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ECTE > SEC Filings for ECTE > Form 10-K on 28-Mar-2014All Recent SEC Filings

Show all filings for ECHO THERAPEUTICS, INC.

Form 10-K for ECHO THERAPEUTICS, INC.


28-Mar-2014

Annual Report


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

The following discussion of our consolidated financial condition and results of operations should be read in conjunction with the consolidated financial statements and the notes thereto, and the financial and other information, included elsewhere in this Form 10-K. The matters discussed herein contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, which involve risks and uncertainties. All statements other than statements of historical information provided herein may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects" and similar expressions are intended to identify forward-looking statements. Factors that could cause actual results to differ materially from those reflected in the forward-looking statements include, but are not limited to, those discussed in "Risk Factors" and elsewhere in this report and the risks discussed in our other filings with the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis, judgment, belief or expectation only as of the date hereof. Except as required by law, we undertake no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof.

Overview

General

We are a medical device company with expertise in advanced skin permeation technology. We are developing our Symphony® CGM System ("Symphony") as a non-invasive, wireless continuous glucose monitoring ("CGM") system for use in hospital critical care units. The Symphony® SkinPrep System ("SkinPrep"), a component of our Symphony CGM System, allows for enhanced skin permeation that will enable extraction of analytes such as glucose.

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Regular monitoring of blood glucose levels is rapidly becoming a preferred procedure by hospital critical care personnel to achieve tight glycemic control and ensure improved patient outcomes. Clinical studies have demonstrated that intensive insulin therapy and frequent glucose monitoring to maintain tight glycemic control ("TGC") significantly reduces patient mortality, complications and infection rates, as well as hospital stays, services and overall hospital costs. Most intensive care units ("ICUs") in the United States have protocols in place for tight glycemic control regardless of whether the patients have diabetes. We believe that a non-invasive, needle-free CGM system, such as Symphony, will save valuable nursing time and expense by avoiding the need for frequent blood glucose sampling, in addition to providing more clinically relevant, real-time glucose level and trending information that is needed to develop better control algorithms for insulin administration. We have evaluated Symphony in a clinical setting at several leading U.S. hospitals for the continuous monitoring of glucose.
Research and Development

We believe that ongoing research and development efforts are essential to our success. A major portion of our operating expenses to date is related to our research and development activities. R&D expenses generally consist of internal salaries and related costs, and third-party vendor expenses for product design and development, product engineering and contract manufacturing. In addition, R&D costs include regulatory consulting, feasibility product testing (internal and external) and conducting nonclinical and clinical studies. R&D expenses were approximately $11,299,000, $8,671,000 and $3,796,000 for the years ended December 31, 2013, 2012 and 2011, respectively. We intend to maintain our strong commitment to R&D as an essential component of our product development efforts. Licensed or acquired technology developed by third parties may be an additional source of potential products; however, our ability to raise sufficient financing may impact our level of R&D spending.

Critical Accounting Policies and Estimates

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As of December 31, 2013, we had cash of approximately $8,055,000, working capital of approximately $5,731,000, and an accumulated deficit of approximately $112,969,000. Through December 31, 2013, we have not been able to generate sufficient revenues from our operations to cover our costs and operating expenses. Although we have been able to raise capital through a series of Common Stock and preferred stock offerings in order to fund our operations, it is not known whether we will be able to continue this practice, or be able to obtain other types of financing to meet our future cash operating expenses. Additional financing is necessary to fund operations in 2014 and beyond. We are currently pursuing various financing options, and such financing is expected to be completed during 2014; however, no assurances can be given as to the success of these plans. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

Subsequent to December 31, 2013, we have received net cash proceeds from a Common Stock financing with MTIA of $1,904,793 as part of their total $5,000,000 investment. Management believes that the cash received from this Common Stock financing coupled with the cash on hand at December 31, 2013 will be sufficient to fund the cash requirements under the 2014 budget and fund operations through December 31, 2014. If all cash proceeds from MTIA are not received, management believes certain expenditures can be deferred until additional financing is obtained.

