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ALQA > SEC Filings for ALQA > Form 10-K/A on 16-May-2013All Recent SEC Filings

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Form 10-K/A for ALLIQUA, INC.


16-May-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying condensed consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

Overview

We develop, manufacture and market high water content, electron beam cross-linked, aqueous polymer hydrogels, or gels, used for wound care, medical diagnostics, transdermal drug delivery and cosmetics. We supply these gels primarily to the wound care and pain management segments of the healthcare industry. We believe that we are one of only two known manufacturers of these gels in the world. We specialize in custom gels by capitalizing on proprietary manufacturing technologies.

Our gels can be utilized as delivery mechanisms for medication to be delivered through the skin into the blood stream, known as transdermal delivery, or to be delivered between the layers of the skin, known as intradermal delivery. Active ingredients can be added to our gels for use in wound/burn dressings and to provide for the topical application of non-prescription drugs. Additionally, our gels can also be used as components in certain medical devices, skin care treatments, cosmetics and other commercial products.


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Our products are manufactured using proprietary and non-proprietary mixing, coating and cross-linking technologies. Together, these technologies enable us to produce gels that can satisfy rigid tolerance specifications with respect to a wide range of physical characteristics (e.g., thickness, water content, adherence, absorption, vapor transmission, release rates) while maintaining product integrity. Additionally, we have the manufacturing ability to offer broad choices in selection of liners onto which the gels are coated. Consequently, our customers are able to determine tolerances in vapor transmission and active ingredient release rates while personalizing color and texture.

We operate through the following wholly-owned subsidiaries: AquaMed Technologies, Inc., Alliqua Biomedical, Inc. and HepaLife Biosystems, Inc.

Recent Events

In July 2012, we began to market two proprietary products, SilverSeal®, a hydrogel wound dressing with silver coated fibers, and Hydress®, an over-the-counter hydrocolloid wound dressing. In order to promote sales of these products, we are currently ramping up our sales and marketing efforts. We have recently restructured our senior management team and appointed a new chairman of our board of directors, with the goal of maximizing the potential for success in achieving our sales and marketing goals. See "Item 10. Directors, Executive Officers and Corporate Governance" for information regarding these changes. We have also hired a national director of sales. We have also retained certain consultants and an outside sales organization to educate medical professionals about the benefits of these dressings. These consultants will perform in-service presentations to healthcare providers so they can better understand the medical benefits offered by our products. We have also assembled an SAB to help us target improvements and new applications for our products and assist in our marketing efforts.

On November 8, 2012, we entered into a securities purchase agreement with certain accredited investors pursuant to which (i) 16,300,000 shares of common stock and (ii) five year warrants to purchase up to 16,300,000 shares of common stock at an exercise price of $0.05 per share were issued in exchange for aggregate consideration of $815,000, of which $50,000 represented the conversion of debt. David Stefansky, Kenneth Londoner and Harborview Value Master Fund, L.P., with respect to which David Stefansky and Richard Rosenblum serve as control persons, invested $125,000, $20,000 and $50,000 (through conversion of a promissory note), respectively. Each warrant is exercisable immediately for cash or by way of a cashless exercise and contains provisions that protect its holder against dilution by adjustment of the exercise price and the number of shares issuable thereunder in certain events such as stock dividends, stock splits and other similar events.

On February 22, 2013, we entered into a securities purchase agreement with certain accredited investors pursuant to which (i) 4,697,532 shares of common stock and (ii) five year warrants to purchase up to 4,697,532 shares of common stock at an exercise price of $0.097 per share were issued in exchange for aggregate consideration of $380,500. Jerome Zeldis, David Johnson, David Stefansky, Joseph Leone and an affiliate of Richard Rosenblum invested $100,000, $50,000, $50,000, $20,000 and $50,000, respectively. Each warrant is exercisable immediately for cash or by way of a cashless exercise and contains provisions that protect its holder against dilution by adjustment of the exercise price and the number of shares issuable thereunder in certain events such as stock dividends, stock splits and other similar events.

