercialization services for Surfaxin for the treatment of Respiratory
Distress Syndrome in premature infants, Meconium Aspiration Syndrome in
full-term infants and Acute Lung Injury/Acute Respiratory Distress Syndrome in
adult patients. Our exclusive supply agreement with Esteve provides that Esteve
will purchase from us all of its Surfaxin drug product requirements at an
established transfer price based on sales of Surfaxin by Esteve and/or its
sublicensee(s). Esteve has also agreed to sponsor certain clinical trial costs
related to obtaining regulatory approval in Europe for the Acute Lung
Injury/Acute Respiratory Distress Syndrome indications. Esteve also agreed to
make certain milestone payments to us upon the attainment of European marketing
regulatory approval for Surfaxin.
We will need to generate significant revenues from product sales and/or related
royalties and transfer prices to achieve and maintain profitability. Through
March 31, 2003, we had no revenues from any product sales, and have not achieved
profitability on a quarterly or annual basis. Our ability to achieve
profitability depends upon, among other things, our ability to develop products,
obtain regulatory approval for products under development and enter into
agreements for product development, manufacturing and commercialization. In
addition, our results are dependent upon the performance of our strategic
partners and third party contract manufacturers and suppliers. Moreover, we may
never achieve significant revenues or profitable operations from the sale of any
of our products or technologies.
Through March 31, 2003, we had not generated taxable income. At December 31,
2002, net operating losses available to offset future taxable income for federal
tax purposes were approximately $65.1 million. The future utilization of such
loss carryforwards may be limited pursuant to regulations promulgated under
Section 382 of the Internal Revenue Code. In addition, as of December 31, 2002,
we had a research and development tax credit carryforward of $1,225,000. The
federal net operating loss and research and development tax credit carryforwards
expire beginning in 2008 and continuing through 2021.
Page 9
Results of Operations
Net loss for the three months ended March 31, 2003 was $4,505,000 ($0.14 per
common share). Net loss for the three months ended March 31, 2002 was $3,370,000
($0.13 per common share). The increase was primarily the result of increasing
research and development expenditures as discussed below.
Revenue
Revenues from research and development collaborative agreements for the three
months ended March 31, 2003 and March 31, 2002 were $393,000 and 237,000,
respectively. These revenues are associated with our research and development
collaborative arrangements, primarily our alliance with Esteve to develop,
market and sell Surfaxin throughout Europe and Latin America. Additional
collaborative revenues relate to our Small Business Innovative Research (SBIR)
grant to develop Surfaxin for Acute Lung Injury/Acute Respiratory Distress
Syndrome in adults and our Orphan Products Development grant to develop Surfaxin
for Meconium Aspiration Syndrome in full-term infants.
Expenses
Research and development expenses for the three months ended March 31, 2003 and
March 31, 2002 were $3,844,000 and $2,605,000, respectively. The increases
primarily reflect clinical trial costs incurred for our lead product, Surfaxin,
currently in three Phase 3 trials and two Phase 2 trials for critical care
patients with life threatening respiratory disorders, and research and
development activities related to the development of aerosolized formulations of
our humanized lung surfactant to potentially treat a variety of respiratory and
upper airway conditions.
General and administrative expenses for the three months ended March 31, 2003
and March 31, 2002 were $1,167,000 and $1,132,000, respectively. General and
administrative expenses consist primarily of costs of business and commercial
development, executive management, financial and accounting, legal, facility and
other administrative costs. Included in general and administrative costs for the
first quarter of 2002 and 2003 is approximately $250,000 and $198,000,
respectively, for pre-launch commercialization activities (market research and
analysis) for Surfaxin conducted in connection with a collaboration arrangement
with Quintiles (for which funding is provided by the secured revolving credit
facility with PharmaBio discussed below in "Liquidity and Capital Resources").
Other Income and Expense
Other income and expense (net) for the three months ended March 31, 2003 and
March 31, 2002, was $113,000 and $130,000, respectively. The decrease in other
income and expense (net) is due primarily to interest expense associated with
our secured, revolving credit facility and capital lease financing arrangements.
See "Liquidity and Capital Resources - Secured, Revolving Credit Facility and
Capital Lease Financing Arrangements."
Liquidity and Capital Resources
Cash, Cash Equivalents and Marketable Securities
As of March 31, 2003, we had cash, cash equivalents and marketable securities of
approximately $14.2 million as compared to approximately $19.2 million we had as
of December 31, 2002. As of March 31, 2003, we had working capital of
approximately $11.6 million as compared to the working capital of approximately
$16.3 million we had as of December 31, 2002. The decrease in working capital is
due to funds used in our clinical trial and research and development activities.
Secured, Revolving Credit Facility and Capital Lease Financing Arrangements
We have a secured revolving credit facility of up to $8.5 million to $10 million
with PharmaBio to fund pre-marketing activities for a Surfaxin launch in the
United States. The credit facility is available for use until December 10, 2004,
and monies become available in three tranches upon our satisfaction of certain
conditions. We have satisfied the conditions for availability of the first two
tranches and at March 31, 2003, the amount available under the credit facility
was approximately $5.7 million, of which $1.6 million was outstanding. Interest
on amounts advanced under the credit facility will be payable quarterly in
arrears. We may repay principal
Page 10
amounts owed by us under the credit facility from proceeds of milestone payments
to be paid to us by PharmaBio upon the achievement of certain corporate
milestones. We are obligated to use a significant portion of the funds borrowed
under the credit facility for pre-launch marketing services to be provided by
Quintiles.
We have a capital lease financing arrangement with the Life Science and
Technology Finance Division of General Electric Capital Corporation that
provides, subject to certain conditions, for up to $1 million in financing for
capital purchases. As of March 31, 2003, we had used approximately $475,000 of
this financing arrangement.
Our working capital requirements will depend upon numerous factors, including,
without limitation, the progress of our research and development programs,
clinical trials, timing and cost of obtaining regulatory approvals, timing and
cost of pre-launch marketing activities, levels of resources that we devote to
the development of manufacturing and marketing capabilities, levels of resources
that our collaboration partners devote to the development of sales and marketing
capabilities, technological advances, status of competitors, our ability to
establish collaborative arrangements with other organizations, the ability to
defend and enforce our intellectual property rights and the establishment of
additional strategic or licensing arrangements with other companies or
acquisitions.
