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DSCO > SEC Filings for DSCO > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for DISCOVERY LABORATORIES INC /DE/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for DISCOVERY LABORATORIES INC /DE/


12-Nov-2013

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, debt facilities, strategic alliances, the use of Committed Equity Financing Facilities (CEFFs) and at-the-market equity programs, and capital equipment financings.


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As of September 30, 2013, we had cash and cash equivalents of $21.2 million, approximately $6.6 million of accounts payable and accrued expenses, and $10 million of long-term debt under our Deerfield Facility with Deerfield Management Company, L.P. (Deerfield).

On October 15, 2013, we completed an offering under our At-the-Market Program (ATM Program) (see, Note 4, "Stockholders' Equity - Common Stock Offerings - At-the-Market Program") with Stifel, Nicolaus & Company, Incorporated (Stifel) and issued 713,920 shares of our common stock resulting in net proceeds to us (after deducting commissions due to Stifel) of approximately $1.9 million.
Through our ATM Program, subject to market conditions, we have the ability to sell up to approximately $23 million of common stock at such times and in such amounts that we deem appropriate. However, use of the ATM Program is subject to market and other conditions and the ATM Program can be cancelled at any time by either party. There can be no assurance that the ATM Program will be available when needed, if at all.

On November 5, 2013, we completed a public offering of 25 million shares of common stock, at a price of $2.00 per share resulting in gross proceeds of $50.0 million ($46.8 million net after commissions, discounts and expenses). In addition, we also granted the underwriters a 30-day option to purchase up to an additional 3.75 million shares of common stock (over-allotment) at an offering price of $2.00 per share. On November 8, 2013, we received notification that the underwriters have exercised the full over-allotment and will purchase an additional 3.75 million shares. This transaction is expected to close on or about November 14, 2013 and result in additional net proceeds to us of approximately $7.1 million.

We also have met the conditions for, and expect in early December to receive, an additional advance of $20 million under the Deerfield Facility, which became due upon the first commercial sale of SURFAXIN drug product. See, Note 6, "Long-Term Debt - Loan Facility with Deerfield."

Before any additional financings, including under our ATM Program and taking into account the additional approximately $7.1 million expected from the underwriters' exercise of the over-allotment in our November public offering and the expected $20 million advance under the Deerfield Facility, we anticipate that we will have sufficient cash available to support our operations and debt service obligations through 2015.

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 U.S., as planned; (ii) advance the AEROSURF development program to completion of the phase 2 clinical program in mid-2015; and (iii) secure one or more strategic alliances or other collaboration arrangements to support the development and, if approved, the commercial introduction of SURFAXIN, AEROSURF, AFECTAIR and potentially SURFAXIN LS, in markets outside the U.S. We believe that, if we are successful with the commercial introduction of SURFAXIN and if we are able to complete the AEROSURF phase 2 clinical program on a timely basis and obtain encouraging results, our ability to enter into a significant strategic alliance will be enhanced. There can be no assurance, however, that our efforts will be successful, or that we will be able to obtain additional capital to support our activities when needed on acceptable terms, if at all.

Even if we succeed with the commercial introduction of SURFAXIN and the AFECTAIR device as planned, given the time required to secure formulary acceptance of SURFAXIN at our target hospitals, we expect our revenues from SURFAXIN and AFECTAIR to be modest in the first 12-18 months and then increase over time as our products gain hospital acceptance. As a result, our cash outflows for operations, debt service and development programs are expected to outpace the rate at which we may generate revenues for several years. To execute our business strategy and fund our operations over the long term, we will require significant additional infusions of capital until such time as the net revenues from SURFAXIN, AFECTAIR and, if approved, AEROSURF, from potential strategic alliances and from other sources are sufficient to offset our cash flow requirements. To secure the necessary capital, we would prefer to enter into strategic alliances or collaboration agreements with partners that 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) and introduce our approved products in various markets outside the U.S. We also plan to consider other public and private equity offerings, including under our ATM Program, as well as other financing transactions, such as secured equipment financing facilities or other similar transactions.