On April 16, 2013, the Company entered into a securities purchase agreement with certain accredited investors pursuant to which we will issue, in the aggregate 6,753,086 shares of common stock and five year warrants to purchase, in the aggregate, up to 6,753,086 shares of common stock at an exercise price of $0.097 per share, in exchange for aggregate consideration of $547,000, of which $311,000 was held in escrow on April 16, 2013 by the placement agent. Each warrant is immediately exercisable for cash of by way of cashless exercise and contains provisions that protect its holder against dilution by adjustment of exercise price and the number of shares issuable thereunder in certain events such as stock dividends, stock splits and other similar events.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses and related disclosures. We review our estimates on an ongoing basis.

We consider an accounting estimate to be critical if it requires assumptions to be made that were uncertain at the time the estimate was made and changes in the estimate or different estimates that could have been made could have a material impact on our results of operations or financial condition. We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

We apply revenue recognition principles in accordance with Accounting Standard Codification, or ASC, 605, "Revenue Recognition." Accordingly, we record revenue when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the seller's price to the buyer is fixed or determinable, and
(iv) collectability is reasonably assured.


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Research and Development Expenses

Research and development expenses represent costs incurred to develop our technology. We charge all research and development expenses to operations as they are incurred, including internal costs, costs paid to sponsoring organizations, and contract services for any third party laboratory work.

Acquired In-Process Research and Development

In accordance with authoritative guidance, we recognize IPR&D at fair value as of the acquisition date, and subsequently account for it as an indefinite-lived intangible asset until completion or abandonment of the associated research and development efforts. Once an IPR&D project has been completed, the useful life of the IPR&D asset is determined and amortized accordingly. If the IPR&D asset is abandoned, the remaining carrying value will be written off. During fiscal year 2010, we acquired IPR&D through the merger with AquaMed Technologies, Inc. Our IPR&D is comprised of the HepaMate technology, which was valued on the date of the merger, May 11, 2010. It will take additional financial resources to continue development of this technology. We believe that the HepaMate technology has significant long-term profit potential and we have recently begun to allocate resources to find ways to realize its value.

We assessed the following qualitative factors to determine the fair value of the IPR&D:

? Analysis of the technology's current phase.

? Additional testing necessary to bring the technology to market.

? Development of competing products.

? Changes in projections caused by delays.

? Changes in regulations.

? Changes in the market for the technology.

? Changes in cost projections to bring the technology to market.

Our examination further reviewed the following criteria when observing and measuring using qualitative analysis:

? Relevant drivers of fair value: We observed multiple factors, including market opportunity, projected revenues, cost of revenues, operating expenses, EBIDTA, working capital required and capital expenditures. We determined these elements to be consistent from prior periods and remain relevant and applicable.

? Relevant events and circumstances: Our observation included macroeconomic and industry conditions along with other relevant events. Management determined that overall economic conditions seem to be improving and patients with acute liver failure patients still only have surgery as an option. As well, the additions of Dr. Jerome Zeldis as Chairman and James Sapirstein to management are key factors to lead the company's further development of the IPR&D.

? Prioritizing the events and circumstances: Although some time has passed since acquiring the technology, management believes the market for a bioartificial liver still exists and we have brought on key personnel to lead the initiative.

Based on the above criteria used when performing our qualitative analysis, management has concluded that, at December 31, 2012, there is no need for further testing of IPR&D and, therefore, no need for impairment at this time.

We continue to seek additional resources for further development of HepaMate. Through December 31, 2012, we have not been successful in these efforts. However, management is actively pursuing capital resources and industry experts to assist in this process. We are also actively seeking strategic partners for a joint venture to further this technology. Although there can be no assurance that these efforts will be successful, we intend to allocate financial and personnel resources when deemed possible and/or necessary. If we choose to abandon these efforts, the related IPR&D will need to be written down to zero.