Historically, the Company's working capital has been provided from the proceeds
of private financings:
In November 2002, we completed the sale of securities in a private placement to
selected institutional and accredited investors for net proceeds of
approximately $11.9 million. We issued 6,397,517 shares of Common Stock and
2,878,883 Class I Warrants to purchase shares of Common Stock at an exercise
price of $2.425 per share. The Class I warrants have a five-year term.
Pursuant to our collaboration arrangement with Esteve on March 6, 2002, we
issued 821,862 shares of Common Stock to Esteve at a purchase price equal to
$4.867 per share and received a licensing fee of $500,000, for approximate net
aggregate proceeds of $4.45 million. See Item 1: "Description of Business."
Pursuant to the collaboration arrangement we entered into with Quintiles and
PharmaBio in December 2001, we issued to PharmaBio, for approximate net
aggregate proceeds of $2.7 million: (i) 791,905 shares of common stock at a
price equal to $3.79 per share; and (ii) Class G warrants to purchase 357,143
shares of common stock at an exercise price equal to $3.485 per share (subject
to adjustment). In connection with the credit facility, we issued to PharmaBio
Class H warrants to purchase 320,000 shares of common stock. The Class H
warrants are exercisable at $3.03 per share (subject to adjustment) and are
exercisable proportionately only upon availability of the credit facility. To
the extent the credit facility availability is increased to greater than $8.5
million, for each $1 million increase, the amount of shares of common stock
issuable pursuant to the Class H warrants shall be increased by approximately
38,000 shares.
In October 2001, we received approximately $7.3 million in net proceeds from a
private financing. In the financing, we issued 3,562,759 shares of common stock
and 712,553 Class F warrants to purchase shares of common stock at an exercise
price equal to $2.365 per share. The Class F warrants have a five-year term.
In April 2001, we received approximately $1 million in proceeds in a private
offering of 296,560 shares of common stock at a per share price equal to $3.37.
In March 2000, we received approximately $17,500,000 in net proceeds in a
private placement offering from the sale of 2,902,846 shares of common stock and
580,567 Class E warrants to purchase common stock at $7.38 per share. The Class
E warrants issued in the offering are exercisable through March 2005.
In October 1999, in connection with our strategic alliance with Esteve, we
issued to Esteve in a private placement 317,164 shares of common stock at a
purchase price of $2.68 per share.
In July 1999, we raised approximately $2,233,000 in net proceeds in a private
placement offering of an aggregate of 2,024,792 shares of common stock and
2,024,792 Class D warrants to purchase common stock. All of the Class D warrants
have been exercised.
During March and April 1999, we raised $1.0 million in a private placement
offering of 826,447 shares of common stock and 569,026 Class C warrants to
purchase common stock at an exercise price of $2.15 per share. The Class C
warrants are exercisable through April 2006.
Page 11
We will require substantial additional funding to conduct our business,
including our expanded research and product development activities. Based on our
current operating plan, we believe that our currently available resources,
including amounts currently available under our credit facility with PharmaBio,
will be adequate to satisfy our capital needs into the second quarter of 2004.
Our future capital requirements will depend on the results of our research and
development activities, clinical studies and trials, competitive and
technological advances and the regulatory process. Our operations will not
become profitable before we exhaust our current resources; therefore, we will
need to raise substantial additional funds through additional debt or equity
financings or through collaborative ventures with potential corporate partners.
We may in some cases elect to develop products on our own instead of entering
into collaboration arrangements and this would increase our cash requirements.
Other than our credit facility with PharmaBio and our capital lease financing
arrangement with General Electric Capital Corporation, we have not entered into
any additional arrangements to obtain any additional financing. The sale of
additional equity and debt securities may result in additional dilution to our
stockholders, and we cannot be certain that additional financing will be
available in amounts or on terms acceptable to us, if at all. If we fail to
enter into collaborative ventures or to receive additional funding, we may have
to reduce significantly the scope of or discontinue our planned research,
development and commercialization activities, which could significantly harm our
financial condition and operating results. Furthermore, we could cease to
qualify for listing of our common stock on the NASDAQ SmallCap Market if the
market price of our common stock declines as a result of the dilutive aspects of
such potential financings. See "Risks Related to Our Business - We will need
additional capital, and our ability to continue all of our existing planned
research and development activities is uncertain. Any additional financing could
result in equity dilution"; "- The market price of our stock may be adversely
affected by market volatility"; and "- A substantial number of our securities
are eligible for future sale and this could affect the market price for our
stock and our ability to raise capital."
Risks Related to Our Business
The following risks, among others, could cause our actual results, performance,
achievements or industry results to differ materially from those expressed in
our forward-looking statements contained herein and presented elsewhere by
management from time to time.
Because we are a development stage company, we may not successfully develop and
market our products, and even if we do, we may not generate enough revenue or
become profitable.
We are a development stage company. Therefore, you must evaluate us in light of
the uncertainties and complexities present in a development stage biotechnology
company. We currently have no products approved for sale and are conducting
research and development on our product candidates. As a result, we have not
begun to market or generate revenues from the commercialization of any of these
products. Our long-term viability will be impaired if we are unable to obtain
regulatory approval for, or successfully market, our product candidates.
To date, we have only generated revenues from investments, research grants and
collaborative research and development agreements. We will need to engage in
significant, time-consuming and costly research, development, pre-clinical
studies, clinical testing and regulatory approval for our products under
development prior to their commercialization. In addition, pre-clinical or
clinical studies may show that our products are not effective or safe for one or
more of their intended uses. We may fail in the development and
commercialization of our products. As of March 31, 2003, we have incurred a
deficit accumulated during the development stage of approximately $77 million,
and we expect to continue to incur significant increasing operating losses over
the next several years. If we succeed in the development of our products, we
still may not generate sufficient or sustainable revenues or we may not be
profitable.
Our technology platform is based solely on our proprietary humanized, engineered
surfactant technology and only our lead product candidate, Surfaxin, has been
subject to clinical studies. Our ongoing Phase 3 clinical trials for Surfaxin
for the treatment of Respiratory Distress Syndrome in premature infants may be
delayed, or fail, which will harm our business.
