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AOLS > SEC Filings for AOLS > Form 10-K/A on 14-May-2013All Recent SEC Filings

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Form 10-K/A for AEOLUS PHARMACEUTICALS, INC.


14-May-2013

Annual Report


Item 7.Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Introduction

You should read the following discussion in conjunction with our consolidated financial statements and the notes appearing elsewhere in this Annual Report on Form 10-K/A. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of various factors, including those discussed in Item 1A - "Risk Factors" and elsewhere in this Annual Report on Form 10-K/A.

Overview

We are developing a new class of catalytic antioxidant compounds as a medical countermeasure against biological, chemical and radiological weapons as well as for diseases and disorders of the central nervous system, respiratory system, autoimmune system and oncology. Our initial target indications are as a protective agent against the effects of acute radiation syndrome, sulfur mustard gas exposure and chlorine gas exposure. We have reported positive safety results from two Phase I clinical trials of AEOL 10150, our lead drug candidate, with no serious adverse events noted.

We had net income of approximately $1,698,000 and $299,000 for the fiscal years ended September 30, 2012 and 2011, respectively. We had an accumulated deficit of approximately $180,714,000 at September 30, 2012. We have not yet generated any revenue from product sales and do not expect to receive any product revenue from non-government sales in the foreseeable future, if at all. Under the BARDA Contract, we are expected to file an EUA in the second half of 2013, after which BARDA may begin purchasing AEOL 10150 for the Strategic National Stockpile.

We have not had any recurring revenue from product sales. Therefore, we have relied on public or private equity offerings, debt financings, collaboration arrangements and grants to finance our operations.

Corporate Matters

On February 11, 2011, we signed an agreement with BARDA for the development of AEOL 10150 as a MCM against Lung-ARS (the "BARDA Contract"). Pursuant to the BARDA Contract we were awarded approximately $10.4 million in the base period of the contract. On April 16, 2012, we announced that BARDA had exercised two options under the BARDA Contract worth approximately $9.1 million, bringing the total exercised contract value to date to approximately $19.5 million. We may receive up to an additional $98.9 million in options exercisable over the years following the base period. If all of the options are exercised by BARDA, the total value of the contract would be approximately $118.4 million. Pursuant to the Statement of Work in the BARDA Contract, we expect to provide the data necessary for filing an EUA in the second half of 2013. Once the EUA is filed, it would be possible for BARDA to begin procuring AEOL 10150 for the strategic national stockpile. Procurements from BARDA may result in significant revenues, and profitability, for Aeolus. If all options are exercised, the period of performance would continue through at least 2016.


Activities conducted during the base period of performance include developing animal models with radiation survival curves, dosing studies, bulk drug manufacturing, final drug product manufacturing, validation testing, compliance studies and the filing of IND, an orphan drug status application and a fast track designation application with the FDA. In the event BARDA exercises options to extend the term of the BARDA Contract, optional activities to be conducted would include, among other things, bulk drug and final drug product manufacturing, stability studies, animal pivotal efficacy studies, human clinical safety studies and Phase I, Phase II and pre-new drug application ("NDA") meetings and applications with the FDA.

On February 14, 2012, the Aeolus team presented the results and deliverables that had been produced during the first twelve months under the base period of the BARDA Contract at an "In-Progress Review" meeting with BARDA, and requested the exercise of additional contract options, which contain the key items required to further advance development of AEOL 10150.

On February 15, 2012, we announced that we entered into a contract modification and no-cost extension with the BARDA. The modification and extension allowed us to continue operating under the base period of the contract awarded in February 2011, and restructured the timing and components of the options that could be awarded under the remaining four years of the agreement. The changes did not impact the total potential value of the contract, which remains at approximately $118.4 million. The contract restructure was driven by our ability to generate cost savings in the base year contract, and to allow BARDA to better manage contract options to expedite development program.

