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DSCO > SEC Filings for DSCO > Form 10-Q on 14-Nov-2011All Recent SEC Filings




Quarterly Report

Note 2 - Liquidity Risks and Management's Plans

We have incurred substantial losses since inception, due to investments in research and development, manufacturing and potential commercialization activities and we expect to continue to incur substantial losses over the next several years. Historically, we have funded our business operations through various sources, including public and private securities offerings, draw downs under our Committed Equity Financing Facilities (CEFFs), capital equipment and debt facilities, and strategic alliances. We expect to continue to fund our business operations through a combination of some or all of these sources. We also believe that anticipated revenue from the commercial introduction of Surfaxin, if approved, and/or Afectair could serve as a potential non-dilutive source of funds to support our research and development activities in the future.

As of September 30, 2011, we had cash and cash equivalents of $15.4 million. We also have a CEFF, which could allow us, at our discretion, to raise capital (subject to certain conditions, including minimum stock price and volume limitations) at a time and in amounts deemed suitable for us to support our business plans. Based on the closing market price of our common stock on November 8, 2011 ($1.79) and assuming that all available shares are issued, the potential availability under our CEFF is approximately $1.8 million. In addition, in connection with our February 2011 public offering, we issued 15-month warrants to purchase five million shares of our common stock at an exercise price of $2.94 per share (15-month warrants). If the market price of our common stock should exceed $2.94 at any time prior to May 2012 (the expiration date of the 15-month warrants), we potentially could raise up to an additional $14.7 million in proceeds if the holders determine (in their discretion) to exercise the 15-month warrants and we have an effective registration statement covering the warrant shares to be issued upon exercise of the warrants. Through November 8, 2011, we have raised aggregate gross proceeds of $24.8 million, including $23.5 million ($21.6 million net) from a public offering in February 2011 and $1.3 million from financings under our CEFF. In addition, in 2011, we have received $0.6 million under a Fast Track Small Business Innovation Research Grant (SBIR) from the National Institutes of Health to support the development of aerosolized KL4 surfactant for RDS.

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Our future capital requirements depend upon many factors, primarily the success of our efforts (i) to gain regulatory approval for Surfaxin in the United States, (ii) to register and execute the commercial introduction of Afectair in the United States and the European union in 2012, (iii) to raise capital through financings and other transactions, and (iv) to secure one or more strategic alliances or other collaboration arrangements to support our product development activities and, if approved, commercialization plans. We anticipate that, at the end of 2011, we will have less than one year's cash available to support our operations. Although we do not currently plan to conduct a significant capital-raising transaction prior to March 6, 2012, the target action date set by the FDA under PDUFA to complete its review and potentially grant marketing approval for Surfaxin for the prevention of RDS in premature infants, we are assessing various forms of financing facilities that would allow us to partially offset cash outflows and raise capital in our discretion from time to time. There can be no assurance, however, that we will not undertake a financing or that we will enter into a financing facility to allow us to partially offset cash outflows. We believe that our ability to enter into financings, strategic alliances and other similar transactions will likely improve if we are able to gain regulatory approval for Surfaxin, initiate the commercial introduction of Afectair, and advance our Surfaxin LS and Aerosurf development programs towards initiation of clinical trials.

If we are unable for any reason to obtain approval for Surfaxin in the United States, or if approval of Surfaxin is delayed for a significant period of time, or if we are unable to introduce Afectair in the United States and European Union markets as planned, we may have difficulty securing additional capital. If we are unable to raise sufficient additional capital, through financing and strategic alternatives, we will likely not have sufficient cash flow and liquidity to fund our business operations, forcing us to curtail our activities and, ultimately, potentially cease operations. Even if we are able to raise additional capital, such financings may only be available on unattractive terms, or could result in significant dilution of stockholders' interests and, in such event, the market price of our common stock may decline. Even if we succeed in gaining regulatory approvals for, and subsequently commercializing, Surfaxin and Afectair and our other product candidates; in raising additional capital and in securing strategic alliances to support our research and development activities as needed, we may never achieve sufficient sales revenue to achieve or maintain profitability.

There can be no assurance that that products we develop, including Surfaxin and Afectair, will obtain necessary regulatory approvals, that any approved product will be commercially viable, that we will be able to secure strategic partners or collaborators to support and provide expert advice to guide our activities, that our research and development activities will be successful, that any CEFF or other equity facility will be available for future financings, or that we will be able to obtain additional capital when needed on acceptable terms, if at all. Until such time as we secure sufficient financial and strategic resources to support the continuing development of our KL4 surfactant and aerosol drug delivery technologies and fund our operations, we will continue to limit investment in our pipeline programs. During 2011, we have continued to manage our expenditures and focus our financial resources on our RDS programs, primarily in support of the potential approval of Surfaxin, and the Afectair program.

