The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our results of operations for the years ended December 31, 2008, 2007 and 2006, and financial condition for the years ended December 31, 2008 and 2007.
Critical Accounting Policies and Practices The preparation of our Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States requires management to adopt critical accounting policies and to make estimates and assumptions that affect the amounts reported in our Consolidated Financial Statements and accompanying notes. These critical accounting policies and estimates have been reviewed by our Audit Committee. The principal items in our Consolidated Financial Statements reflecting critical accounting policies or requiring significant estimates and judgments are as follows:
Stock-based compensation
From our inception, August 8, 2002, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, Accounting for Stock-Based Compensation and have, since inception, recognized equity compensation expense over the requisite service period. Beginning January 1, 2006, we adopted SFAS No. 123(R), Share-based Payment using the modified-prospective transition method. There was no significant impact from switching from SFAS No. 123 to SFAS No. 123(R). Since inception, we have used the Black-Scholes formula to estimate the fair value of stock options and have elected to continue to estimate the fair value of stock options using the Black-Scholes formula. The volatility and expected term assumptions have the most significant effect on the results obtained from the Black-Scholes option-pricing model. We have to date assumed that stock options have an expected life of five years, representing about half of their contractual life, and assumed Common Stock volatility of between 41% and 75%. Higher estimates of volatility and expected life of the option increase the value of an option and the resulting expense. Given the absence of an active market for our Common Stock in prior periods, the fair value of our Common Stock has periodically been estimated using several criteria, including progress and milestones achieved in our research activities along with the price per share of our preferred and Common Stock offerings.
Results of Operations
Year ended December 31, 2008 compared to year ended December 31, 2007 Since inception, our only revenues have been from grants and other research arrangements. Grant and research revenues were $1,066,000 and $1,126,000 for the years ended December 31, 2008 and 2007, respectively. The decrease in grant and research revenue was attributable to the timing of expenses and related funds received in connection with our advanced technology grant from the National Institute of Health, or NIH, in support of our development of our i.v. antibiotic product candidate and our heptagonist product candidate. We currently have $7,000 remaining available under these grants.
We incurred research and development expenses of $7,401,000 and $9,328,000 for the years ended December 31, 2008 and 2007, respectively. The decrease was the result of the delay and scale-back of certain research and delay of certain clinical development costs during 2008. With the closing of our third quarter financing activities, costs to bring both PMX-30063 and PMX-60056 through Phase 1 development were prioritized and deployed. Research and development costs include $440,000 and $323,000 related to stock-based compensation expense for the years ended December 31, 2008 and 2007, respectively. Pending timely and adequate additional funding, we expect our research and development costs to increase in the second half of 2009 as a result of increased staff hiring in connection with the start of preparation for Phase 2 studies for our PMX-30063 and PMX-60056 product candidates.
General and administrative expenses were $4,875,000 and $4,473,000 for the years ended December 31, 2008 and 2007, respectively. The overall increase was mostly attributable to increased legal costs and personnel costs. General and administrative costs include $964,000 and $936,000 related to stock-based compensation expense for the years ended December 31, 2008 and 2007, respectively.
Interest income and other expenses were $224,000 and $511,000 for the years ended December 31, 2008 and 2007, respectively. The decrease was due to decreased interest rates on our cash, cash equivalent and investment balances. Cash Flows
Operating Activities. Cash used in operating activities during the year ended December 31, 2008 increased to $10,926,000 as compared to $8,266,000 used for the year ended December 31, 2007. The increase was primarily due to increased general and administrative expenses and decreased current liabilities. Investing Activities. Cash used for investing activities represents cash paid for purchases of investments and property and equipment, net of maturities of investments. During the year ended December 31, 2008 and 2007, we purchased $9,553,000 and $9,880,000 of investments, respectively. During the year ended December 31, 2008 and 2007, maturities of our investments were $5,700,000 and $12,098,000, respectively. During the years ended December 31, 2008 and 2007, property and equipment purchases were $0 and $266,000, respectively.