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Impairment of Long-Lived Assets Subject to Amortization

We amortize intangible assets with finite lives over their estimated useful lives and review them for impairment at least annually whenever an impairment indicator exists. We continually monitor events and changes in circumstances that could indicate carrying amounts of our long-lived assets, including our intangible assets, may not be recoverable. When such events or changes in circumstances occur, we assess recoverability by determining whether the carrying value of such assets will be recovered through the undiscounted expected future cash flows. If the future undiscounted cash flows are less than the carrying amount of these assets, we recognize an impairment loss based on the excess of the carrying amount over the fair value of the assets. We did not recognize any intangible asset impairment charges for the years ended December 31, 2012 and 2011. See "Acquired In-Process Research and Development" for further information.

Goodwill

Goodwill represents the premium paid over the fair value of net tangible and intangible assets that we acquire in a business combination. Goodwill is allocated to specific reporting units.

When testing goodwill for impairment, qualitative factors are assessed to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill. Alternatively, we may bypass this qualitative assessment and perform a detailed quantitative test of impairment (step 1). If we perform the detailed quantitative impairment test and the carrying amount exceeds its fair value, we would perform an analysis (step 2) to measure such impairment.

In the fourth quarter of 2012, we performed our annual assessment of goodwill, which relates to our AquaMed Technologies, Inc. reporting unit. The Company assessed qualitative factors to determine whether current events and circumstances led to a determination that it was more likely than not that the fair value of the reporting unit was less than its carrying amount. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include a sustained, significant decline in share price and market capitalization, a decline in expected future cash flows, a significant adverse change in legal factors, the business climate and/or competition, among others. After assessing the totality of events and circumstances, the Company determined that it is not more likely than not that the fair value of the reporting unit was less than its carrying amount, and therefore, the two-step impairment test was unnecessary at December 31, 2012. The Company did not recognize any impairment charges for goodwill for the year ended December 31, 2012.

On May 11, 2010, the date of our merger with AquaMed Technologies, Inc., $9,386,780 of goodwill was assigned to the HepaLife Biosystems, Inc. reporting unit. During the second half of 2011, we experienced a steady decline in our common stock price despite improvement in equity markets generally. This lower stock price prevailed throughout the fourth quarter and into 2012. As a result, our enterprise market value declined and we performed the two step goodwill impairment test. Step 1 of the goodwill impairment test concluded that the market value of the HepaLife Biosystems, Inc. reporting unit was less than the carrying amount. As a result, we performed the required Step 2 of the analysis to measure any goodwill impairment. To measure the amount of the impairment charge, we determined the implied fair value of goodwill in the same manner as if this reporting unit were being acquired in a business combination. Based on our Step 2 assessment, we concluded, in the fourth quarter of 2011, that the net book value of the HepaLife Biosystems, Inc. reporting unit exceeded its fair value, and a goodwill impairment charge of $9,386,780 was recorded for the entire goodwill relating to the HepaLife Biosystems, Inc. reporting unit.

Additionally, we estimated the fair value of the AquaMed Technologies, Inc. reporting unit using discounted expected future cash flows. We determined the fair value of this reporting unit was greater than the carrying amount and that there was no impairment of the goodwill of this reporting unit.

Common stock purchase warrants

We assess classification of common stock purchase warrants at each reporting date to determine whether a change in classification between assets and liabilities or equity is required. Our free standing derivatives consist of warrants to purchase common stock that were issued pursuant to a securities purchase agreement on November 8, 2012. We evaluated the common stock purchase warrants to assess their proper classification in the consolidated balance sheet and determined that the common stock purchase warrants contain exercise reset provisions. Accordingly, these instruments have been classified as warrant liabilities. We re-measure warrant liabilities at each reporting date, with changes in fair value recognized in earnings for each reporting period.

Fair Value of Financial Instruments

We measure fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the reporting date. We utilize a three-tier hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:


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Level 1. Valuations based on quoted prices in active markets for identical assets or liabilities that an entity has the ability to access. We have no assets or liabilities valued with Level 1 inputs.

Level 2. Valuations based on quoted prices for similar assets or liabilities, quoted prices for identical assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable data for substantially the full term of the assets or liabilities. We have no assets or liabilities valued with Level 2 inputs.

