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DSCO > SEC Filings for DSCO > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for DISCOVERY LABORATORIES INC /DE/

Form 10-Q for DISCOVERY LABORATORIES INC /DE/


14-Nov-2012

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 a series of Committed Equity Financing Facilities (CEFFs) and our At-the-Market Program (ATM Program), capital equipment and debt facilities, and strategic alliances.

Our future capital requirements depend upon many factors, primarily the success of our efforts to: (i) execute the commercial introduction of SURFAXIN and AFECTAIR in the United States and other markets, within our anticipated time frame; (ii) secure one or more strategic alliances or other collaboration arrangements to support the development and, if approved, commercial introduction of AEROSURF and SURFAXIN LS in markets outside the United States;
(iii) advance the AEROSURF and SURFAXIN LS development programs to be in a position to initiate planned Phase 2 and Phase 3 clinical trials; and
(iv) procure the additional capital necessary and desirable to support our activities until such time as the net revenues from our approved products, from potential strategic alliance and collaboration arrangements and from other sources are sufficient to offset cash flow requirements.

For the nine months ended September 30, 2012, we completed the following financing transactions:

o On March 21, 2012, we completed a public offering of 16,071,429 shares of common stock, resulting in net proceeds to us (after underwriter fees and anticipated expenses) of approximately $42.1 million.


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o On March 7, 2012, we delivered a sales notice under our ATM Program to sell shares of common stock. We terminated the offering on March 8, 2012. In connection with that offering, we issued 350,374 shares of our common stock at an aggregate purchase price of approximately $1.6 million, resulting in net proceeds to us of approximately $1.5 million, after deducting commissions due to the sales agent.

o Holders of the 15-month warrants that we issued in February 2011 exercised warrants to purchase 2,238,000 shares of our common stock at an exercise price of $2.94 per share, resulting in proceeds to us of $6.6 million. The remaining 15-month warrants to purchase 2,762,000 shares expired unexercised on May 22, 2012.

o Holders of the five-year warrants that we issued in February 2011 (February 2011 five-year warrants) exercised warrants to purchase 51,250 shares of our common stock at an exercise price ranging from $2.80 to $3.20 per share, resulting in proceeds to us of $162,000.

As of September 30, 2012, 100 million shares of common stock were authorized under our Amended and Restated Certificate of Incorporation, as amended, and approximately 40.3 million shares of common stock were available for issuance and not otherwise reserved.

As of September 30, 2012, we had cash and cash equivalents of $36.1 million. We anticipate that, before financing activities, we will have sufficient cash available to support our operations through the second quarter of 2013.

To execute our business strategy and fund our operations over time, we anticipate potentially securing additional infusions of capital from a combination of some or all of the following sources:

Upfront and milestone payments and co-funding of development activities associated with potential strategic alliances or other similar transactions:
o We are engaged in discussions with potential strategic partners who could provide development and commercial expertise as well as financial resources (potentially in the form of upfront payments, milestone payments, commercialization royalties and a sharing of research and development expenses) to support the development of AEROSURF and SURFAXIN LS and, if approved, the introduction of these products in the European Union and various markets outside the United States.

Secured debt arrangements to fund working capital and/or investment in capital assets:
o If our efforts are successful, we believe that debt could be a component of our capital structure and financing plans. We could potentially enter into capital equipment financing facilities, revolving working capital lines of credit, term loans and other similar transactions to satisfy our working capital requirements.

Synthetic royalty financing arrangements
o In addition to potential debt arrangements, we believe that we may raise non-dilutive capital through a synthetic royalty arrangement that provides for the receipt of funds in exchange for a royalty to be paid on future revenues earned on our approved products. There can be no assurance, however, that we will enter into any synthetic royalty arrangement in the near future, if at all, or on favorable terms or otherwise.

In appropriate circumstances, to secure additional capital and strengthen our financial condition, we will also consider equity public offerings and other financing transactions:
o Our CEFF with Kingsbridge Capital Ltd. (Kingsbridge) allows us, in our discretion, to raise capital (subject to certain conditions, including volume limitations) at a time and in amounts we deem suitable to support our business plans. Based on the closing market price of our common stock on November 2, 2012 ($2.31) and assuming the issuance of all available shares, the potential availability under our CEFF is approximately $2.3 million. There can be no assurance, however, that the CEFF will be available at any time, or, even if available, that we will utilize the CEFF prior to its expiration in June 2013, or that we will undertake any financings or similar transactions, on favorable terms or otherwise.