Financing Activities. We have financed our operating and investing activities primarily from the proceeds from the sale of equity securities. During the years ended December 31, 2008 and 2007, we received $16,966,000 and $2,558,000, respectively, in net proceeds of such issuances of equity securities. Additionally, during 2008 and 2007 we received $214,000 and $184,000, respectively from the exercise of stock options.
Year ended December 31, 2007 compared to year ended December 31, 2006 Grant and research revenues were $1,126,000 and $821,000 for the years ended December 31, 2007 and 2006, respectively. The increase in grant and research revenue was attributable to funds received in connection with our advanced technology grant from the National Institute of Health, or NIH, in support of our development of our i.v. antibiotic product candidate, which commenced in April 2006.
We incurred research and development expenses of $9,328,000 and $3,306,000 for the years ended December 31, 2007 and 2006, respectively. The increase was the result of increased headcount and outside laboratory research costs associated with our preclinical development, GMP compliant manufacturing and GLP compliant toxicology, safety pharmacology and genotoxicity studies for PMX-60056 and PMX-30063 planned for 2008. Research and development costs include $323,000 and $205,000 related to stock-based compensation expense for the years ended December 31, 2007 and 2006, respectively.
General and administrative expenses were $4,473,000 and $4,174,000 for the years ended December 31, 2007 and 2006, respectively. The increase was the result of facility, investor relations and legal costs. General and administrative costs include $936,000 and $934,000 related stock-based compensation expense for the years ended December 31, 2007 and 2006, respectively.
Interest income and other expenses were $511,000 and $693,000 for the years ended December 31, 2007 and 2006, respectively. The decrease was a result of our decreased average cash and investment balances along with declining interest rates.
Cash Flows
Operating Activities. Cash used in operating activities during the year ended December 31, 2007 increased to $8,266,000 as compared to $4,319,000 used for the year ended December 31, 2006. The increase is attributed primarily to increased research and development spending and increased general and administrative expenses.
Investing Activities. Cash used for investing activities represents cash paid for purchases of investments and property and equipment, net of maturities of investments. During the year ended December 31, 2007 and 2006, we purchased $9,880,000 and $10,810,000 of investments, respectively. During the year ended December 31, 2007 and 2006, maturities of our investments were $12,098,000 and $5,000,000, respectively. During the years ended December 31, 2007 and 2006, property and equipment purchases were $266,000 and $274,000, respectively. Financing Activities. We have financed our operating and investing activities primarily from the proceeds from the sale of equity securities. During the years ended December 31, 2007 and 2006, we received $2,558,000 and $3,720,000, respectively, in net proceeds of such issuances of equity securities. Additionally, during 2007 we received $184,000 from the exercise of stock options.
Liquidity and Capital Resources
As of December 31, 2008 and December 31, 2007, we had cash and investment balances of approximately $15,106,000 and $8,903,000, respectively, and total liabilities of approximately $2,934,000 and $4,588,000, respectively. The increase in our cash balance was attributable to net proceeds of $16,966,000 received from our third quarter 2008 financing activities, which we believe is sufficient to fund our operations for at least the next twelve months as described below.
The global financial markets have been and continue to be in turmoil, with extreme volatility in the equity and credit markets and with some financial and other institutions experiencing significant financial distress. In addition, neither our access to nor the value of our cash equivalents or short-term investments have been negatively affected by the recent liquidity problems of financial institutions. Although we have attempted to be prudent in our investment strategy and in funding our anticipated near term liquidity needs, it is not possible to predict how the financial market turmoil and the deteriorating economic conditions may affect our financial position.

