WINDTREE THERAPEUTICS INC /DE/ - Quarter Report: 2017 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2017

or

For the transition period from to

Commission file number 000-26422

Windtree Therapeutics, Inc.

 (Exact name of registrant as specified in its charter)

(215) 488-9300

(Registrant’s telephone number, including area code)

__________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES ☒    NO ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ☒    NO ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES ☐    NO ☒

As of August 15, 2017, there were outstanding 13,994,960 shares of the registrant’s common stock, par value $0.001 per share. 

Table of Contents

PART I - FINANCIAL INFORMATION

Unless the context otherwise requires, all references to “we,” “us,” “our,” and the “Company” include Windtree Therapeutics, Inc., and its wholly owned, presently inactive subsidiary, Discovery Laboratories, Inc.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The forward-looking statements provide our current expectations or forecasts of future events and financial performance and may be identified by the use of forward-looking terminology, including such terms as “believes,” “estimates,” “anticipates,” “expects,” “plans,” “intends,” “may,” “will” or “should” or, in each case, their negative, or other variations or comparable terminology, though the absence of these words does not necessarily mean that a statement is not forward-looking.  Forward-looking statements include all matters that are not historical facts and include, without limitation, statements concerning: our business strategy, outlook, objectives, future milestones, plans, intentions, goals, and future financial condition, including the period of time during which our existing resources will enable us to fund our operations and continue as a going concern. Forward-looking statements also include our financial, clinical, manufacturing and distribution plans, and our expectations related to our development and potential regulatory plans to secure marketing authorization for AEROSURF®, if approved, and other potential future products that we may develop; our expectations, timing and anticipated outcomes of submitting regulatory filings for our products under development; our research and development programs, including planning for development activities, anticipated timing of clinical trials and potential development milestones, for our KL4 surfactant product candidates, our aerosol delivery system (ADS) based on our proprietary aerosol technology for delivery of aerosolized medications; plans for the manufacture of drug products, active pharmaceutical ingredients (APIs), materials and medical devices; plans regarding potential strategic alliances and collaborative arrangements to develop, manufacture and market our products, and other potential strategic transactions.

We intend that all forward-looking statements be subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to many risks and uncertainties that could cause actual results to differ materially from any future results expressed or implied by the forward-looking statements. We caution you therefore against relying on any of these forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance. Examples of the risks and uncertainties include, but are not limited to:

Risks Related to Capital Resource Requirements

Risks related to Development Activities

Risks Related to Strategic and Other Transactions

Risks related to Manufacturing

Other Risks Affecting our Business

Pharmaceutical, biotechnology and medical technology companies have suffered significant setbacks conducting clinical trials, even after obtaining promising earlier preclinical and clinical data. Moreover, data obtained from clinical trials are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. After gaining approval of a drug product, pharmaceutical and biotechnology companies face considerable challenges in marketing and distributing their products, and may never become profitable.

The forward-looking statements contained in this report or the documents incorporated by reference herein speak only as of their respective dates. Factors or events that could cause our actual results to differ may emerge from time to time and it is not possible for us to predict them all. Except to the extent required by applicable laws, rules or regulations, we do not undertake any obligation to publicly update any forward-looking statements or to publicly announce revisions to any of the forward-looking statements, whether as a result of new information, future events or otherwise.

Trademark Notice

AEROSURF®, SURFAXIN®, SURFAXIN LS™, WINDTREE THERAPEUTICS™, and WINDTREE™ are registered and common law trademarks of Windtree Therapeutics, Inc. (Warrington, PA).

PART I - FINANCIAL INFORMATION

ITEM 1.      Financial Statements

WINDTREE THERAPEUTICS, INC. AND SUBSIDIARY

Condensed Consolidated Balance Sheets

(in thousands, except share data)

WINDTREE THERAPEUTICS, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Operations

(Unaudited)

(in thousands, except per share data)

WINDTREE THERAPEUTICS, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

Notes to Condensed Consolidated Financial Statements (unaudited)

Windtree Therapeutics, Inc. (referred to as “we,” “us,” or the “Company”) is a biotechnology company focused on developing novel KL4 surfactant therapies for respiratory diseases and other potential applications. Surfactants are produced naturally in the lung and are essential for normal respiratory function and survival. Our proprietary technology platform includes a synthetic, peptide-containing surfactant (KL4 surfactant) that is structurally similar to endogenous pulmonary surfactant, and novel drug delivery technologies being developed to enable noninvasive administration of aerosolized KL4 surfactant. We believe that our proprietary technology platform may make it possible to develop a pipeline of surfactant products to address a variety of respiratory diseases for which there are few or no approved therapies.