In addition, as of September 30, 2012, we had outstanding warrants to purchase approximately 8.0 million shares of our common stock at various prices, exercisable on different dates into 2016. Of these warrants, approximately 4.9 million are February 2011 five-year warrants that were issued at an exercise price of $3.20 per share. These warrants contain anti-dilution provisions that adjust the exercise price if we issue any common stock, securities convertible into common stock, or other securities (subject to certain exceptions) at a value below the then-existing exercise price of the warrants. Accordingly, the exercise price of these warrants was adjusted downward to $2.80 per share at the time of the March 2012 public offering, which was conducted at an offering price of $2.80 per share. As of September 30, 2012, 4,948,750 of the February 2011 five-year warrants were outstanding. If the market price of our common stock should exceed $2.80 at any time prior to the expiration date of these warrants (February 2016) and if the holders determine in their discretion to exercise these warrants (and we have an effective registration statement covering the warrant shares to be issued upon exercise of the warrants), we potentially could raise up to an additional $13.9 million. There can be no assurance, however, that the market price of our common stock will equal or exceed price levels that make exercise of outstanding warrants likely or that holders of outstanding warrants will choose to exercise any or all of their warrants prior to the warrant expiration date.


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Although we currently believe that we will be successful in meeting our strategic planning goals, there can be no assurance that we will be successful. We currently anticipate that the commercial introduction of AFECTAIR will occur in late 2012 and that the commercial introduction of SURFAXIN will be delayed until early in the second quarter of 2013. We do not believe that the delay of the SURFAXIN commercial introduction will have a material adverse effect on our business or financial position, in part, because our plan for SURFAXIN has always contemplated an uptake period in which our commercial and medical affairs teams would focus primarily on securing formulary acceptance, and we expect that these efforts may accelerate formulary uptake of SURFAXIN when the product is available. See, Note 1- Organization and Business. There can be no assurance, however, that we will be in a position to successfully execute the commercial introduction of SURFAXIN and AFECTAIR within the anticipated time frame, if ever; that we will successfully identify one or more strategic partners or collaboration arrangements to support development and, if approved, commercial introduction of AEROSURF and SURFAXIN LS; that the revenues we may realize from the sale of SURFAXIN and AFECTAIR will be in line with current expectations; or that the revenues, if any, that we generate in the future will be sufficient at any time to fund the further development of our research and development programs and support our operations. Even if we are successful in executing the commercial introduction of SURFAXIN and AFECTAIR within our planned timeframe, given the time required to secure formulary acceptance at our target hospitals, we do not expect that our revenues will be significant in the early years and we will require additional capital from other sources to support our operations in the near term. If we are unable to identify and enter into strategic alliances for the development of AEROSURF and SURFAXIN LS, and if approved, commercialization of AEROSURF and SURFAXIN LS in markets outside the United States, we may be unable to fund our planned clinical trials, which would have a material adverse effect on our research and development programs.

Note 3 - Summary of Significant Accounting Policies

Basis of Presentation.

The accompanying interim unaudited 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 and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. There have been no changes to our critical accounting policies since December 31, 2011. For further information, refer to the consolidated financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011 that we filed with the Securities and Exchange Commission (SEC) on March 30, 2012, as amended on April 27, 2012 (2011 Form 10-K). Readers are encouraged to review those disclosures in conjunction with this Quarterly Report on Form 10-Q.

Inventory

Inventories are determined at the lower of cost or market value with cost determined under the specific identification method. In connection with the FDA's approval of SURFAXIN and the registration of our initial AFECTAIR device in the United States, we assessed the potential capitalization of inventory and the timing of when the related costs are expected to be recoverable through the commercialization of our products. Costs incurred prior to receipt of marketing authorization have been recorded in our statement of operations as research and development expense. As a result, inventory balances and cost of revenue may reflect a lower average per-unit cost of materials for several quarters after we launch our products. As of September 30, 2012, inventories were valued at $0.1 million and consisted of raw materials used in the production of SURFAXIN.