Our humanized, engineered surfactant platform technology is based on the
scientific rationale for surfactant replacement therapy to treat life
threatening respiratory disorders and as the foundation for the development of
novel respiratory therapies and products. Our business is dependent upon the
successful development and
Page 12
approval of our product candidates based on this platform technology. Our lead
product, Surfaxin, is currently in two Phase 3 clinical trials for Respiratory
Distress Syndrome in premature infants, a Phase 3 clinical trial and a Phase 2
clinical trial for Meconium Aspiration Syndrome in full-term infants, and a
Phase 2 clinical trial for Acute Respiratory Distress syndrome in adults.
Companies in the pharmaceutical and biotechnology industries have suffered
significant setbacks in advanced clinical trials, even after obtaining promising
results in earlier trials. Data obtained from tests are susceptible to varying
interpretations which may delay, limit or prevent regulatory approval. In
addition, we may be unable to enroll patients quickly enough to meet our
expectations for completing any or all of these trials. The timing and
completion of current and planned clinical trials of our product candidates
depend on, among other factors, the rate at which patients are enrolled, which
is a function of many factors, including:
- --the number of clinical sites;
- --the size of the patient population;
- --the proximity of patients to the clinical sites;
- --the eligibility criteria for the study;
- --the existence of competing clinical trials; and
- --the existence of alternative available products.
Delays in patient enrollment in clinical trials may occur, which would likely
result in increased costs, program delays or both.
We will need additional capital, and our ability to continue all of our existing
planned research and development activities is uncertain. Any additional
financing could result in equity dilution.
We will need substantial additional funding to conduct our presently planned
research and product development activities. Based on our current operating
plan, we believe that our currently available financial resources will be
adequate to satisfy our capital needs into the second quarter of 2004. Our
future capital requirements will depend on a number of factors that are
uncertain, including the results of our research and development activities,
clinical studies and trials, competitive and technological advances and the
regulatory process, among others. We will likely need to raise substantial
additional funds through collaborative ventures with potential corporate
partners and through additional debt or equity financings. We may also continue
to seek additional funding through capital lease transactions. We may in some
cases elect to develop products on our own instead of entering into
collaboration arrangements. This would increase our cash requirements for
research and development.
We have not entered into arrangements to obtain any additional financing, except
for the credit facility with PharmaBio and our capital equipment lease financing
arrangement with General Electric Capital Corporation. Any additional financing
could include unattractive terms or result in significant dilution of
stockholders' interests and share prices may decline. If we fail to enter into
collaborative ventures or to receive additional funding, we may have to delay,
scale back or discontinue certain of our research and development operations,
and consider licensing the development and commercialization of products that we
consider valuable and which we otherwise would have developed ourselves. If we
are unable to raise required capital, we may be forced to limit many, if not
all, of our research and development programs and related operations, curtail
commercialization of our product candidates and, ultimately, cease operations.
Furthermore, we could cease to qualify for listing of our securities on the
NASDAQ SmallCap Market if the market price of our common stock declines as a
result of the dilutive aspects of such potential financings. See "Risks Related
to Our Business - The market price of our stock may be adversely affected by
market volatility."
The clinical trial and regulatory approval process for our products is expensive
and time consuming, and the outcome is uncertain.
In order to sell our products that are under development, we must receive
regulatory approvals for each product. The FDA and comparable agencies in
foreign countries extensively and rigorously regulate the testing, manufacture,
distribution, advertising, pricing and marketing of drug products like our
products. This approval process includes preclinical studies and clinical trials
of each pharmaceutical compound to establish its safety and effectiveness and
confirmation by the FDA and comparable agencies in foreign countries that the
manufacturer maintains good laboratory and manufacturing practices during
testing and manufacturing. Although we are
Page 13
involved in certain late-stage clinical trials, pharmaceutical and biotechnology
companies have suffered significant setbacks in advanced clinical trials, even
after promising results in earlier clinical trials.
The approval process is lengthy, expensive and uncertain. It is also possible
that the FDA or comparable foreign regulatory authorities could interrupt, delay
or halt any one or more of our clinical trials. If we, or any regulatory
authorities, believe that trial participants face unacceptable health risks, any
one or more of our trials could be suspended or terminated. We also may not
reach agreement with the FDA and/or comparable foreign agencies on the design of
any one or more of the clinical studies necessary for approval. Conditions
imposed by the FDA and comparable agencies in foreign countries on our clinical
trials could significantly increase the time required for completion of such
clinical trials and the costs of conducting the clinical trials. Data obtained
from clinical testing are susceptible to varying interpretations which may
delay, limit or prevent regulatory approval.
Delays and terminations of the clinical trials we conduct could result from
insufficient patient enrollment. Patient enrollment is a function of several
factors, including the size of the patient population, stringent enrollment
criteria, the proximity of the patients to the trial sites, having to compete
with other clinical trials for eligible patients, geographical and geopolitical
considerations and others. Delays in patient enrollment can result in greater
costs and longer trial timeframes. Patients may also suffer adverse medical
events or side effects that are common to this class of drug such as a decrease
in the oxygen level of the blood upon administration.
Clinical trials generally take two to five years or more to complete, and,
accordingly, our first product is not expected to be commercially available in
the United States until at least 2004, and our other product candidates will
take longer. The FDA has notified us that two of our intended indications for
Surfaxin, Meconium Aspiration Syndrome in full-term infants and Acute
Respiratory Distress Syndrome in adults, have been granted designation as
"fast-track" products under provisions of the Food and Drug Administration
Modernization Act of 1997, and the FDA has awarded us an Orphan Products
Development Grant to support our development of Surfaxin for the treatment of
Meconium Aspiration Syndrome. Fast-Track Status does not accelerate the clinical
trials nor does it mean that the regulatory requirements are less stringent. The
Fast-Track Status provisions are designed to expedite the FDA's review of new
drugs intended to treat serious or life-threatening conditions. The FDA
generally will review the New Drug Application for a drug granted Fast-Track
Status within six months instead of the typical one to three years. Our products
may not, however, continue to qualify for expedited review and our other drug
candidates may fail to qualify for fast track development or expedited review.
Even though some of our drug candidates have qualified for expedited review, the
FDA may not approve them at all or any sooner than other drug candidates that do
not qualify for expedited review.
The FDA and comparable foreign agencies could withdraw any approvals we obtain.