These and any future financial institution failures could cause losses to the extent cash amounts or the values of securities exceed government deposit insurance limits, and could restrict our access to the public equity and debt markets. In particular, the cost of raising money in the debt and equity capital markets has increased substantially while the availability of funds from those markets has diminished significantly. Also, as a result of concern about the stability of financial markets generally and the solvency of counterparties specifically, the cost of obtaining money from the credit markets has increased as many lenders and institutional investors have increased interest rates, enacted tighter lending standards and reduced and, in some cases, ceased to provide funding to borrowers. Low valuations and decreased appetite for equity investments, among other factors, may make the equity markets difficult to access on acceptable terms or unavailable altogether.
We are a development stage company and have not experienced significant revenue generating activities since our formation. We reached a positive working capital position for the first time in the fourth quarter of 2005 as a result of our financing activities. We have incurred operating losses for each year since our inception in 2002. To achieve operating profits, we, alone or with others, must successfully identify, develop and market product candidates. Our principal activities, from the beginning of our development stage, have been organizational matters, issuance of stock, product research and development, fund raising and market research.
In the near-term, we expect to continue to incur significant and increasing operating losses as a result of the research and development expenses we expect to incur in developing our product candidates and the general and administrative expenses we incur as a reporting company under the Securities Exchange Act of 1934, as amended. Additionally, we do not expect to generate any revenues from sources other than research grants for the foreseeable future.
We believe that our current cash and investment balances will fund our planned Phase 1 studies for PMX-30063 and PMX-60056 and can fund our operations for at least the next twelve months. Our current cash and investment balances are not sufficient to fund the Phase 2 development of either of these product candidates. We plan to seek additional funding during 2009 in one or more financings. However, if we are unable to secure adequate additional funding by the end of the second quarter of 2009, we will delay, scale-back or eliminate certain of our future research, drug discovery or development activities or certain other aspects of our operations and our business until such time as we are successful in securing adequate additional funding. In the absence of adequate additional funding, we believe that we have the ability to scale our operations, however, in doing so our current cash and investment balances can only fund our operations into the second half of 2010. Our short and long-term capital requirements depend upon a variety of factors, including market acceptance for our technologies and product candidates and various other factors, many of which we cannot control, including:
• success of our clinical trials for PMX-30063 and PMX-60056;

• continued progress of and increased spending related to our research and development activities, including our plan to hire additional research and development employees;

• the conditions in the capital markets and the biopharmaceutical industry that make raising capital or entering into strategic arrangements difficult and expensive;

• progress with preclinical experiments and clinical trials;

• ongoing general and administrative expenses related to our being a reporting company;

• the cost, timing, and results of regulatory reviews and approvals;

• the maintenance of our existing licenses with the Penn and UMass;

• the success, timing, and financial consequences of any future collaborative, licensing and other arrangements that we may establish;

• the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights;

• the costs of commercializing any of our other product candidates;

• technological and market developments;

• the cost of manufacturing development; and

• timing and volume of sales of products for which we obtain marketing approval.

We expect to seek additional funds through equity or debt financing, collaborative or other arrangements with corporate partners, and from other sources. For instance, we may actively seek more funding through government grants and contracts. We may not be able to obtain any additional financing on terms acceptable to us, if at all, or we may not raise as much as we expect. If adequate additional funds are not available when required, we will have to delay, scale-back or eliminate certain of our future research, drug discovery or development activities or certain other aspects of our operations and our business will be materially and adversely affected.
We are subject to many risks associated with development-stage businesses, including the above-discussed risks associated with the ability to raise capital. Please see the section entitled "Risk Factors" for more information regarding risks associated with our business. Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.
Commitments and Contingencies
As described above, we believe our current cash and investment balances are adequate to fund operations, including the following commitments and contingencies, at least for the next twelve months. If we are unable to secure adequate additional funding during the first half of 2009, we will delay, scale-back or eliminate certain of our future research, drug discovery or development activities or certain other aspects of our operations and our business until such time as we are successful in securing adequate additional funding.
Capital Lease
We have entered into lease agreements for laboratory equipment. The initial obligation under these capital leases was $331,000. The value of the laboratory equipment acquired in connection with these leases was $398,000 and the depreciation associated with these assets is included along with that of other owned property and equipment. These equipment leases have terms of up to three years, at interest rates ranging from 9.5% to 11.5% and contain bargain purchase options. In connection with these capital leases, we will pay $108,000 during 2009, $4,000 of which will be for interest. These capital leases end during 2009.
Operating Lease
In June 2006, we entered into a lease agreement for 24,223 square feet of combined office and laboratory space located in Radnor, Pennsylvania. The initial term of the lease is 12 years. Payments under the lease commenced on December 1, 2006. Our future minimum lease payments under this non-cancelable operating lease are as follows (in thousands):