Research and development expense

We track research and development expense by activity, as follows: (a) product development and manufacturing, (b) medical and regulatory operations, and
(c) direct preclinical and clinical programs. Research and development expense includes personnel, facilities, manufacturing and quality operations, pharmaceutical and device development, research, clinical, regulatory, other preclinical and clinical activities and medical affairs. Research and development costs are charged to operations as incurred. For the nine months ended September 30, 2012, research and development expense includes a $0.5 million charge related to a milestone payment that became payable to Johnson & Johnson (J&J) upon FDA approval of SURFAXIN, in accordance with terms of our license agreement with J&J.

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, 2012 and 2011, 12.0 million and 14.0 million shares of common stock, respectively, were potentially issuable upon the exercise of certain stock options and warrants. Due to our net loss, the shares potentially issuable upon the exercise of options and warrants 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.


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Recent accounting pronouncements

In May 2011, the Financial Accounting Standards Board (FASB) amended the accounting guidance for measuring 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. We adopted this guidance prospectively effective January 1, 2012, 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 June 2011, the FASB issued accounting guidance on comprehensive income. This guidance, which is effective for interim and annual periods beginning after December 15, 2011, is intended to increase the prominence of other comprehensive income in financial statements by presenting it in either a single- or two-statement approach. We adopted this guidance on January 1, 2012, and the adoption did not have a material impact on our consolidated results of operations, financial position or cash flows.

Note 4 - Stockholders' Equity

Registered Public Offerings

On March 21, 2012, we completed a registered public offering of 16,071,429 shares of our common stock, at a price of $2.80 per share resulting in gross proceeds of $45.0 million ($42.1 million net proceeds).

At-the-Market Program (ATM Program)

On March 12, 2012, we completed an offering under our ATM Program of 350,374 shares of our common stock for an aggregate purchase price of approximately $1.6 million, resulting in net proceeds to us of approximately $1.5 million, after deducting commissions due to Lazard. See, Note 10 - Stockholders' Equity - Registered Public Offerings and Private Placements - ATM Program, to the consolidated financial statements in our 2011 Form 10-K, for a detailed description of our ATM.

We understand that under the U.S. securities regulations, analysts affiliated with brokers and dealers are not permitted to initiate coverage of an issuer's securities while a securities offering is underway. Also under the securities laws, ATM Programs are deemed to be continuous securities offerings at all times, including when no sales are taking place. As a result, an analyst affiliated with Lazard would be prohibited from initiating coverage of our stock so long as we maintain an ATM Program with Lazard. Therefore, in connection with initiation of coverage of our stock by an analyst affiliated with Lazard, we agreed with Lazard to terminate the ATM Program effective August 6, 2012. This decision was based on a number of factors, including, among others, that we did not intend the ATM Program to be the primary source of the capital that we will need to execute our business plan, and that we believe that coverage of our stock by well-regarded stock analysts may enhance our market exposure and may improve the trading support that our stock receives in the future. We may determine in the future to initiate another ATM Program. There can be no assurance, however, that we will initiate an ATM Program or that other sources of capital will be available on favorable terms when needed, if at all, or that trading in our stock will be affected in any way by such analyst coverage.

Committed Equity Financing Facility (CEFF)

We have a CEFF with Kingsbridge Capital Limited (Kingsbridge), under which, for a period of up to three years ending June 11, 2013, Kingsbridge is obligated to purchase, subject to certain conditions, newly issued shares of our common stock. Our ability to access the CEFF is subject to certain covenants and conditions, including stock price and volume limitations. See also, Note 10 - Stockholders' Equity - Registered Public Offerings and Private Placements - Committed Equity Financing Facility (CEFF), to the consolidated financial statements in our 2011 Form 10-K, for a detailed description of our CEFF.

As of September 30, 2012, there were approximately 1.1 million shares potentially available for issuance (up to a maximum of $32.3 million) under the CEFF. Based on the closing market price of our common stock on November 2, 2012 ($2.31), and assuming that all available shares are issued, the potential availability under our CEFF is approximately $2.3 million.

We have not utilized the CEFF in 2012.


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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 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.