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.

On an ongoing basis, we evaluate our estimates and judgments for all assets and liabilities, including those related to stock-based compensation expense, intangible assets, other long-lived assets, and the fair value of stock purchase warrants classified as derivative liabilities. We base our estimates and judgments on historical experience, current economic and industry conditions and on various other factors that are believed to be reasonable under the circumstances. This forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our significant accounting policies are described in Note 2 to the Consolidated Financial Statements in Part II, Item 8 of this Report on Form 10-K. We believe the critical accounting policies discussed below are those most important for an understanding of our financial condition and results of operations and require our most difficult, subjective or complex judgments.

We believe that full consideration has been given to all relevant circumstances that we may be subject to, and the consolidated financial statements accurately reflect our best estimate of the results of operations, financial position and cash flows for the periods presented.

Intangible Assets and Other Long-Lived Assets - We record intangible assets at acquisition date fair value. In connection with our acquisition of Durham Pharmaceuticals Ltd., a North Carolina corporation doing business as Echo Therapeutics, Inc., in September 2007, intangible assets related to contractual arrangements were amortized over the estimated useful life of 3 years which ended in 2010. Intangible assets related to technology are expected to be amortized on a straight-line basis over the period ending in mid-2019 when the underlying patents expire and will commence upon revenue generation.

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Accounting for Impairment and Disposal of Long-Lived Assets - We review intangible assets subject to amortization annually to determine if any adverse conditions exist or a change in circumstances has occurred that would indicate impairment or a change in the remaining useful life. Conditions that would indicate impairment and trigger an impairment assessment include, but are not limited to, a significant adverse change in legal factors or business climate that could affect the value of an asset, or an adverse action or assessment by a regulator. If the carrying value of an asset exceeds its undiscounted cash flows, we write-down the carrying value of the intangible asset to its fair value in the period identified.

For purposes of this analysis, we estimate our cash flows using a projection period not exceeding ten years, market size based on estimated market share, estimated costs to complete product development, operating expenses and a blended tax rate. Generally, cash flow forecasts for purposes of impairment analysis are prepared on a consistent basis and methodology as those used to initially estimate the intangible asset's fair value.

If the carrying value of assets is determined not to be recoverable, we record an impairment loss equal to the excess of the carrying value over the fair value of the assets. Our estimate of fair value is based on the best information available to us, in the absence of quoted market prices.

We generally calculate fair value as the present value of estimated future cash flows that we expect to generate from the asset using the income approach. Significant estimates included in the discounted cash flow analysis as consistent with those described above are used except that we introduce a risk-adjusted discount rate. The risk-adjusted discount rate is estimated using a weighted-average cost of capital analysis. If the estimate of an intangible asset's remaining useful life is changed, we amortize the remaining carrying value of the intangible asset prospectively over the revised remaining useful life. For other long-lived assets, we evaluate quarterly whether events or circumstances have occurred that indicate that the carrying value of these assets may be impaired.

Share-based Payments - We record share-based payments at fair value. The grant date fair value of awards to employees and directors, net of expected forfeitures, is recognized as expense in the statement of operations over the requisite service period. The fair value of options is calculated using the Black-Scholes option pricing model. This option valuation model requires input of assumptions including, among others, the volatility of our stock price, the expected life of the option and the risk-free interest rate. We estimate the volatility of our stock price using historical prices. We estimate the expected life of our option using the average of the vesting period and the contractual term of the option. The estimated forfeiture rate is based on historical forfeiture information as well as subsequent events occurring prior to the issuance of the financial statements. Because our stock options have characteristics significantly different from those of traded options, and because changes in the input assumptions can materially affect the fair value estimate, the existing model may not necessarily provide a reliable single measure of fair value of our stock options.