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

Results of Operations

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

Overview. For the year ended December 31, 2012, we had a net loss of $4,905,335, which was inclusive of non-cash items totaling approximately $2,330,000. For the year ended December 31, 2011, we had a net loss of $13,853,203, which was inclusive of non-cash items totaling approximately $11,700,000. There may be significant future expense for non-cash stock based compensation if the milestones are achieved in the options granted to members of the board in May and November of 2012. See "Item 11. Executive Compensation - Compensation of Directors."

Revenues. We earned revenue of $1,228,674 for the year ended December 31, 2012, compared to revenue of $1,832,234 for the year ended December 31, 2011, representing a decrease of 32.9% as sales levels in the contract manufacturing business decreased due to lower sales volume from the Company's largest customer for the manufacture of hydrogel products. This decrease was due to weak sales to our largest customer during the first half of 2012. Sales to this customer fluctuated during 2011 and 2012 due to organizational and strategic changes experienced by the customer. We believe that sales have stabilized at levels comparable to those experienced during 2011 and the second half of 2012.

Gross Loss. Our gross loss was $608,495 for the year ended December 31, 2012, compared to a gross loss of $86,357 for the year ended December 31, 2011. The increase in gross loss was primarily attributable to a decrease in revenue of $603,560. The decreased margin for the year ended December 31, 2012, as compared to 2011, was due to the lower volume of sales with sustained fixed overhead expenses. Our sales were not sufficient to cover our fixed overhead expenses.

Fixed overhead includes depreciation, labor and occupancy expense. Depreciation of equipment and amortization of technology included in cost of goods sold for the year ended December 31, 2012 was $644,305, compared to $629,563 in 2011. This increase was attributable to the purchase of equipment in 2012. Labor-related expense for the year ended December 31, 2012, was $442,558, as compared to $386,788 in 2011. The increase in labor related expense was due to the fact that less labor expense was allocated to research and development in 2012 versus 2011. Rent expense for the year ended December 31, 2011 was $261,661, as compared to $252,548 in 2011. This increase was due to the timing of operating escalation expenses in 2012. Utility expense for the year ended December 31, 2012 was $58,633, as compared to $85,798 in 2011. This decrease was due to lower electrical consumption as a result of lower production and lower energy costs as a result of outsourcing to an alternate utility provider.

General and Administrative Expenses. General and administrative expense was $4,054,373 for the year ended December 31, 2012, as compared to $3,852,706 for the year ended December 31, 2011, which represented an increase of $201,667 or 5.2%. This increase was primarily due to an increase in consulting expenses. Consulting fees for the year ended December 31, 2012, were $332,576, as compared to $153,259, in 2011 with much of the increased expense being allocated for business development and strategic planning.

Research and Development. We incurred $233,819 in research and development expenses for the year ended December 31, 2012, as compared to $522,830 for the year ended December 31, 2011. This decrease was due partly to a reduction in expenses associated with the development of our transdermal pain patch along with the completion of research & development efforts for our wound dressings, which we began to market in the second half of 2012. We have been committing non-cash resources to the further development of the HepaMate asset and have engaged leading experts in the field of liver transplant medicine to continue our efforts. We are currently finalizing a strategic plan for this asset which we intend to finalize in the first half of 2013.


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Impairment of Goodwill. Goodwill is evaluated for impairment at the reporting unit level at least annually on December 31 of each calendar year or more often if events or changes in circumstances indicate the carrying value may not be recoverable. As of December 31, 2012 and 2011, we had $425,969 of goodwill related to our AquaMed Technologies, Inc. subsidiary; no goodwill impairment charge was recorded during the years then ended. However, based on our analysis in the fourth quarter of 2011, we recorded an impairment charge of $9,386,780 to write down the carrying value of the goodwill associated with the HepaLife Biosystems, Inc. subsidiary, to its estimated fair value of zero. There was no tax benefit associated with the impairment.

Interest Income. Interest income for the years ended December 31, 2012 and 2011 represents interest earned on cash and cash equivalents, which totaled $817 and $4,349, respectively. The decrease in interest income was due to the lower interest rates during the year as well as lower average cash balances on hand during the year.