Further, if there is a later discovery of unknown problems or if we fail to
comply with other applicable regulatory requirements at any stage in the
regulatory process, the FDA may restrict or delay our marketing of a product or
force us to make product recalls. In addition, the FDA could impose other
sanctions such as fines, injunctions, civil penalties or criminal prosecutions.
To market our products outside the United States, we also need to comply with
foreign regulatory requirements governing human clinical trials and marketing
approval for pharmaceutical products. The FDA and foreign regulators have not
yet approved any of our products under development for marketing in the United
States or elsewhere. If the FDA and other regulators do not approve our
products, we will not be able to market our products.
In order to conduct our clinical trials we need adequate supplies of our drug
substance and drug product and competitors drug product, which may not be
readily available.
To succeed, clinical trials require adequate supplies of drug substance and drug
product, which may be difficult or uneconomical to procure or manufacture. We
rely on outside manufacturers for our drug substance and other active
ingredients for Surfaxin and to produce material that meets appropriate
standards for use in clinical studies for our products. We have validated only a
single clinical manufacturing facility, owned and operated by Akorn, Inc., to
produce appropriate clinical grade material of our drug substance that meets
standards for use in our ongoing clinical studies. Akorn has been experiencing
significant operational and financial difficulties and is currently attempting
to restructure its financial obligations and improve its day to day operations.
Akorn has informed us that certain operating difficulties experienced in one of
its production rooms primarily used for the filling of sterile pharmaceuticals
have been rectified and that the room had been returned to operational status.
Manufacturing activities for Surfaxin for our Acute Respiratory Distress
Syndrome trial recommenced in March 2003 and certain filling-related processes,
solely related to Akorn's sterile filling room, needed additional attention.
These issues have been addressed to the satisfaction of our manufacturing
personnel and we are
Page 14
scheduled to recommence Surfaxin manufacture for the trial by the end of May
2003. Our ability to timely recommence Surfaxin manufacture for this trial is
dependent upon a number of factors including, without limitation, Akorn's
ability to maintain operational status of the sterile production room and its
other Surfaxin-related facilities.
If the parties we depend on for manufacturing our pharmaceutical products do not
timely supply these products, it may delay or impair our ability to develop and
market our products.
We rely on outside manufacturers for our drug substance and other active
ingredients for Surfaxin and to produce material that meets appropriate
standards. We have validated only a single clinical manufacturing facility owned
and operated by Akorn to produce appropriate clinical grade material of our drug
substance that meets standards for use in our ongoing clinical studies.
Recently, Akorn has experienced a number of operational and financial
difficulties that, although not directly involving the manufacturing process for
our Surfaxin and other proprietary surfactant drug substance or drug product,
may have an adverse effect on our clinical research and development activities.
We will also rely on outside manufacturers for production of our products after
marketing approval. We anticipate entering into arrangements with other
manufacturers for the manufacture of materials for use in clinical testing and
after marketing approval.
Our outside manufacturers may not perform as they have agreed or may not remain
in the contract manufacturing business for a sufficient time to successfully
produce and market our product candidates. If we do not maintain important
manufacturing relationships, we may fail to find a replacement manufacturer or
to develop our own manufacturing capabilities. If we cannot do so, it could
delay or impair our ability to obtain regulatory approval for our products and
substantially increase our costs or deplete any profit margins. If we do find
replacement manufacturers, we may not be able to enter into agreements with them
on terms and conditions favorable to us and, there could be a substantial delay
before a new facility could be qualified and registered with the FDA and foreign
regulatory authorities.
We may in the future elect to manufacture some of our products on our own.
Although we own certain specialized manufacturing equipment, are considering an
investment in additional manufacturing equipment and employ certain
manufacturing managerial personnel, we do not presently maintain a complete
manufacturing facility or manufacturing department and we do not anticipate
manufacturing on our own any of our products during the next 12 months. If we
decide to manufacture products on our own and do not successfully develop
manufacturing capabilities, it will adversely affect sales of our products.
The FDA and foreign regulatory authorities require manufacturers to register
manufacturing facilities. The FDA and corresponding foreign regulators also
inspect these facilities to confirm compliance with good manufacturing practices
(GMPs) or similar requirements that the FDA or corresponding foreign regulators
establish. Manufacturing or quality control problems could occur at the contract
manufacturers causing product production and shipment delays or a situation
where the contractor may not be able to maintain compliance with the FDA's
current GMP requirements necessary to continue manufacturing our drug substance.
If our third-party foreign or domestic suppliers or manufacturers of our
products, or, if we decide to manufacture our products on our own, we, fail to
comply with GMP requirements or other FDA and comparable foreign regulatory
requirements, it could adversely affect our clinical research activities and our
ability to market and develop our products.
Page 15
Our strategy, in many cases, is to enter into collaboration agreements with
third parties with respect to our products and we may require additional
collaboration agreements. If we fail to enter into these agreements or if we or
the third parties do not perform under such agreements, it could impair our
ability to commercialize our products.
Our strategy for the completion of the required development and clinical testing
of our products and for the manufacturing, marketing and commercialization of
our products, in many cases, depends upon entering into collaboration
arrangements with pharmaceutical companies to market, commercialize and
distribute our products. In March 2002, we expanded our relationship with Esteve
by entering into a collaboration arrangement with Esteve for Surfaxin covering
all of Europe and Latin America. Esteve will be responsible for the marketing of
Surfaxin for the treatment of Respiratory Distress Syndrome in premature
infants, Meconium Aspiration Syndrome in full-term infants, and Acute Lung
Injury/Acute Respiratory Distress Syndrome in adults. Esteve will also be
responsible for the sponsorship of certain clinical trial costs related to
obtaining European Medicines Evaluation Agency approval for commercialization of
Surfaxin in Europe for the Acute Lung Injury/Acute Respiratory Distress Syndrome
indications. We will be responsible for the remainder of the regulatory
activities relating to Surfaxin, including with respect to European Medicines
Evaluation Agency filings.