Derivative Instruments - We generally do not use derivative instruments to hedge exposures to cash-flow or market risks; however, certain warrants to purchase Common Stock that do not meet the requirements for classification as equity are classified as liabilities. In such instances, net-cash settlement is assumed for financial reporting purposes, even when the terms of the underlying contracts do not provide for a net-cash settlement. Such financial instruments are initially recorded at fair value with subsequent changes in fair value charged (credited) to operations in each reporting period. If these instruments subsequently meet the requirements for classification as equity, we reclassify the fair value to equity.

Revenue Recognition - To date, we have generated revenue primarily from licensing agreements, including upfront, nonrefundable license fees, and from amounts reimbursed by licensees for third-party engineering services for product development. We recognize revenue when the following criteria have been met:

· persuasive evidence of an arrangement exists;

· delivery has occurred and risk of loss has passed;

· the price to the buyer is fixed or determinable; and

· collectability is reasonably assured.

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In the past, we have received upfront, nonrefundable payments for the licensing of our intellectual property upon the signing of a license agreement. We believe that these payments generally are not separable from the payments we receive for providing research and development services because the license does not have stand-alone value from the research and development services we provide under these agreements. Accordingly, we account for these elements as one unit of accounting and recognize upfront, nonrefundable payments as revenue on a straight-line basis over its contractual or estimated performance period. Revenue from the reimbursement of research and development efforts is recognized as the services are performed based on proportional performance adjusted from time to time for any delays or acceleration in the development of the product. We estimate the performance period based on the contractual requirements of its collaboration agreements. At each reporting period, we evaluate whether events warrant a change in the estimated performance period.

Other Revenue includes amounts earned and billed under the license and collaboration agreements for reimbursement for research and development costs for contract engineering services. For the services rendered, principally third-party contract engineering services, the revenue recognized approximates the costs associated with the services.

Recently Issued Accounting Pronouncements

In July 2013, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") No. 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists to clarify the balance sheet presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. It was issued to resolve the diversity in practice that had developed in the absence of any on-point U.S. GAAP guidance. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company is currently assessing its adoption plans.

Results of Operations

Comparison of the Years ended December 31, 2013 and 2012

Licensing Revenue - We signed two licensing agreements during fiscal year 2009 (the "2009 Licensing Agreement"), each with a minimum term of ten years, that required non-refundable license payments by the licensees. The non-refundable license payments received in cash totaled $1,250,000 across both transactions. We are recognizing the non-refundable payments as revenue on a straight-line basis over our contractual or estimated performance period. Periodically, we have adjusted our amortization period for revenue recognition for each of our license arrangements to reflect a revision in the estimated timing of regulatory approval. Accordingly, we determined that approximately $28,000 and $5,000 of licensing revenue was recognizable in years ended December 31, 2013 and 2012, respectively. Approximately $76,000 is recognizable over the next 12 months and is shown as current deferred revenue. Approximately $76,000 is recognizable as revenue beyond the 12 month period and is classified as non-current.

Research and Development Expenses - Research and development expenses increased by approximately $2,628,000, or 30%, to approximately $11,299,000 for the year ended December 31, 2013 from approximately $8,671,000 for the year ended December 31, 2012. R&D expenses increased primarily as a result of increased engineering and design expenses incurred with outside contractors and personnel relating to Symphony development.

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R&D expenses for Symphony CGM and Symphony SkinPrep devices amounted to approximately 57% and 58% of total operating expenses during the years ended December 31, 2013 and 2012, respectively. For the year ended December 31, 2013, expenses consisted of primarily development, clinical and manufacturing of approximately $9,226,000, $1,324,000 and $503,000, respectively. For the year ended December 31, 2012, expenses consisted of primarily development, clinical and manufacturing of approximately $8,029,000, $575,000 and $28,000, respectively.

Selling, General and Administrative Expenses - Selling, general and administrative expenses increased by approximately $1,991,000, or 31%, to approximately $8,365,000 for the year ended December 31, 2013 from approximately $6,374,000 for the year ended December 31, 2012. We have experienced increases in personnel costs, legal costs, investor relations, travel and other expenses related to the expansion of the corporate office and staff in Philadelphia.