Liquidity and Capital Resources

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

At December 31, 2012, cash and cash equivalents totaled $260,357, up from $260,111 at December 31, 2011. The increase was attributable to $2,052,525 net cash provided by financing activities, related to our issuance of common stock, offset by cash used in operating activities of $1,966,093 and capital expenditures of $86,186.

Net cash flow used in operating activities was $1,966,093 for 2012, compared to $2,196,825 for the year ended December 31, 2011. The decrease in cash used in operating activities was primarily attributable to an increase in accounts payable as a result of our limited cash flows. Although operating expenses increased, we experienced a decrease in cash used in operating activities because a significant amount of expenses were non-cash. The following table summarizes our cash flows year over year:

                                                          Year Ended December 31,
                                                           2012             2011
Net Loss                                                 (4,905,335 )     (13,853,203 )
Net Cash Used in Operating Activities                    (1,966,093 )      (2,196,825 )
Net Cash Provided by Investing Activities                   (86,186 )          73,209
Net Cash Provided by Financing Activities                 2,052,525           990,000
Net Increase (Decrease) in Cash and Cash Equivalents            246        (1,133,616 )
Cash & Equivalents - Beginning of Year                      260,111         1,393,727
Cash & Equivalents - End of Year                            260,357           260,111

We recognized revenue of $1,228,674 in 2012. Expenses that contributed to our net loss in 2012 included $1,837,169 for cost of sales, $332,576 for consultant fees, $494,523 for professional fees including legal and accounting, with the balance attributable to various general and administrative expenses. Inventory increased by $106,686, which reduced cash available. Accounts payable and accrued expenses, net of deposits and prepaid expenses, increased by $351,181, and accounts receivable decreased by $41,093. Both of these factors increased available cash. Deferred revenue increased by $39,000, which further increased cash available.

We did implement certain cost savings strategies. We terminated monthly cash rental payments for our executive offices in December 2011 and, beginning in 2012, we discontinued paying cash fees to our directors. Both of these expenses were paid in common stock in 2012. Termination of these cash payments resulted in a $330,000 reduction in expenses in 2012.


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Cash used by investing activities was $86,186 in 2012, compared to $73,209 cash provided by investing in 2011. In 2011, we used the $362,546 balance of restricted cash received in a May 2010 financing, which was offset by purchases of equipment. Cash flow generated from financing activities was $2,052,525 in 2012 up from $990,000 in 2011.

At December 31, 2012, current assets totaled $882,196 and current liabilities totaled $1,507,606 as compared to current assets of $603,908 and current liabilities totaled $337,193 at December 31, 2011. As a result, our working capital deficit was $625,410 at December 31, 2012. This decrease was primarily due to the increase in warrant liability as well as the increase in accounts payable and accrued expenses.

We have experienced negative operating cash flows since inception and have funded our operations primarily from sales of common stock and other securities. Our cash requirements have historically been for product development, clinical trials, marketing and sales activities, finance and administrative costs, capital expenditures and overall working capital.

In 2012 and continuing into 2013, we raised additional financing through common equity issuances as follows:

? On February 16, 2012, the Company entered into a securities purchase agreement with certain accredited investors pursuant to which (i) 21,000,000 shares of common stock and (ii) five year warrants to purchase 10,500,000 shares of common stock at an exercise price of $0.069 per share were issued for consideration of $987,025, net of fees.

? On August 14, 2012, the Company entered into a securities purchase agreement with certain accredited investors pursuant to which (i) 5,300,000 shares of common stock and (ii) five year warrants to purchase up to 2,650,000 shares of common stock at an exercise price of $0.05 per share were issued in exchange for consideration of $265,000.

? On September 28, 2012, pursuant to the securities purchase agreement dated August 14, 2012, an additional (i) 500,000 shares of common stock, and (ii) five year warrants to purchase up to 250,000 shares of common stock at an exercise price of $0.05 per share were issued in exchange for net proceeds of $25,000.

? On October 11, 2012, pursuant to the securities purchase agreement dated August 14, 2012, an additional (i) 100,000 shares of common stock, and
(ii) five year warrants to purchase up to 50,000 shares of common stock . . .

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