In December 2001, we entered into an exclusive collaboration arrangement in the
United States with Quintiles, and its affiliate, PharmaBio, to commercialize,
sell and market Surfaxin in the United States for indications of Respiratory
Distress Syndrome and Meconium Aspiration Syndrome. As part of our collaboration
with Quintiles, Quintiles will build a sales force solely dedicated to the sale
of Surfaxin upon the approval of a New Drug Application for either of the two
indications. If Quintiles and we fail to devote appropriate resources to
commercialize, sell and market Surfaxin, sales of Surfaxin could be reduced. As
part of the collaboration, PharmaBio is obligated to provide us with certain
financial assistance in connection with the commercialization of Surfaxin,
including, but not limited to, a secured, revolving credit facility for at least
$8.5 million which may be increased to $10 million. A failure by us to repay
amounts outstanding under the credit facility would have a material adverse
effect on us. To obtain the benefits of such financing, we are obligated to meet
certain development and performance milestones. The failure by us to meet the
milestones or other terms and conditions of the financing leading to PharmaBio's
termination thereof or the failure by PharmaBio to fulfill its obligation to
partially fund the commercialization of Surfaxin, may affect our ability to
successfully market Surfaxin.
If Esteve, Quintiles or we breach or terminate the agreements that make up such
collaboration arrangements or Esteve or Quintiles otherwise fail to conduct
their Surfaxin-related activities in a timely manner or if there is a dispute
about their respective obligations, we may need to seek other partners or we may
have to develop our own internal sales and marketing capability for the
indications of Surfaxin which Esteve and/or Quintiles have agreed to assist in
commercializing. Accordingly, we may need to enter into additional collaboration
agreements and our success, particularly outside of the United States, may
depend upon obtaining additional collaboration partners. In addition, we may
depend on our partners' expertise and dedication of sufficient resources to
develop and commercialize our proposed products. We may, in the future, grant to
collaboration partners rights to license and commercialize pharmaceutical
products developed under collaboration agreements. Under these arrangements, our
collaboration partners may control key decisions relating to the development of
the products. The rights of our collaboration partners would limit our
flexibility in considering alternatives for the commercialization of our
products. If we fail to successfully develop these relationships or if our
collaboration partners fail to successfully develop or commercialize any of our
products, it may delay or prevent us from developing or commercializing our
products in a competitive and timely manner and would have a material adverse
effect on the commercialization of Surfaxin. See "Risks Related to Our Business
- - Our lack of marketing and sales experience could limit our ability to generate
revenues from future product sales."
If we cannot protect our intellectual property, other companies could use our
technology in competitive products. If we infringe the intellectual property
rights of others, other companies could prevent us from developing or marketing
our products.
We seek patent protection for our drug candidates so as to prevent others from
commercializing equivalent products in substantially less time and at
substantially lower expense. The pharmaceutical industry places considerable
importance on obtaining patent and trade secret protection for new technologies,
products and processes. Our success will depend in part on our ability and that
of parties from whom we license technology to:
- --defend our patents and otherwise prevent others from infringing on our
proprietary rights;
Page 16
- --protect trade secrets; and
- --operate without infringing upon the proprietary rights of others, both in the
United States and in other countries.
The patent position of firms relying upon biotechnology is highly uncertain and
involves complex legal and factual questions for which important legal
principles are unresolved. To date, the United States Patent and Trademark
Office has not adopted a consistent policy regarding the breadth of claims that
the United States Patent and Trademark Office allows in biotechnology patents or
the degree of protection that these types of patents afford. As a result, there
are risks that we may not develop or obtain rights to products or processes that
are or may seem to be patentable.
Even if we obtain patents to protect our products, those patents may not be
sufficiently broad and others could compete with us.
We, and the parties licensing technologies to us, have filed various United
States and foreign patent applications with respect to the products and
technologies under our development, and the United States Patent and Trademark
Office and foreign patent offices have issued patents with respect to our
products and technologies. These patent applications include international
applications filed under the Patent Cooperation Treaty. Our pending patent
applications, those we may file in the future or those we may license from third
parties may not result in the United States Patent and Trademark Office or
foreign patent office issuing patents. Also, if patent rights covering our
products are not sufficiently broad, they may not provide us with sufficient
proprietary protection or competitive advantages against competitors with
similar products and technologies. Furthermore, if the United States Patent and
Trademark Office or foreign patent offices issue patents to us or our licensors,
others may challenge the patents or circumvent the patents, or the patent office
or the courts may invalidate the patents. Thus, any patents we own or license
from or to third parties may not provide any protection against competitors.
Furthermore, the life of our patents is limited. We have licensed a series of
patents from Johnson & Johnson, Inc., and Ortho Pharmaceutical Corporation which
are important, either individually or collectively, to our strategy of
commercializing our surfactant technology. Such patents, which include relevant
European patents, expire on various dates beginning in 2009 and ending in 2017
or, in some cases, possibly later. We have filed, and when possible and
appropriate, will file, other patent applications with respect to our products
and processes in the United States and in foreign countries. We may not be able
to develop additional products or processes that will be patentable or
additional patents may not be issued to us. See also "Risks Related to Our
Business - If we cannot meet requirements under our license agreements, we could
lose the rights to our products."
Intellectual property rights of third parties could limit our ability to market
our products.
Our commercial success also significantly depends on our ability to operate
without infringing the patents or violating the proprietary rights of others.
The United States Patent and Trademark Office keeps United States patent
applications confidential while the applications are pending. As a result, we
cannot determine which inventions third parties claim in pending patent
applications that they have filed. We may need to engage in litigation to defend
or enforce our patent and license rights or to determine the scope and validity
of the proprietary rights of others. It will be expensive and time consuming to
defend and enforce patent claims. Thus, even in those instances in which the
outcome is favorable to us, the proceedings can result in the diversion of
substantial resources from our other activities. An adverse determination may
subject us to significant liabilities or require us to seek licenses that third
parties may not grant to us or may only grant at rates that diminish or deplete
the profitability of the products to us. An adverse determination could also
require us to alter our products or processes or cease altogether any related
research and development activities or product sales.
If we cannot meet requirements under our license agreements, we could lose the
rights to our products.
We depend on licensing arrangements with third parties to maintain the
intellectual property rights to our products under development. Presently, we
have licensed rights from Johnson & Johnson and Ortho Pharmaceutical. These
agreements require us to make payments and satisfy performance obligations in
order to maintain our rights under these licensing arrangements. All of these
agreements last either throughout the life of the patents, or with respect to
other licensed technology, for a number of years after the first commercial sale
of the relevant product.
Page 17
In addition, we are responsible for the cost of filing and prosecuting certain
patent applications and maintaining certain issued patents licensed to us. If we
do not meet our obligations under our license agreements in a timely manner, we
could lose the rights to our proprietary technology.