Fair Value on a Recurring Basis

The table below categorizes assets and liabilities measured at fair value on a
recurring basis as of September 30, 2012 and December 31, 2011:

                                             Fair Value                Fair value measurement using
                                            September 30,
                                                2012             Level 1            Level 2         Level 3
Assets:
Money Market                               $        33,377     $     33,377       $          -     $       -
Certificate of Deposit                                 400              400                  -             -
Total Assets                               $        33,777     $     33,777       $          -     $       -

Liabilities:
Common stock warrant liability             $        11,923     $          -       $          -     $  11,923



                                  Fair Value              Fair value measurement using
                                 December 31,
                                     2011            Level 1          Level 2        Level 3
Assets:
Money Market                     $       9,377     $     9,377       $       -       $      -
Certificate of Deposit                     400             400               -              -
Total Assets                     $       9,777     $     9,777       $       -       $      -

Liabilities:
Common stock warrant liability   $       6,996     $         -       $       -       $  6,996


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The table below summarizes the activity of Level 3 inputs measured on a recurring basis for the nine months ended September 30, 2012 and 2011:

                                                            Fair Value Measurements of
                                                            Common Stock Warrants Using
                                                          Significant Unobservable Inputs
(in thousands)                                                       (Level 3)

Balance at December 31, 2011                             $                           6,996
Exercise of warrants (1)                                                              (136 )
Change in fair value of common stock warrant liability                               5,063
Balance at September 30, 2012                            $                          11,923

(1) See, Note 6 - Common Stock Warrant Liability.

                                                             Fair Value Measurements of
                                                             Common Stock Warrants Using
                                                           Significant Unobservable Inputs
(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

The significant unobservable inputs used in the fair value measurement of the May 2009 and February 2010 common stock warrants are the historical volatility of our common stock market price, expected term of the applicable warrants, and the risk-free interest rate based on the U.S. Treasury yield curve in effect at the measurement date. In addition to the significant unobservable inputs noted above, the fair value measurement of the February 2011 five-year warrants also takes into account an assumption of the likelihood and timing of the occurrence of an event that would result in an adjustment to the exercise price in accordance with the anti-dilutive pricing provisions in the warrant. Any significant increases or decreases in the unobservable inputs, with the exception of the risk-free interest rate, would result in significantly higher or lower fair value measurements.

      Significant Unobservable Input      September 30,
     Assumptions of Level 3 Valuations        2012            December 31, 2011

     Historical Volatility                   62% -104%             98% - 116%
     Expected Term (in years)                1.6 - 3.4             2.4 - 4.2
     Risk-free interest rate               0.23% - 0.31%         0.31% - 0.60%

Note 6 - Common Stock Warrant Liability

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

The registered warrants that we issued in May 2009 and February 2010 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 February 2011 five-year warrants have been classified as derivative liabilities and reported, at each balance sheet date, at estimated fair value determined using a trinomial pricing model. See Note 8 in our 2011 Form 10-K for a discussion of the common stock warrant liability.


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Selected terms and estimated fair value of warrants accounted for as derivative liabilities at September 30, 2012 are as follows:

                                                             Fair Value of Warrants
                                                                 (in thousands)
                                            Warrant
Issuance      Number of        Exercise    Expiration      Issuance       September 30,
   Date     Warrant Shares       Price        Date           Date              2012

5/13/2009      466,667       $   17.25     5/13/2014       $  3,360    $            17
2/23/2010      916,669           12.75     2/23/2015          5,701                497
2/22/2011     4,948,750           2.80     2/22/2016          8,004             11,409

During the nine months ended September 30, 2012, holders of the February 2011 five-year warrants exercised warrants to purchase 51,250 shares of common stock for total proceeds of $162,000. In addition, these warrants contain anti-dilution provisions that adjust the exercise price if we issue any common stock, securities convertible into common stock, or other securities (subject to certain exceptions) at a value below the then-existing exercise price of the warrants. Accordingly, the exercise price of these warrants was adjusted downward to $2.80 per share at the time of the March 2012 public offering, which was conducted at an offering price of $2.80 per share.

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 in our financial statements all stock-based awards to employees and non-employee directors based on their fair value on the date of grant, calculated using the Black-Scholes option-pricing model. Compensation expense related to stock-based awards is recognized ratably over the vesting period, which for employees is typically three years.

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,
                                                      2012            2011

        Weighted-average expected volatility            110%            112%
        Weighted-average expected term              4.8 years       4.9 years
        Weighted-average risk-free interest rate       0.79%           1.47%
        Expected dividends                               -               -

. . .

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