On April 16, 2012, we announced that BARDA had exercised two contract options worth approximately $9.1 million. BARDA's exercise of the options was in response to the presentation of the deliverables and progress made under the contract at the meeting on February 14, 2012. Among the key items in the options BARDA exercised are animal efficacy studies, mechanism of action research and manufacturing and process validation work. All of these items build off of work successfully completed during the first twelve months of the contract base period. The contract is designed to produce the data necessary for an approval under the FDA "Animal Rule" and for a potential Emergency Use Authorization (EUA). An approval or EUA would allow the federal government to buy AEOL 10150 for the Strategic National Stockpile under Project Bioshield. Project Bioshield is designed to accelerate the research, development, purchase and availability of effective medical countermeasures for the Strategic National Stockpile

Since February 11, 2011, we have been actively developing AEOL 10150 under the BARDA Contract. Among the key deliverables accomplished in the program, we hired the necessary personnel required under the contract, initiated the radiation dose studies in mice and NHPs, manufactured a GMP batch for use in human safety studies and a non-GMP batch of material for use in animal efficacy studies, developed significant improvements to the process for manufacturing compound which will reduce the cost of producing the drug; made several discoveries related to the mechanism of damage of radiation and mechanism of action of AEOL 10150; met with the FDA to discuss our IND filing for Lung-ARS; and designed and initiated quality, reporting, risk management and project management programs required under the BARDA Contract.

Under the BARDA Contract, we plan to provide to BARDA the data necessary in order to file an Emergency Use Authorization ("EUA") with the FDA in approximately the second half of 2013. An EUA is a legal means for the FDA to approve new drugs or new indications for previously approved drugs that may be stockpiled and used during a declared emergency. To date, about half of the procurements for the national stockpile for medical countermeasures against potential terrorist events have been made under EUAs, prior to approval by the FDA for the indication in question.

Results of Operations

Fiscal Year Ended September 30, 2012 Compared to Fiscal Year Ended September 30, 2011

We had net income of $1,698,000 (including a non-cash gain for decreases in valuation of warrants of approximately $4,069,000) for the fiscal year ended September 30, 2012, versus net income of $299,000 (including a non-cash gain for decreases in valuation of warrants of $3,887,000) for the fiscal year ended September 30, 2011.


Revenue for the fiscal year ended September 30, 2012 was approximately $7,293,000, compared to $4,821,000 revenue for the fiscal year ended September 30, 2011. The revenue is from the collaboration with BARDA announced on February 11, 2011. Since being awarded the BARDA Contract, we generate contract revenue from a cost-plus fee arrangement. Revenues on reimbursable contracts are recognized as costs are incurred, generally based on allowable costs incurred during the period, plus any recognizable earned fee. We consider fixed fees under cost-plus fee contracts to be earned in proportion to the allowable costs incurred in performance of the contract.

Research and Development

Research and development expenses increased by $1,413,000, or 28%, to approximately $6,468,000 for the fiscal year ended September 30, 2012 from approximately $5,055,000 for the fiscal year ended September 30, 2011. R&D expenses were higher during the fiscal year ended September 30, 2012 versus September 30, 2011 due to work related to the BARDA Contract. For the fiscal year ended September 30, 2012, consultant expenses increased by $626,000 due to costs associated with the BARDA Contract. Preclinical fees increased about $202,000 over the comparable period in 2011 due to increased animal studies to support our ARS development program. The increase also reflected production and development of AEOL 10150 for planned upcoming BARDA studies, for which manufacturing expenses increased about $590,000. We currently have eight development programs in progress: studies of AEOL 10150 as a medical countermeasure against the effects of sulfur mustard gas and chlorine gas on the lungs, against the effects of radiation on the lungs and on the gastro-intestinal tract, and as a treatment for cancer, studies of AEOL 11207 and several other compounds as potential treatments for Parkinson's disease and epilepsy, and a study of Hexyl as protectant against radiation exposure.

R&D expenses for our antioxidant program have totaled approximately $48,723,000 from inception through September 30, 2012. Because of the uncertainty of our research and development and clinical studies, we are unable to predict the total level of spending on the program or the program completion date. However, we expect R&D expenses during fiscal year 2013 will be comparable to fiscal 2012 since we will continue development under the BARDA Contract. We anticipate that much of the R&D spending should be reimbursed under that contract.

General and Administrative

General and administrative ("G&A") expenses include corporate costs required to support Aeolus, our employees and consultants and our stockholders. These costs include personnel and outside costs in the areas of legal, human resources, investor relations and finance. Additionally, we include in general and administrative expenses such costs as rent, repair and maintenance of equipment, depreciation, utilities, information technology and procurement costs that we need to support the corporate functions listed above.