In addition, we may be required to obtain licenses to patents or other
proprietary rights of third parties in connection with the development and use
of our products and technologies. Licenses required under any such patents or
proprietary rights might not be made available on terms acceptable to us, if at
all.
We rely on confidentiality agreements that could be breached and may be
difficult to enforce.
Although we believe that we take reasonable steps to protect our intellectual
property, including the use of agreements relating to the non-disclosure of
confidential information to third parties, as well as agreements that purport to
require the disclosure and assignment to us of the rights to the ideas,
developments, discoveries and inventions of our employees and consultants while
we employ them, the agreements can be difficult and costly to enforce. Although
we seek to obtain these types of agreements from our consultants, advisors and
research collaborators, to the extent that they apply or independently develop
intellectual property in connection with any of our projects, disputes may arise
as to the proprietary rights to this type of information. If a dispute arises, a
court may determine that the right belongs to a third party, and enforcement of
our rights can be costly and unpredictable. In addition, we will rely on trade
secrets and proprietary know-how that we will seek to protect in part by
confidentiality agreements with our employees, consultants, advisors or others.
Despite the protective measures we employ, we still face the risk that:
- --they will breach these agreements;
- --any agreements we obtain will not provide adequate remedies for this type of
breach or that our trade secrets or proprietary know-how will otherwise become
known or competitors will independently develop similar technology; and
- --our competitors will independently discover our proprietary information and
trade secrets.
Our lack of marketing and sales experience could limit our ability to generate
revenues from future product sales.
We do not have marketing, sales or distribution experience or marketing or sales
personnel. As a result, we will depend on our collaboration with Quintiles for
the marketing and sales of Surfaxin for indications of Respiratory Distress
Syndrome in premature infants and Meconium Aspiration Syndrome in full-term
infants in the United States and with Esteve for the marketing and sales of
Surfaxin for the treatment of Respiratory Distress Syndrome, Meconium Aspiration
Syndrome and Acute Lung Injury/Acute Respiratory Distress Syndrome in adult
patients in all of Europe and Latin America. See "Risks Related to Our Business
- - Our strategy, in many cases, is to enter into collaboration agreements with
third parties with respect to our products and we may require additional
collaboration agreements. If we fail to enter into these agreements or if we or
the third parties do not perform under such agreements, it could impair our
ability to commercialize our products." If we do not develop a marketing and
sales force of our own, then we will depend on arrangements with corporate
partners or other entities for the marketing and sale of our remaining products.
The sales and marketing of Surfaxin for indications of Respiratory Distress
Syndrome in premature infants, Meconium Aspiration Syndrome in full-term
infants, and Acute Lung Injury/Acute Respiratory Distress Syndrome in adult
patients in the relevant territories depends, in part, on Quintiles' and
Esteve's performance of their contractual obligations. The failure of either
party to do so would have a material adverse effect on the sales and marketing
of Surfaxin. We may not succeed in entering into any satisfactory third party
arrangements for the marketing and sale of our remaining products. In addition,
we may not succeed in developing marketing and sales capabilities, our
commercial launch of certain products may be delayed until we establish
marketing and sales capabilities or we may not have sufficient resources to do
so. If we fail to establish marketing and sales capabilities or fail to enter
into arrangements with third parties, either in a timely manner, it will
adversely affect sales of our products.
Page 18
We depend upon key employees and consultants in a competitive market for skilled
personnel. If we are unable to attract and retain key personnel, it could
adversely affect our ability to develop and market our products.
We are highly dependent upon the principal members of our management team,
especially our Chief Executive Officer, Dr. Capetola, and our directors, as well
as our scientific advisory board members, consultants and collaborating
scientists. Many of these people have been involved in our formation or have
otherwise been involved with us for many years, have played integral roles in
our progress and we believe that they will continue to provide value to us. A
loss of any of these personnel may have a material adverse effect on aspects of
our business and clinical development and regulatory programs. We have an
employment agreement with Dr. Capetola that expires on December 31, 2005. We
also have employment agreements with other key personnel with termination dates
from 2003 through 2005. Although these employment agreements generally provide
for severance payments that are contingent upon the applicable employee's
refraining from competition with us, the loss of any of these persons' services
would adversely affect our ability to develop and market our products and obtain
necessary regulatory approvals, and the applicable noncompete provisions can be
difficult and costly to monitor and enforce. Further, we do not maintain key-man
life insurance.
Our future success also will depend in part on the continued service of our key
scientific and management personnel and our ability to identify, hire and retain
additional personnel, including marketing and sales staff. We experience intense
competition for qualified personnel, and the existence of non-competition
agreements between prospective employees and their former employers may prevent
us from hiring those individuals or subject us to suit from their former
employers.
While we attempt to provide competitive compensation packages to attract and
retain key personnel, some of our competitors are likely to have greater
resources and more experience than we have, making it difficult for us to
compete successfully for key personnel.
Our industry is highly competitive and we have less capital and resources than
many of our competitors, which may give them an advantage in developing and
marketing products similar to ours or make our products obsolete.
Our industry is highly competitive and subject to rapid technological innovation
and evolving industry standards. We compete with numerous existing companies
intensely in many ways. We intend to market our products under development for
the treatment of diseases for which other technologies and treatments are
rapidly developing and, consequently, we expect new companies to enter our
industry and that competition in the industry will increase. Many of these
companies have substantially greater research and development, manufacturing,
marketing, financial, technological, personnel and managerial resources than we
have. In addition, many of these competitors, either alone or with their
collaborative partners, have significantly greater experience than we do in:
- --developing products;
- --undertaking preclinical testing and human clinical trials;
- --obtaining FDA and other regulatory approvals or products; and
- --manufacturing and marketing products.
Accordingly, our competitors may succeed in obtaining patent protection,
receiving FDA or comparable foreign approval or commercializing products before
us. If we commence commercial product sales, we will compete against companies
with greater marketing and manufacturing capabilities who may successfully
develop and commercialize products that are more effective or less expensive
than ours. These are areas in which, as yet, we have limited or no experience.
In addition, developments by our competitors may render our product candidates
obsolete or noncompetitive.