                                                Operating Leases
                2009                           $              497
                2010                           $              589
                2011                           $              667
                2012                           $              686
                2013                           $              705
                Thereafter                     $            3,610

                Total minimum lease payments   $            6,754

Prior to the commencement of our current operating lease for our Radnor Facility, we leased approximately 3,500 square feet of combined office and laboratory space on a month-to-month basis in Philadelphia, Pennsylvania. Rent expense was $598,000, $598,000 and $559,000 and $1,877,000 for the years ended December 31, 2008, 2007, and 2006, and for the period from August 8, 2002 (Inception) to December 31, 2008, respectively. Patent License Agreements
University of Pennsylvania. In January 2003, we entered into a Patent License Agreement with Penn. Under the terms of the agreement, we were granted an exclusive, worldwide royalty-bearing license to make and sell products utilizing seven of Penn's issued or pending patents for the life of such patents. One issued patent and five patent applications cover the composition of matter on antimicrobial compounds, including small molecules, oligomers and polymers. One patent application covers the composition and use of polycationic compounds for treating cancer. If a change-of-control event occurs, in which we transfer the license to these patents to a third party or we are acquired by another company, we are required to pay a 3% royalty on the gross sales for licensed products that are sold as pharmaceuticals and a 1.5% royalty on products sold as coatings for use in medical devices. We are permitted to sublicense the patents provided that (a) the sublicensee is prohibited from further licensing of the patents and
(b) the sublicensee is subject to all of the terms of the original license granted to us. In addition, we are required to share with Penn any consideration we receive from sublicensing our patents to a third party. University of Massachusetts. In January 2004, we entered into a five-year sponsored research agreement with UMass. Under the terms of this agreement, we have the exclusive option to license any intellectual property that may be generated by Dr. Gregory Tew pursuant to research sponsored under the agreement. We may exercise this option by issuing 7,500 shares of our Common Stock to UMass for each $100,000 of research conducted by Dr. Tew. If we exercise this option, we are also required to reimburse UMass for direct patent costs incurred by it for the patents licensed by us. During 2007, we issued 12,500 shares to UMass in connection with this agreement. We sponsored $36,000 and $107,000, $118,000 of Dr. Tew's research for 2008, 2007 and 2006, respectively. Other
Agreements with Employees. We have entered into employment agreements with various executives. These agreements provide for severance arrangements and accelerated vesting of equity compensation awards in the event that the executive is terminated by us other than for cause or disability or if the executive resigns for good reason.
Credit Line. In April 2006, we entered into a line of credit agreement with a financial institution. This line of credit provides for monthly interest-only payments at a variable per annum rate of 3% plus the 30-day LIBOR rate. The amount available under this line of credit ranges from 85% to 92% of cash and investments pledged as collateral, based upon the amount and security type. There is currently no outstanding balance on this line of credit. In June 2006, we entered into a letter of credit agreement with the same financial institution to secure our payment obligations under our facility operating lease. This letter of credit is for $1,400,000, expires on December 1, 2009 and is secured by our credit line.
Recently Issued Accounting Pronouncements In September 2006, the Financial Accounting Standards Board (or "FASB") issued Statement of Financial Accounting Standards (or "SFAS") No. 157, Fair Value Measurements ("SFAS 157"). SFAS 157 clarifies the definition of fair value, establishes a framework for measuring fair value and expands disclosures on fair value measurements. SFAS 157 was effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years; however, the FASB did provide a one-year deferral for the implementation of SFAS 157 for nonfinancial assets and liabilities. SFAS 157 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument. Level 3 inputs are unobservable inputs based on management's own assumptions used to measure assets and liabilities at fair value. A financial asset or liability's classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The adoption of SFAS 157 did not have any impact on our consolidated financial statements.

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