G&A expenses decreased approximately $472,000, or 13%, to approximately $3,196,000 for the fiscal year ended September 30, 2012 from about $3,668,000 for the fiscal year ended September 30, 2011. Consulting fees decreased by about $456,000 due to shifting some contractors to employees. As a result, the decrease in consulting fees was partially offset by an increase in salaries and wages of about $304,000. Consulting stock expense decreased by about $356,000 as a result of fewer awards and a lower stock price for the period.

Other Income or Expense

As previously disclosed, certain of our warrants to purchase common stock were deemed to be a liability upon adoption of a new accounting pronouncement on October 1, 2009. Subsequent changes to the fair market value resulted in an offsetting gain in the statements of operations of approximately $4,069,000 for the fiscal year ended September 30, 2012, as compared to approximately $3,887,000 for the fiscal year ended September 30, 2011. The warrant liability and revaluations have not and will not have any impact on our working capital, liquidity or business operations.

Fiscal Year Ended September 30, 2011 Compared to Fiscal Year Ended September 30, 2010

We had net income of $299,000 (including a non-cash gain for decreases in valuation of warrants of approximately $3,887,000) for the fiscal year ended September 30, 2011, versus a net loss of $25,869,000 (including a non-cash charge for increases in valuation of warrants of $21,347,000) for fiscal year ended September 30, 2010.


Revenue for the fiscal year ended September 30, 2011 was approximately $4,821,000, which compares to zero revenue for the fiscal year ended September 30, 2010. The revenue is from the collaboration with BARDA announced on February 11, 2011. Since being awarded the BARDA Contract, we generate contract revenue from a cost-plus fee arrangement. Revenues on reimbursable contracts are recognized as costs are incurred, generally based on allowable costs incurred during the period, plus any recognizable earned fee. We consider fixed fees under cost-plus fee contracts to be earned in proportion to the allowable costs incurred in performance of the contract.

Research and Development

Research and development expenses increased by about $3,365,000, or 199%, to approximately $5,055,000 for the fiscal year ended September 30, 2011 from approximately $1,690,000 for the fiscal year ended September 30, 2010. R&D expenses were higher during the fiscal year ended September 30, 2011 versus September 30, 2010 due to work related to the BARDA Contract. For the fiscal year ended September 30, 2011, consultant expenses increased by about $264,000 due to costs associated with the aforementioned consultant. Preclinical fees increased about $1,907,000 over the comparable period in 2010 due to increased animal studies to support our ARS development program. The increase also reflected the initiation of production of a compound for oncology studies anticipated that began in fiscal year 2011, for which manufacturing expenses increased about $1,118,000. We currently have eight development programs in progress: studies of AEOL 10150 as a medical countermeasure against the effects of sulfur mustard gas and chlorine gas on the lungs, against the effects of radiation on the lungs and on the gastro-intestinal tract, and as a treatment for cancer, studies of AEOL 11207 and several other compounds as potential treatments for Parkinson's disease and epilepsy, and a study of Hexyl as protectant against radiation exposure.

R&D expenses for our antioxidant program have totaled approximately $42,255,000 from inception through September 30, 2011. Because of the uncertainty of our research and development and clinical studies, we are unable to predict the total level of spending on the program or the program completion date. However, we expect R&D expenses during fiscal year 2012 will be higher than fiscal 2011 since we have been awarded the BARDA Contract. We anticipate that much of the increase in R&D spending should be reimbursed under that contract.

General and Administrative

General and administrative ("G&A") expenses include corporate costs required to support our company, our employees and consultants and our stockholders. These costs include personnel and outside costs in the areas of legal, human resources, investor relations and finance. Additionally, we include in general and administrative expenses such costs as rent, repair and maintenance of equipment, depreciation, utilities, information technology and procurement costs that we need to support the corporate functions listed above.

G&A expenses increased approximately $1,714,000, or 88%, to approximately $3,668,000 for the fiscal year ended September 30, 2011 from about $1,954,000 for the fiscal year ended September 30, 2010. Salaries and wages increased by about $646,000 due to the addition of a Chief Financial Officer, a Vice President of Manufacturing, a Director of Quality Assurance and Quality Control, and Corporate Controller. Consulting stock expense increased by about $422,000 as a result of the hiring of the aforementioned staff and also due to decreased stock compensation activity in the prior comparable period. Investor relations expenses increased by $118,000, due to increased IR-related activities performed by outside consultants. Legal fees increased by $143,000 as a result of higher reliance on our outside legal counsel for review and compliance related to SEC filings during the current quarter, as well as the review of the BARDA Contract and related contracts.