Presently, there are no approved drugs that are specifically indicated for
Meconium Aspiration Syndrome in full-term infants or Acute Lung Injury/Acute
Respiratory Distress Syndrome in adults. Current therapy consists of general
supportive care and mechanical ventilation.
Four products, three that are animal-derived and one that is a synthetic, are
specifically approved for the treatment of Respiratory Distress Syndrome in
premature infants. Exosurf(R) is synthetic and is marketed by GlaxoSmithKline,
plc, outside the United States and contains only phospholipids (the fats
normally present in the lungs) and synthetic organic detergents and no
stabilizing protein or peptides. Curosurf(R) is a porcine lung extract
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that is marketed in Europe by Chiesi Farmaceutici S.p.A., and in the United
States by Dey Laboratories, Inc. Survanta(R), marketed by the Ross division of
Abbott Laboratories, Inc., is an extract of bovine lung that contains the cow
version of surfactant protein B. Forest Laboratories, Inc., markets its calf
lung surfactant, Infasurf(R) in the United States for the treatment of
Respiratory Distress Syndrome in premature infants. Although none of the four
approved surfactants for Respiratory Distress Syndrome in premature infants is
approved for Acute Lung Injury or Acute Respiratory Distress Syndrome in adults,
which are significantly larger markets, there are a significant number of other
potential therapies in development for the treatment of Acute Lung Injury/Acute
Respiratory Distress Syndrome that are not surfactant-related. Any of these
various drugs or devices could significantly impact the commercial opportunity
for Surfaxin. We believe that engineered humanized surfactants such as Surfaxin
will be far less expensive to produce than the animal-derived products approved
for the treatment of Respiratory Distress Syndrome in premature infants and will
have no capability of transmitting the brain-wasting bovine spongiform
encephalopathy (commonly called "mad-cow disease") or causing adverse
immunological responses in young and older adults.
We also face, and will continue to face, competition from colleges,
universities, governmental agencies and other public and private research
organizations. These competitors are becoming more active in seeking patent
protection and licensing arrangements to collect royalties for use of technology
that they have developed. Some of these technologies may compete directly with
the technologies that we are developing. These institutions will also compete
with us in recruiting highly qualified scientific personnel. We expect that
therapeutic developments in the areas in which we are active may occur at a
rapid rate and that competition will intensify as advances in this field are
made. As a result, we need to continue to devote substantial resources and
efforts to research and development activities.
If product liability claims are brought against us, it may result in reduced
demand for our products or damages that exceed our insurance coverage.
The clinical testing of, marketing and use of our products exposes us to product
liability claims in the event that the use or misuse of those products causes
injury, disease or results in adverse effects. Use of our products in clinical
trials, as well as commercial sale, could result in product liability claims. In
addition, sales of our products through third party arrangements could also
subject us to product liability claims. We presently carry product liability
insurance with coverages of up to $10,000,000 per occurrence and $10,000,000 in
the aggregate, an amount we consider reasonable and customary relating to our
clinical trials of Surfaxin. However, this insurance coverage includes various
deductibles, limitations and exclusions from coverage, and in any event might
not fully cover any potential claims. We may need to obtain additional product
liability insurance coverage prior to initiating other clinical trials. We
expect to obtain product liability insurance coverage before commercialization
of our proposed products; however, the insurance is expensive and insurance
companies may not issue this type of insurance when we need it. We may not be
able to obtain adequate insurance in the future at an acceptable cost. Any
product liability claim, even one that was not in excess of our insurance
coverage or one that is meritless and/or unsuccessful, could adversely affect
our cash available for other purposes, such as research and development. In
addition, the existence of a product liability claim could affect the market
price of our common stock.
We expect to face uncertainty over reimbursement and healthcare reform.
In both the United States and other countries, sales of our products will depend
in part upon the availability of reimbursement from third party payors, which
include government health administration authorities, managed care providers and
private health insurers. Third party payors are increasingly challenging the
price and examining the cost effectiveness of medical products and services.
Directors, executive officers, principal stockholders and affiliated entities
own a significant percentage of our capital stock, and they may make decisions
that you do not consider to be in your best interest.
As of March 31, 2003, our directors, executive officers, principal stockholders
and affiliated entities beneficially owned, in the aggregate, approximately 15%
of our outstanding voting securities. As a result, if some or all of them acted
together, they would have the ability to exert substantial influence over the
election of our Board of Directors and the outcome of issues requiring approval
by our stockholders. This concentration of ownership may have the effect of
delaying or preventing a change in control of our company that may be favored by
other stockholders. This could prevent transactions in which stockholders might
otherwise recover a premium for their shares over current market prices.
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The market price of our stock may be adversely affected by market volatility.
The market price of our common stock, like that of many other development stage
pharmaceutical or biotechnology companies, has been and is likely to be
volatile. In addition to general economic, political and market conditions, the
price and trading volume of our stock could fluctuate widely in response to many
factors, including:
- --announcements of the results of clinical trials by us or our competitors;
- --adverse reactions to products;
- --governmental approvals, delays in expected governmental approvals or
withdrawals of any prior governmental approvals or public or regulatory agency
concerns regarding the safety or effectiveness of our products;
- --changes in the United States or foreign regulatory policy during the period of
product development;
- --developments in patent or other proprietary rights, including any third party
challenges of our intellectual property rights;
- --announcements of technological innovations by us or our competitors;
- --announcements of new products or new contracts by us or our competitors;
- --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 "Management's Discussion
and Analysis - Risks Related to Our Business."
Our common stock is listed for quotation on the NASDAQ SmallCap Market. For the
three-month period ended March 31, 2003, the price of our common stock has
ranged from $2.07 to $2.23. We expect the price of our common stock to remain
volatile. The average daily trading volume in our common stock varies
significantly. For the three-month period ending March 31, 2003, the average
daily trading volume in our common stock was approximately 38,027 shares and the
average number of transactions per day was approximately 60. Our relatively low
average volume and low average number of transactions per day may affect the
ability of our stockholders to sell their shares in the public market at
prevailing prices and a more active market may never develop.
In addition, we may not be able to continue to adhere to the strict listing
criteria of the SmallCap Market. If the common stock were no longer listed on
the SmallCap Market, investors might only be able to trade in the
over-the-counter market in the Pink Sheets(R) (a quotation medium operated by
the National Quotation Bureau, LLC) or on the OTC Bulletin Board(R) of the
National Association of Securities Dealers, Inc. This would impair the liquidity
of our securities not only in the number of shares that could be bought and sold
at a given price, which might be depressed by the relative illiquidity, but also
through delays in the timing of transactions and reduction in media coverage.