Selling, general and administrative expenses represented 43% and 42% of total operating expenses during the years ended December 31, 2013 and 2012, respectively. We are not engaged in selling activities and, accordingly, general and administrative expenses relate principally to salaries and benefits for our executive, financial and administrative staff, public company costs, investor relations, legal, accounting, public relations, capital-raising costs and facilities costs. We have also begun prelaunch marketing and manufacturing activities and added related personnel, which accounts for much of the increase period over period to date.

Interest Income - Interest income was approximately $3,000 and $5,000 for the years ended December 31, 2013 and 2012, respectively.

Interest Expense - Interest expense was approximately $3,900,000 and $505,000 for the years ended December 31, 2013 and 2012, respectively. The 2013 interest consists of $968,000 in amortization through December 31, 2013 on deferred financing costs from the $4,840,000 fair value of the Montaur credit facility commitment warrant issued pursuant to the loan agreement. An additional $2,879,000 is the accretion through December 31, 2013 of the $3,000,000 debt discount recorded for the three warrants issued for each of the draws under the Montaur credit facility. The remaining $53,000 of interest expense relates to the accrued and paid interest on the $3,000,000 note outstanding until March 2013 at a rate of 10% per annum, compounded monthly.

The 2012 interest consists of $323,000 in amortization through December 31, 2012 on deferred financing costs from the $4,840,000 fair value of the Montaur credit facility commitment warrant issued pursuant to the loan agreement. An additional $121,000 is the accretion through December 31, 2012 of the $3,000,000 debt discount recorded for the three warrants issued for each of the draws under the Montaur credit facility. The remaining $61,000 of interest expense relates to the accrued interest on the $3,000,000 note outstanding at a rate of 10% per annum, compounded monthly.

Gain (Loss) on Revaluation of Derivative Warrant Liability - Changes in the fair value of the derivative financial instruments are recognized in the Consolidated Statement of Operations as a derivative gain or loss. The primary underlying risk exposure pertaining to the warrants is the change in fair value of the underlying Common Stock. The gain on revaluation of the derivative warrant liability for the year ended December 31, 2013 was approximately $4,466,000. The gain on revaluation of the derivative warrant liability for the year ended December 31, 2012 was approximately $3,684,000.

Net Loss - As a result of the factors described above, we had a net loss of approximately $19,067,000 for the year ended December 31, 2013 compared to approximately $12,332,000 for the year ended December 31, 2012.

Cost Reduction Initiatives - During the quarter ended September 30, 2013, we implemented a number of substantial cost reduction measures in ways that we believe will not diminish our ability to execute on our short-term objectives as part of a restructuring plan approved by our independent directors on September 30, 2013. This is being achieved through cost-cutting initiatives aimed at reducing future operating costs, particularly marketing and manufacturing expenditures and corporate general and administrative costs. While improving operating efficiency and containing costs are on-going priorities, we targeted cost reductions across all aspects of our operations in both external spend and head count. On September 30, 2013, we implemented a staff reduction of approximately 33% of our workforce. As a result of these initiatives, our cash usage for the quarter ended December 31, 2013 decreased by approximately 39% from the average quarterly cash usage experienced during the first three quarters of 2013.

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Comparison of the Years ended December 31, 2012 and 2011

Licensing Revenue - During 2012 and 2011, we adjusted our amortization period for revenue recognition for each of the 2009 Licensing Agreements to reflect a revision in the estimated timing of regulatory approval (or clearance). Accordingly, we determined that approximately $5,000 and $302,000 of licensing revenue was recognizable in years ended December 31, 2012 and 2011, respectively. Approximately $90,000 was estimated to be recognizable over the next 12 months and was shown as current deferred revenue. Approximately $90,000 was estimated to be recognizable as revenue beyond the 12 month period and was classified as non-current at year ended December 31, 2012.