Note 3 - Accounting Policies and Recent Accounting Pronouncements

Accounting policies

There have been no changes to our critical accounting policies since December 31, 2010. For more information on critical accounting policies, see, Note 3 - "Summary of Significant Accounting Policies and Recent Accounting Pronouncements" to the consolidated financial statements included in our 2010 Form 10-K. Readers are encouraged to review those disclosures in conjunction with the this Quarterly Report on Form 10-Q.

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Net loss per common share

Basic net loss per common share is computed by dividing the net loss by the weighted average number of common shares outstanding for the periods. As of September 30, 2011 and 2010, 14.0 million and 5.2 million shares of common stock, respectively, were potentially issuable upon the exercise of certain stock options and warrants. There also were 128,000 and 119,000 unvested restricted stock awards (RSAs) outstanding as of September 30, 2011 and 2010, respectively. Due to our net loss, the potentially issuable shares and RSAs were not included in the calculation of diluted net loss per share as the effect would be anti-dilutive, therefore basic and dilutive net loss per share are the same.

Recent accounting pronouncements

In October 2009, the Financial Accounting Standards Board (FASB) issued amendments to the accounting and disclosure guidance for revenue recognition. These amendments, effective for fiscal years beginning on or after June 15, 2010, modify the criteria for recognizing revenue in multiple element arrangements and the scope of what constitutes a non-software deliverable. We adopted this guidance prospectively on January 1, 2011 and the adoption had no impact on our consolidated financial statements. The potential future impact of the adoption of these amendments will depend on the nature of any new arrangements that we enter into in the future.

In May 2011, the FASB amended the accounting guidance for fair value to develop common requirements between U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards. The amendments, which are effective for interim and annual periods beginning after December 15, 2011, require entities to (i) provide information about valuation techniques and unobservable inputs used in Level 3 fair value measurements, and (ii) provide a narrative description of the sensitivity of Level 3 measurements to changes in unobservable inputs. The adoption of this update is not expected to have a material impact on the Company's consolidated financial statements.

Note 4 - Stockholders' Equity

Registered Public Offerings

On February 22, 2011, we completed a registered public offering of 10 million shares of our common stock, 15-month warrants to purchase five million shares of our common stock, and five-year warrants to purchase five million shares of our common stock. The securities were sold as units, with each unit consisting of one share of common stock, a 15-month warrant to purchase one half share of common stock, and a five-year warrant to purchase one half share of common stock, at a public offering price of $2.35 per unit, resulting in gross proceeds to us of $23.5 million ($21.6 million net). The 15-month warrants expire in May 2012 and are exercisable at a price per share of $2.94. The five-year warrants expire in February 2016 and are exercisable at a price per share of $3.20. The warrants are excisable for cash only, except that if the related registration statement or an exemption from registration is not otherwise available for the resale of the warrant shares, the holder may exercise on a cashless basis. The exercise price and number of shares or type of property issuable upon exercise of the warrants are subject to customary adjustments in the event of a Fundamental Transaction (as such term is defined in the warrants). In addition, the exercise price of the five-year warrants is subject to adjustment if we issue or sell common stock or securities convertible into common stock (in each case, subject to certain exceptions) at a price (determined as set forth in the warrant) that is less than the exercise price of the warrant.

Committed Equity Financing Facility (CEFF)

As of September 30, 2011, we had one Committed Equity Financing Facility dated June 11, 2010 (CEFF) with Kingsbridge Capital Limited (Kingsbridge). Under the CEFF, Kingsbridge is committed to purchase, subject to certain conditions, newly-issued shares of our common stock. The CEFF allows us at our discretion to raise capital for a period of three years ending June 11, 2013, at the time and in amounts deemed suitable to us. Two prior CEFFs, dated May 22, 2008 and December 12, 2008, expired in June 2011 and February 2011, respectively. We are not obligated to utilize any of the funds available under the CEFF. Our ability to access funds available under the CEFF is subject to certain conditions, including stock price and volume limitations. See, in our 2010 Form 10-K, "Item
7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Committed Equity Financing Facilities (CEFFs)" for a detailed description of our CEFF.