In the past, following periods of volatility in the market price of the
securities of companies in our industry, securities class action litigation has
often been instituted against companies in our industry. If we face securities
litigation in the future, even if meritless or unsuccessful, it would result in
substantial costs and a diversion of management attention and resources, which
would negatively impact our business.
A substantial number of our securities are eligible for future sale and this
could affect the market price for our stock and our ability to raise capital.
The market price of our common stock could drop due to sales of a large number
of shares of our common stock or the perception that these sales could occur. As
of March 31, 2003, we had 32,856,526 shares of common stock outstanding. In
addition, as of March 31, 2003, up to approximately 11,494,000 shares of our
common stock were issuable upon exercise of outstanding options and warrants.
Holders of our stock options and warrants are likely to exercise them, if ever,
at a time when we otherwise could obtain a price for the sale of our securities
that is higher than the exercise price per security of the options or warrants.
This exercise, or the possibility of this exercise, may impede our efforts to
obtain additional financing
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through the sale of additional securities or make this financing more costly,
and may reduce the price of our common stock.
Provisions of our Certificate of Incorporation and Delaware law could defer a
change of our management which could discourage or delay offers to acquire us.
Provisions of our Certificate of Incorporation and Delaware law may make it more
difficult for someone to acquire control of us or for our stockholders to remove
existing management, and might discourage a third party from offering to acquire
us, even if a change in control or in management would be beneficial to our
stockholders. For example, our Certificate of Incorporation allows us to issue
shares of preferred stock without any vote or further action by our
stockholders. Our Board of Directors has the authority to fix and determine the
relative rights and preferences of preferred stock. Our Board of Directors also
has the authority to issue preferred stock without further stockholder approval.
As a result, our Board of Directors could authorize the issuance of a series of
preferred stock that would grant to holders the preferred right to our assets
upon liquidation, the right to receive dividend payments before dividends are
distributed to the holders of common stock and the right to the redemption of
the shares, together with a premium, prior to the redemption of our common
stock. In addition, our Board of Directors, without further stockholder
approval, could issue large blocks of preferred stock.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is confined to our cash, cash equivalents and
available for sale securities. We place our investments with high quality
issuers and, by policy, limit the amount of credit exposure to any one issuer.
We currently do not hedge interest rate or currency exchange exposure. We
classify highly liquid investments purchased with a maturity of three months or
less as "cash equivalents" and commercial paper and fixed income mutual funds as
"available for sale securities." Fixed income securities may have their fair
market value adversely affected due to a rise in interest rates and we may
suffer losses in principal if forced to sell securities that have declined in
market value due to a change in interest rates.
Item 4. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures. 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 judgement in evaluating the cost-benefit relationship of
possible controls and procedures. Our principal executive and financial
officers reviewed and evaluated our disclosure controls and procedures (as
defined in Rule 13a-14 promulgated under the Securities Exchange Act of
1934) as of a date within 90 days before the filing date of this Quarterly
Report. Based on that evaluation, our principal executive and financial
officers concluded that our disclosure controls and procedures are
effective in timely providing them with material information, as required
to be disclosed in the reports the Company we file pursuant to the
Exchange Act.
(b) Changes in internal controls. There were no significant changes in our
internal controls or other factors that could significantly affect those
controls subsequent to the date of our evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGE IN SECURITIES AND USE OF PROCEEDS.
In the quarter ended March 31, 2003, we granted an aggregate of 26,500 options
to our employees and consultants at various exercise prices ranging from $1.70
per share to $2.82 per share. We claim the exemption from registration provided
by Section 4(2) of the Securities Act for these transactions. No broker/dealers
were involved in the sale and no commissions were paid.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
The 2003 Annual Meeting of our Stockholders will be held on Tuesday, July 15,
2003, at 9:00 a.m. Eastern Daylight Time. It is expected that the Proxy
Statement and the form of proxy for the Annual Meeting, together with the 2003
Annual Report, will be mailed to stockholders on or about June 11, 2003.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
99.1 Section 302 Certification of Chief Executive Officer
99.2 Section 302 Certification of Chief Financial Officer
99.3 Section 906 Certification of Chief Executive Officer
99.4 Section 906 Certification of Chief Financial Officer
(b) Reports on Form 8-K:
A current report on Form 8-K was filed on February 26, 2003, reporting two
news releases issued by us; the first updating the progress of our ongoing
pivotal, landmark multinational Phase 3 clinical trial for Surfaxin for
Respiratory Distress Syndrome in premature infants, and the second
announcing our financial results for the fourth quarter and year ended
December 31, 2002, including selected updates on our progress since the
end of the third quarter of 2002.
Signatures, and Certifications of the Chief Executive Officer and the Chief
Financial Officer of the Company.
The following pages include the Signatures page for this Quarterly Report on
Form 10-Q, and two separate Certifications of our Chief Executive Officer and
our Chief Financial Officer.
The first form of Certification is required by Rule 13a-14 under the Exchange
Act in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the
"Section 302 Certification"). The Section 302 Certification includes references
to an evaluation of the effectiveness of the design and operation of our
"disclosure controls and procedures" and our "internal controls and procedures
for financial reporting". Item 4 of Part I of this Quarterly Report presents the
conclusions of our Chief Executive Officer and our Chief Financial Officer about
the effectiveness of such controls based on and as of the date of such
evaluation (relating to Item 4 of the Section 302 Certification), and contains
additional information concerning disclosures to our Audit Committee and
Page 23
independent auditors with regard to deficiencies in internal controls and fraud
(Item 5 of the Section 302 Certification) and related matters (Item 6 of the
Section 302 Certification).
The second form of Certification is required by section 1350 of chapter 63 of
title 18 of the United States Code.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Discovery Laboratories, Inc.
(Registrant)
Date: May 14, 2003 /s/ Robert J. Capetola
------------------------------------------------
Robert J. Capetola, Ph.D.
President and Chief Executive Officer
Date: May 14, 2003 /s/ John G. Cooper
------------------------------------------------
John G. Cooper
Sr. Vice President and Chief Financial Officer
(Principal Financial Officer)
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