Other Revenue - We retain contract engineering and development services in connection with our product development for one of our licensees and such costs are reimbursed by that licensee and recorded as other revenue. We did not have any such other revenue during the year ended December 31, 2012. We recognized approximately $145,000 related to these contract engineering services during the year ended December 31, 2011. The costs from the contract engineering services are included in research and development expenses on the Statements of Operations. There was no markup on the contract engineering services recorded as other revenue.

Research and Development Expenses - Research and development expenses increased by approximately $4,875,000, or 128%, to approximately $8,671,000 for the year ended December 31, 2012 from approximately $3,796,000 for the year ended December 31, 2011. R&D expenses increased primarily as a result of increased engineering and design expenses incurred with outside contractors and personnel relating to Symphony.

R&D expenses for Symphony amounted to approximately 58% and 44% of total operating expenses during the years ended December 31, 2012 and 2011, respectively. For the year ended December 31, 2012, expenses consisted of primarily development, clinical and manufacturing of approximately $8,029,000, $575,000 and $28,000, respectively. For the year ended December 31, 2011, expenses consisted of primarily development, clinical and manufacturing of approximately $3,298,000, $367,000 and $26,000, respectively.

Selling, General and Administrative Expenses - Selling, general and administrative expenses increased by approximately $1,468,000, or 30%, to approximately $6,374,000 for the year ended December 31, 2012 from approximately $4,906,000 for the year ended December 31, 2011. We have experienced increases in personnel costs, legal costs, investor relations, travel and other expenses related to the expansion of the corporate office and staff in Philadelphia.

Selling, general and administrative expenses represented 42% and 56% of total operating expenses during the years ended December 31, 2012 and 2011, respectively. We are not engaged in selling activities and, accordingly, general and administrative expenses relate principally to salaries and benefits for our executive, financial and administrative staff, public company costs, investor relations, legal, accounting, public relations, capital-raising costs and facilities costs.

Interest Income - Interest income was approximately $5,000 for each of the years ended December 31, 2012 and 2011.

Interest Expense - Interest expense was approximately $505,000 and $14,000 for the years ended December 31, 2012 and 2011, respectively. The increase in interest expense in 2012 is due to activities related to our credit facility with Montaur. The $505,000 in interest consists of $323,000 in amortization through December 31, 2012 on deferred financing costs from the $4,840,000 fair value of the Montaur credit facility commitment warrant issued pursuant to the loan agreement. An additional $121,000 is the accretion through December 31, 2012 of the $3,000,000 debt discount recorded for the three warrants issued for each of the draws under the Montaur credit facility. The remaining $61,000 relates to the accrued interest on the $3,000,000 note outstanding at a rate of 10% per annum, compounded monthly. The interest expense for the year ended December 31, 2011 consists mainly of $12,000 in non-cash interest expense relating to short-term promissory notes then outstanding.

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Debt Financing Costs - We have incurred debt financing costs as a result of our credit facility with Montaur. On September 14, 2012, the Company submitted a draw request to Montaur in the amount of $3,000,000 in the form required by the loan agreement (the "September Request"). The Company received this $3,000,000 in fundings by mid-November 2012. In accordance with the loan agreement and as a result of funding received from Montaur, the Company issued to Montaur three warrants concurrent with each of the three funding dates. The fair value of warrants issued was determined to be approximately $3,455,000 at issuance. Of this amount, $3,000,000 was treated as a debt discount and is being accreted to interest expense over the term of the note issued pursuant to the loan agreement. The excess of the fair value of the warrants over the amount drawn under the note payable of approximately $455,000 was expensed at issuance and recorded as debt financing costs in the Consolidated Statement of Operations for the year ended December 31, 2012. No such costs were recorded in 2011.

Gain (Loss) on Revaluation of Derivative Warrant Liability - Changes in the fair value of derivative financial instruments are recognized in the Consolidated Statement of Operations as a derivative gain or loss. The primary underlying risk exposure pertaining to the warrants is the change in fair value of the . . .

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