Other Income or Expense

We incurred interest expense of approximately $21,000 for the fiscal year ended September 30, 2011 compared to interest expense of about $878,000 for the fiscal year ended September 30, 2010. Interest expense in fiscal year 2011 reflects about $21,000 incurred by the second quarter of fiscal year 2011, due to conversion of the Elan note payable compared to the conversion of the Senior Convertible Notes during the prior comparable period.

As previously disclosed, certain of our warrants to purchase common stock were deemed to be a liability upon adoption of a new accounting pronouncement on October 1, 2009. Subsequent changes to the fair market value resulted in an offsetting gain in the statements of operations of approximately $3,887,000 for the fiscal year ended September 30, 2011, as compared to approximately $21,347,000 for the fiscal year ended September 30, 2010. The warrant liability and revaluations have not and will not have any impact on our working capital, liquidity or business operations.


Liquidity and Capital Resources

As of September 30, 2012, we had approximately $281,000 of cash and cash equivalents, a decrease of $237,000 from September 30, 2011. In order to fund on-going operating cash requirements, or to accelerate or expand our oncology and other programs we may need to raise significant additional funds.

We had net income of $1,698,000 (including a non-cash gain for decreases in valuation of warrants of $4,069,000) for the fiscal year ended September 30, 2012, compared to net income of $299,000 (including a non-cash gain for decreases in valuation of warrants of $3,887,000) for the fiscal year ended September 30, 2011. For the same periods, we had cash outflows from operations of approximately $879,000 and $3,102,000, respectively. Our ongoing future cash requirements will depend on numerous factors, particularly the progress of our catalytic antioxidant program and clinical trials and our ability to negotiate and complete collaborative agreements or out-licensing arrangements. In order to help fund our on-going operating cash requirements, we intend to seek new collaborations for our antioxidant research program that include initial cash payments and on-going research support. In addition, we might sell additional shares of our stock and/or convertible debentures and explore other strategic and financial alternatives, including a merger with another company, the sale of stock and/or debt, the establishment of new collaborations for current research programs, that include initial cash payments and ongoing research support and the out-licensing of our compounds for development by a third party. We expect to incur additional losses and negative cash flow from operations for several more years.

In November 2010, we received approximately $244,000 from the QTDP, administered by the IRS and HHS, in support of our development of AEOL 10150 as an MCM for Lung-ARS. Additionally, In November 2010, we received approximately $92,000 from the QTDP in support of our development of AEOL 11207 for Parkinson's Disease.

On February 11, 2011, we were awarded a contract by BARDA to fund the development of AEOL 10150 as an MCM for Lung-ARS from its current status to FDA approval in response to Special Instructions Amendment 4 to a Broad Agency Announcement (BAA-BARDA-09-34) for advanced research and development of medical countermeasures for chemical, biological, radiological and nuclear threats. The contract value could be up to $118.4 million depending on options exercised by BARDA and the requirements for approval by the FDA. Under the BARDA Contract, substantially all of the costs of the development of AEOL 10150 as a medical countermeasure for pulmonary injuries resulting from an acute exposure to radiation from a radiological/nuclear accident or attack, particularly injuries associated with ARS or DEARE would be paid for by the U.S. government through BARDA funding. We recognized approximately $7,293,000 in revenue during the fiscal year ended September 30, 2012 related to the BARDA Contract.

We do not have any revenues from product sales and, therefore, we rely on investors, grants, collaborations and licensing of our compounds to finance our operations. We generate limited revenue from reimbursable, cost-plus fee R&D contracts and grants. Revenues on reimbursable contracts are recognized as costs are incurred, generally based on allowable costs incurred during the period, plus any recognizable earned fee. We consider fixed fees under cost-plus fee contracts to be earned in proportion to the allowable costs incurred in performance of the contract.

Since the terms of the BARDA Contract include provisions to cover some general corporate overhead as well as a small provision for profit, the result on our liquidity is that our projected cash burn has been reduced. In order to fund on-going operating cash requirements, or to further accelerate or expand our programs, we expect to need to raise significant additional funds in order to pursue our oncology program.