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As of September 30, 2013, we had outstanding warrants to purchase approximately 10.3 million shares of our common stock at various prices, exercisable on different dates through 2019. Of these warrants, approximately 2.3 million warrants were issued to Deerfield in connection with the first advance under the Deerfield Facility. Upon receipt of the final $20 million advance under the Deerfield Facility, which is anticipated on or about December 3, 2013, we will issue warrants to purchase an additional 4.66 million shares of our common stock at an exercise price of $2.81 per share (we refer to these warrants and the warrants previously issued to Deerfield as the Deerfield Warrants). The Deerfield Warrants may be exercised for cash or on a cashless basis. In lieu of paying cash upon exercise, the holders also may elect to reduce the principal amount of the Deerfield loan in an amount sufficient to satisfy the exercise price of the Deerfield Warrants. In addition to the Deerfield Warrants, we have outstanding warrants to purchase approximately 4.9 million shares of common stock that were issued in February 2011, are exercisable for five-years, and 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. These warrants were originally issued with an exercise price of $3.20 per share and thereafter adjusted downward, first to $2.80 per share following a public offering in March 2012 and then to $1.50 per share following a public offering in May 2013. Although we believe that, in the future, we will secure additional capital from the exercise of at least a portion of our outstanding warrants, there can be no assurance that the market price of our common stock will equal or exceed price levels that make exercise of outstanding warrants likely, or, even if the price levels are sufficient, that holders of our warrants will choose to exercise any or all of their warrants prior to the warrant expiration date. Moreover, if our outstanding warrants are exercised, such exercises likely will be at a discount to the then-market value of our common stock and have a dilutive effect on the value of our shares of common stock at the time of exercise.

As of September 30, 2013, 150 million shares of common stock were authorized under our Amended and Restated Certificate of Incorporation, and approximately 71.7 million shares of common stock were available for issuance and not otherwise reserved. As of November 8, 2013, following the financings under our ATM Program, our public offering, and establishment of additional reserves for the shares expected to be issued in connection with the underwriters' exercise of the over-allotment in our November public offering and with respect to the warrants expected to be issued to Deerfield upon receipt of the $20 million advance in early December, approximately 42 million shares of common stock were available for issuance and not otherwise reserved.

Although we currently believe that we will be able to execute our business plan and accomplish our objectives, there can be no assurance that we will be successful. There can be no assurance that we will be successful in securing the needed capital, through strategic alliances, collaboration arrangements, financings, debt arrangements and other transactions. Failure to secure the necessary additional capital would have a material adverse effect on our business, financial condition and results of operations.

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 U.S. for interim financial information in accordance with the instructions to Form 10Q. 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, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. There have been no changes to our critical accounting policies since December 31, 2012. 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, 2012 that we filed with the Securities and Exchange Commission (SEC) on March 15, 2013 (2012 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. We assess 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 FDA approval of SURFAXIN drug product and registration of our initial AFECTAIR device have been recorded in our statement of operations as research and development expense. Due to a delay in commercial availability of SURFAXIN drug product, previously capitalized raw material costs of $195,072 were charged to research and development expense in the first quarter of 2013, as these raw materials were no longer expected to be used for commercial production.

Inventory as of September 30, 2013 consists of AFECTAIR devices available for commercial sale. Inventory costs for our AFECTAIR device consist primarily of third-party manufacturing fees, freight, and indirect personnel overhead costs.


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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 net loss by the weighted average number of common shares outstanding for the period. Diluted net loss per common share is computed by giving effect to all potentially dilutive securities outstanding for the period.

In accordance with Accounting Standards Codification (ASC) Topic 260, "Earnings per Share," when calculating diluted net loss per common share, a gain associated with the decrease in the fair value of certain warrants classified as derivative liabilities results in an adjustment to the net loss; and the dilutive impact of the assumed exercise of the warrants results in an adjustment to the weighted average common shares outstanding. We utilize the treasury stock method to calculate the dilutive impact of the assumed exercise of the warrants. For the nine months ended September 30, 2013, the effect of the adjustments for warrants issued in February 2011 was dilutive. For the three months ended September 30, 2013 and for the three and nine months ended September 30, 2012, the effect of the adjustments for all warrants classified as derivative liabilities was non-dilutive.