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As of September 30, 2011, there were approximately 1.3 million shares potentially available for issuance (up to a maximum of $32.6 million) under the CEFF, provided that the volume-weighted average price per share of our common stock (VWAP) on each trading day must be at least equal to a price that we designate in a draw down notice, which may be either a price that we specify, but not less than $0.20 per share, or 90% of the closing market price on the trading day preceding the first day of the draw down. Based on the closing market price of our common stock on November 8, 2011 ($1.79) and assuming that all available shares are issued, the potential availability under our CEFF is approximately $1.8 million. We anticipate using our CEFF (when available) to support our working capital needs and maintain cash availability in 2011.

The financings we have completed under our CEFF in 2011 are as follows:

(in thousands, except per share data)
                                                                                      Average Price
Completion Date                                 Shares Issued      Net Proceeds         Per Share

January 24, 2011                                           314     $         973     $           3.10
October 10, 2011                                            35                67                 1.93
October 24, 2011                                            37                61                 1.68
November 8, 2011                                           129               214                 1.66
                                                           515     $       1,315

Note 5 - Fair Value of Financial Instruments

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

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

Level 1 - Quoted prices in active markets for identical assets and liabilities. Level 1 is generally considered the most reliable measurement of fair value under Accounting Standards Codification (ASC) Topic 820 - "Fair Value Measurements and Disclosures."

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

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The table below categorizes assets and liabilities measured at fair value on a recurring basis as of September 30, 2011:

                                                Fair Value                   Fair value measurement using
Assets:                                     September 30, 2011        Level 1            Level 2          Level 3
Money Market                               $             12,877     $     12,877       $          -      $        -
Certificate of Deposit                                      400              400                  -               -
Total Assets                               $             13,277     $     13,277       $          -      $        -
Common stock warrant liability             $              8,599     $          -       $          -      $    8,599

The table below summarizes the activity of Level 3 inputs measured on a recurring basis for the nine months ended September 30, 2011:

                                                                   Fair Value
                                                                Measurements of
                                                                  Common Stock
 (in thousands)                                                    (Level 3)

 Balance at December 31, 2010                                   $          2,469
 Issuance of common stock warrants                                         8,087
 Change in fair value of common stock warrant liability                   (1,957 )
 Balance at September 30, 2011                                  $          8,599

Note 6 - Common Stock Warrant Liability

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

The registered warrants that we issued in our May 2009 and February 2010 public offerings generally provide that, in the event a related registration statement or an exemption from registration is not available for the issuance or resale of the warrant shares upon exercise of the warrant, the holder may exercise the warrant on a cashless basis. Notwithstanding the availability of cashless exercise, under generally accepted accounting principles, these registered warrants are deemed subject to potential net cash settlement and must be classified as derivative liabilities because (i) under the federal securities laws, it may not be within our absolute control to provide freely-tradable shares upon exercise of the warrants in all circumstances, and (ii) the warrant agreements do not expressly provide that there is no circumstance in which we may be required to effect a net cash settlement of the warrants (all other outstanding registered warrants that we have issued contain this language). The applicable accounting principles do not allow for an evaluation of the likelihood that an event would result in a cash settlement. Accordingly, in compliance with ASC Topic 815, the May 2009 and February 2010 warrants have been classified as derivative liabilities and reported, at each balance sheet date, at estimated fair value determined using the Black-Scholes option pricing model.

The five-year warrants that we issued in February 2011 (February 2011 five-year warrants) contain anti-dilutive provisions that adjust the exercise price if we issue any common stock, securities convertible into common stock, or other securities (subject to certain exceptions) at a value below the then-existing exercise price of the February 2011 five-year warrants. Due to the nature of the anti-dilution provisions, to comply with ASC Topic 815, these warrants have been classified as derivative liabilities and reported, at each balance sheet date, at estimated fair value determined using a trinomial pricing model.

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Selected terms and estimated fair value of warrants accounted for as derivative liabilities at September 30, 2011 are as follows:

                                                                           Fair Value of Warrants
                                                                               (in thousands)
                          Number of                       Warrant
                        Warrant Shares       Exercise    Expiration    Issuance          September 30,
   Issuance Date           Issuable           Price         Date         Date                2011

5/13/2009                       466,667     $    17.25   5/13/2014    $     3,360       $           289
2/23/2010                       916,669          12.75   2/23/2015          5,701                   862
2/22/2011                     5,000,000           3.20   2/22/2016          8,087                 7,448

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

Note 7 - Stock Options and Stock-Based Employee Compensation

We recognize all share-based payments to employees and non-employee directors in our financial statements based on their grant date fair values, calculated using the Black-Scholes option pricing model. Compensation expense related to share-based awards is recognized ratably over the requisite service period, typically three years for employees.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing formula that uses weighted-average assumptions noted in the following table.