We have incurred significant losses from operations to date. Our ongoing future cash requirements will depend on numerous factors, particularly the progress of our catalytic antioxidant program, clinical trials and ability to negotiate and complete collaborative agreements or out-licensing arrangements. In addition, we might sell additional shares of our stock and/or debt and explore other strategic and financial alternatives, including a merger or joint venture with another company, the sale of stock and/or debt, the establishment of new collaborations for current research programs, that include initial cash payments and ongoing research support and the out-licensing of our compounds for development by a third party.


There are significant uncertainties as to our ability to access potential sources of capital. We may not be able to enter into any collaboration on terms acceptable to us, or at all, due to conditions in the pharmaceutical industry or in the economy in general or based on the prospects of our catalytic antioxidant program. Even if we are successful in obtaining collaboration for our antioxidant program, we may have to relinquish rights to technologies, product candidates or markets that we might otherwise develop ourselves. These same risks apply to any attempt to out-license our compounds.

Similarly, due to market conditions, the illiquid nature of our stock and other possible limitations on equity offerings, we may not be able to sell additional securities or raise other funds on terms acceptable to us, if at all. Any additional equity financing, if available, could result in substantial dilution to existing stockholders.

Our forecast of the period of time through which our financial resources will be adequate to support our operations is forward-looking information, and actual results could vary.

Contractual Obligations

Our contractual obligations (in thousands) as of September 30, 2012 were as
follows:

                                                       Payments due by period
                                                                                      More
                                           Less than         1-3           3-5       than 5
Contractual Obligations      Total           1 Year         Years         Years       Years

Short and long-term debt    $     -     $           -       $    -       $     -     $     -
Capital lease obligations         -                 -            -             -           -
Operating leases                  3                 3            -             -           -
Purchase obligations              -                 -            -             -           -
Total                       $     3     $           3       $    -       $     -     $     -

Off Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources as defined under the rules of SEC Release No. FR-67. We do not have any capital leases.

Relationship with Goodnow Capital, LLC and Xmark Opportunity Partners, LLC

In July 2003, we initiated a series of transactions that led to our corporate reorganization and recapitalization. We obtained an aggregate of $8,000,000 in secured bridge financing in the form of convertible promissory notes we issued to Goodnow Capital, LLC ("Goodnow"). A portion of this financing allowed us to pay our past due payables and become current. We used the remainder for our operations, including a toxicology study for our catalytic antioxidant compounds under development as a treatment for ALS.

We completed our corporate reorganization on November 20, 2003. The reorganization involved the merger of our former parent company into one of our wholly owned subsidiaries. Subsequent to our 2003 reorganization, we completed a number of equity and debt financings, the majority of which included Xmark as investors. As of September 30, 2012, Xmark Opportunity Partners, LLC, through its management of Goodnow and the Xmark Funds, and through the Xmark Voting Trust and options held by David Cavalier, an affiliate of Xmark and the Chairperson of our Board of Directors, had voting power over 63.1% of our outstanding common stock and had beneficial ownership, calculated based on SEC requirements, of approximately 63.2% of our common stock. As a result of this significant ownership, Xmark Opportunity Partners, LLC and its affiliates is able to control future actions voted on by our stockholders.


In addition, under the terms of the warrants to purchase up to 61,822,749 shares of our common stock issued to Xmark on October 6, 2009 as well as subsequent warrant issuances on July 30, 2010, August 11, 2010 and December 28, 2010 (collectively, the "Xmark Warrants"), if we were to pay a dividend on our common stock the exercise price of these warrants would be reset from $0.28 per share or $0.50 per share, as applicable, to $0.01 per share and the warrant holders would also receive any such dividend paid. The Xmark Warrants also contain a provision that provides for the reduction of the exercise price to $0.01 upon a change of control and anti-dilution provisions in the event of a stock dividend or split, dividend payment or other issuance, reorganization, recapitalization or similar event. In addition, the Xmark Warrants, among other restrictions, prohibit the sale of Aeolus to an entity other than one that is publicly traded.

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. We evaluate our estimates, judgments and the policies underlying these estimates on a periodic basis as the situation changes, and regularly discuss financial events, policies, and issues with our independent registered public accounting firm and members of our audit committee. We routinely evaluate our estimates and policies regarding revenue recognition; . . .

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