The table below provides information pertaining to the calculation of diluted net loss per common share for the periods presented:

                                             Three Months Ended           Nine Months Ended
(in thousands)                                  September 30,               September 30,
                                             2013          2012          2013          2012
Numerator:
Net loss as reported                       $ (12,224 )   $ (13,346 )   $ (33,486 )   $ (30,500 )
Less: income from change in fair value
of warrant liability                               -             -        (1,525 )           -
Numerator for diluted net loss per
common share                               $ (12,224 )   $ (13,346 )   $ (35,011 )   $ (30,500 )

Denominator:
Basic weighted average common shares
outstanding                                   54,792        43,444        49,235        38,061
Dilutive common shares from assumed
warrant exercises                                  -             -         1,142             -
Diluted weighted average common shares
outstanding                                   54,792        43,444        50,377        38,061

As of September 30, 2013 and 2012, 10.7 million and 12.0 million shares of common stock potentially issuable upon the exercise of certain stock options and warrants were excluded from the computation of diluted net loss per common share because their impact would have been anti-dilutive.

Recent accounting pronouncements

There were no new accounting pronouncements issued during the nine months ended September 30, 2013 that are expected to have a material impact on the Company's financial position, operating results, cash flows or disclosures.


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Note 4 - Stockholders' Equity

Registered Public Offerings

On May 15, 2013, we completed a registered public offering of 9.5 million shares of our common stock, at a price of $1.50 per share resulting in gross proceeds of $14.3 million ($13.2 million net). We also granted the underwriter a 30-day option to purchase up to an additional 1.425 million shares of common stock at an offering price of $1.50 per share. On May 31, 2013, the underwriter exercised its option and purchased 1.347 million additional shares of common stock for net proceeds to us (after underwriter fees) of $1.9 million. In connection with this offering, we agreed not to issue or sell (with certain limited exceptions) securities for a period of 90 days after the date of the prospectus supplement ending August 8, 2013. Regarding our ATM Program, we agreed not to issue or sell securities for a period of 30 days after the date of the underwriting agreement ending on June 9, 2013.

At-the-Market Program

In February 2013, we entered into an At-the-Market Equity Offering Sales Agreement with Stifel, under which Stifel, as our exclusive agent, at our discretion and at such times that we may determine from time to time, may sell up to a maximum of $25 million of our common stock over a three-year period. We are not required to sell any shares at any time during the term of the ATM Program. We have agreed to pay Stifel a commission of 3% of gross proceeds of any sales of shares. See, Note 17, "Subsequent Events - ATM Program," to the consolidated financial statements in our 2012 Form 10-K.

Committed Equity Financing Facility (CEFF)

We had a CEFF dated June 11, 2010 with Kingsbridge Capital Limited (Kingsbridge), under which, for a period of up to three years, Kingsbridge was committed to purchase, subject to certain conditions, newly issued shares of our common stock. Our ability to access the CEFF was subject to certain covenants and conditions, including stock price and volume limitations. For a detailed description of our CEFF, see, Note 10, "Stockholders' Equity - Registered Public Offerings - Committed Equity Financing Facility (CEFF)," to the consolidated financial statements in our 2012 Form 10-K.

The CEFF expired on June 11, 2013 with approximately 1.1 million available shares not issued.

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.


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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, 2013 and December 31, 2012:

                                            Fair Value                Fair value measurement using
                                           September 30,       Level 1            Level 2          Level 3
                                               2013

Assets:
Money Market                               $      19,877     $     19,877       $          -      $        -
Certificate of Deposit                               400              400                  -               -
Total Assets                               $      20,277     $     20,277       $          -      $        -

Liabilities:
Common stock warrant liability             $       4,678     $          -       $          -      $    4,678



                                            Fair Value               Fair value measurement using
                                           December 31,       Level 1            Level 2          Level 3
                                               2012

Assets:
Money Market                               $     23,377     $     23,377       $          -      $        -
Certificate of Deposit                              400              400                  -               -
Total Assets                               $     23,777     $     23,777       $          -      $        -

Liabilities:
Common stock warrant liability             $      6,305     $          -       $          -      $    6,305

The tables below summarizes the activity of Level 3 inputs measured on a recurring basis for the nine months ended September 30, 2013 and 2012:

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

Balance at December 31, 2012                             $                            6,305
Change in fair value of common stock warrant liability                               (1,627 )
Balance at September 30, 2013                            $                            4,678




                                                             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                                                                   (136 )
Change in fair value of common stock warrant liability                                5,063
Balance at September 30, 2012                            $                           11,923

The significant unobservable inputs used in the fair value measurement of 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 certain five-year warrants issued in February 2011 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.