                                       September 30,       September 30,
                                           2011                2010

            Expected volatility                   112 %                99 %
            Expected term                   4.9 years           4.7 years
            Risk-free interest rate              1.47 %               1.7 %
            Expected dividends                      -                   -

The total employee stock-based compensation for the three and nine months ended September 30, 2011 and 2010 was as follows:

                                     Three Months Ended           Nine Months Ended
                                        September 30,               September 30,
                                    2011            2010          2011          2010
       Research & Development     $      67       $      73     $    203       $   367
       General & Administrative          81             175          309           684
       Total                      $     148       $     248     $    512       $ 1,051

As of September 30, 2011, there was $0.4 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under our 2007 Long-Term Incentive Plan. That cost is expected to be recognized over a weighted-average vesting period of 1.9 years for stock options and 1.0 year for restricted stock awards.

Note 8 - Contractual Obligations and Commitments

Former Executive Commitment

On July 12, 2011, we entered into a Separation of Employment Agreement and General Release Agreement ("Separation Agreement") with David L. Lopez, Esq., C.P.A., Executive Vice President, General Counsel, Corporate Secretary and Chief Compliance Officer. Pursuant to the Separation Agreement, Mr. Lopez resigned his positions effective July 31, 2011. Under the Separation Agreement, Mr. Lopez is entitled to: (1) immediate payment of his accrued and unpaid salary and vacation pay through July 31, 2011; (2) the right to continue to hold a restricted stock award for 15,000 shares, subject to continued vesting in accordance with the terms and conditions of his Restricted Stock Agreement ("RSA") without any requirement that he be actively providing Service (as defined in the RSA); (3) reimbursement of COBRA medical and insurance premiums for a period of up to 18 months depending on the circumstances; and (4) reimbursement of up to $10,000 for use of outplacement services if Mr. Lopez has not secured full time employment as a practicing attorney or corporate professional by May 1, 2012. In addition, on February 1, 2012, (i) if not previously paid in full, Mr. Lopez will pay the outstanding aggregate principal and accrued interest on a promissory note issued to us in 2001 (as of September 30, 2011, the outstanding aggregate principal amount of the Note was $170,967), and (ii) we will pay Mr. Lopez $400,000 in separation pay. If Mr. Lopez does not pay the Note on or prior to February 1, 2012, we will reduce the separation pay by the amount due under the Note and the Note shall be deemed to be paid in full. The Separation Agreement also contains a general release of claims by the parties and a 12-month non-competition covenant by Mr. Lopez. In addition, effective as of August 4, 2011, Mr. Lopez agreed to forfeit all outstanding options held by him that were granted pursuant to the 2007 Plan. If not forfeited, the options would have expired 90 days following the effective date of his resignation.

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The full text of the separation agreement is attached to our Current Report on Form 8-K that we filed with the SEC on July18, 2011.

Note 9 - Subsequent Events

We evaluated all events or transactions that occurred after September 30, 2011 up through the date we issued these financial statements. During this period we did not have any material recognized subsequent events, however, there were three nonrecognized subsequent events related to financings under our CEFF. See, Note 4 - "Stockholders' Equity."


Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans and strategy for our business and related financing activities, includes forward-looking statements that involve risks and uncertainties. You should review the "Forward-Looking Statements" section, and the risk factors discussed in the "Risk Factors" section and elsewhere in this Quarterly Report on Form 10-Q, as well as in our Annual Report on Form 10-K and other filings with the Securities and Exchange Commission (SEC), and any amendments thereto, for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis or elsewhere in this Quarterly Report on Form 10-Q.

Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided as a supplement to the accompanying interim unaudited consolidated financial statements and footnotes to help provide an understanding of our financial condition, the changes in our financial condition and our results of operations. This item should be read in connection with our accompanying interim unaudited consolidated financial statements (including the notes thereto) appearing elsewhere herein.


Discovery Laboratories, Inc. (referred to as "we," "us," or the "Company") is a specialty biotechnology company dedicated to improving the standard of care for pulmonary medicine by creating life-saving products for critical care patients with respiratory disease. Our KL4 surfactant technology produces a synthetic, peptide-containing surfactant that is structurally similar to pulmonary surfactant and is being developed in liquid, lyophilized and aerosolized formulations. Surfactants are produced naturally in the lungs and are essential for breathing. We are also developing proprietary drug delivery technologies to enable efficient, targeted upper-respiratory or alveolar delivery of aerosolized KL4 surfactant and other inhaled therapies. We believe that our proprietary technologies may make it possible, for the first time, to develop a significant pipeline of respiratory critical care products to address a variety of . . .

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