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    Significant Unobservable Input
   Assumptions of Level 3 Valuations    September 30, 2013       December 31, 2012

   Historical Volatility                           55% - 61 %               56% -80 %
   Expected Term (in years)                       0.6 - 2.4               1.4 - 3.2
   Risk-free interest rate                     0.05% - 0.45 %          0.16% - 0.36 %

Fair Value of Long-Term Debt

As of September 30, 2013, the carrying value of our long-term debt, net of discounts, approximates fair value. We had no long-term debt as of December 31, 2012. We estimate the fair value of the Deerfield Facility using a discounted cash flow analysis. This analysis utilizes certain Level 3 unobservable inputs, including the effective interest rate and current cost of capital. Considerable judgment is required to interpret market data and to develop estimates of fair value. The estimates presented are not necessarily indicative of amounts we could realize in a current market exchange. The use of alternative market assumptions and estimation methodologies could have a material effect on these estimates of fair value.

Note 6 - Long-term Debt

Loan Facility with Deerfield

On February 13, 2013, we entered into a secured loan facility (Deerfield Facility) with affiliates of Deerfield Management Company, L.P. (Deerfield) for up to $30 million in secured financing in 2013. Deerfield advanced to us $10 million upon execution of the agreement and agreed to advance an additional $20 million, subject to certain conditions, on or about the date of the first commercial sale of SURFAXIN drug product (Milestone Date), if the Milestone Date occurs on or before December 31, 2013. On November 8, 2013, we notified Deerfield that the first commercial sale of SURFAXIN has occurred, and anticipate receipt of the $20 million advance on or about December 3, 2013.

The loan may be prepaid in whole or in part without penalty at any time. In addition, the principal amount of the loan may be reduced to the extent that holders of the notes elect to apply all or a portion of the principal amount outstanding under the loan to satisfy the exercise price of all or a portion of the Deerfield Warrants upon exercise. The principal amount of the loan is payable in equal annual installments on the fourth, fifth and sixth anniversaries of the Deerfield Facility agreement, provided that the amount payable on the fourth anniversary shall be deferred for one year if either (i) our "Net Sales" (defined below) for the immediately preceding 12-month period are at least $20 million, or (ii) our "Equity Value" (defined below) is at least $200 million; and provided further, that the amount payable on the fifth anniversary (together with any amount deferred on the fourth anniversary) shall be deferred until the sixth anniversary if either (i) our "Net Sales" for the immediately preceding 12 month period are at least $30 million, or (ii) our "Equity Value" is at least $250 million. For the purposes of the foregoing deferrals of principal, "Net Sales" means, without duplication, the gross amount invoiced by us or on our behalf, any of our subsidiaries or any direct or indirect assignee or licensee for products, sold globally in bona fide, arm's length transactions, less customary deductions determined without duplication in accordance with generally accepted accounting principles; and "Equity Value" means, with respect to each measurement date, the product of (x) the number of issued and outstanding shares of our common stock on such measurement date multiplied by (y) the per share closing price of our common stock on such measurement date. Accordingly, if the milestones are achieved in each year, payment of the principal amount could be deferred until the sixth anniversary date of the loan on February 13, 2019.

Any amounts received and outstanding under the Deerfield Facility will accrue interest at a rate of 8.75%, payable quarterly in cash. The Deerfield Facility agreement contains customary terms and conditions but does not require us to meet minimum financial and revenue performance covenants. In connection with each advance, Deerfield has received and, upon advance of the additional $20 million, will receive, a transaction fee equal to 1.5% of the amount disbursed.
The facility agreement also contains various representations and warranties and affirmative and negative covenants customary for financings of this type, including restrictions on our ability to incur additional indebtedness and grant additional liens on our assets. In addition, all amounts outstanding under the Deerfield Facility may become immediately due and payable upon (i) an "Event of Default," as defined in the Deerfield Facility agreement, in which case . . .

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