Our lead development program is AEROSURF® (lucinactant for inhalation), an investigational combination drug/device product that combines our KL4 surfactant with our novel aerosol delivery system (ADS). We are developing AEROSURF to improve the management of respiratory distress syndrome (RDS) in premature infants. RDS is a serious respiratory condition caused by a deficiency of natural lung surfactant in lungs of premature infants, and the most prevalent respiratory disease in the neonatal intensive care unit. By enabling administration of aerosolized KL4 surfactant, AEROSURF may reduce or eliminate the need for invasive endotracheal intubation and mechanical ventilation, which currently are required to administer life-saving surfactant therapy, but which are associated with serious respiratory conditions and other complications. To avoid the risks of surfactant administration, many neonatologists initially delay surfactant therapy and treat premature infants with noninvasive respiratory support (such as nasal continuous positive airway pressure (nCPAP)). We believe that AEROSURF, if approved, has the potential to address a serious unmet medical need by enabling earlier KL4 surfactant therapy for infants receiving nCPAP alone, reducing the number of premature infants who are subjected to invasive surfactant administration, and potentially providing transformative clinical and pharmacoeconomic benefits.

We recently completed an AEROSURF phase 2b clinical trial that was designed to evaluate aerosolized KL4 surfactant administered to premature infants 28 to 32 week gestational age receiving nCPAP, in two dose groups (25 and 50 minutes) with up to two potential repeat doses, compared to infants receiving nCPAP alone. This trial was conducted in approximately 50 clinical sites in the U.S., Canada, the European Union and Latin America.  Based on the planned top-line results, data show that AEROSURF did not meet the primary endpoint of a reduction in nCPAP failure at 72 hours, which we believe was due in large part to an unexpected rate of treatment interruptions.  Such interruptions occurred in about 24% of active enrollments, predominantly in the 50 minute dose group, and were primarily related to specific lots of disposable cartridge filters in our proprietary ADS that had a tendency to clog.  After excluding the patients whose dose was interrupted in the 50 minute dose group, the data show an nCPAP failure rate of 32% compared to 44% in the control group which is a 12% absolute reduction or a 27% relative reduction in nCPAP failure compared to control. These data suggest a meaningful treatment effect in line with our targeted outcome.

In addition, in June 2017, we and Lee’s Pharmaceutical (HK), Ltd. (Lee’s) announced an exclusive license and collaboration agreement (License Agreement) for the development and commercialization of KL4 surfactant products in China, Hong Kong and other select Asian markets, with a future option to potentially add Japan. The agreement includes AEROSURF as well as the non-aerosol products, SURFAXIN® (approved in the U.S. in 2012) and SURFAXIN LS™ (an improved lyophilized formulation of SURFAXIN).  We also granted Lee’s an exclusive license to manufacture KL4 surfactant in China for use in non-aerosol surfactant products in the licensed territory and a future option to manufacture the device in the licensed territory.  In connection with the Loan Agreement (see, “– Note 2 – Liquidity Risks and Management's Plans”), we amended the License Agreement to expand certain of Lee’s rights, including by immediately adding Japan to the licensed territory, accelerating the right to manufacture the ADS in and for the licensed territory, reducing or eliminating certain of the milestone and royalty payments and adding an affiliate of Lee’s as a party to the License Agreement.  We are presently engaged in a technology transfer of our KL4 surfactant manufacturing process to Lee’s.  

As of June 30, 2017, we had cash and cash equivalents of $2.5 million, current liabilities of $25.4 million (including $12.5 million of long-term debt, current portion) and $12.5 million of long-term debt, non-current portion.  Total long-term debt of $25 million is with affiliates of Deerfield Management, L.P. (Deerfield), who hold a security interest in substantially all of our assets (Deerfield Loan). 

We expect to continue to incur significant losses and require significant additional capital to further advance our AEROSURF clinical development program, support our operations and meet our debt service obligations for the next several years, and we do not have sufficient existing cash and cash equivalents for at least the next year following the date that these financial statements are issued. These conditions raise substantial doubt about our ability to continue as a going concern within one year after the date that these financial statements are issued.

To potentially alleviate the conditions that raise substantial doubt about our ability to continue as a going concern, management plans to seek additional capital through the following: (i) all or a combination of strategic transactions, and other potential alliances and collaborations focused on markets outside the U.S., as well as potential combinations (including by merger or acquisition) or other corporate transactions; and (ii) through public or private equity offerings. However, there can be no assurance that these alternatives will be available, or if available, that we will be able to raise sufficient capital through such transactions. If we are unable to raise the required capital, we will not have sufficient cash resources and liquidity to fund our business operations for at least the next year following the date that these financial statements are issued. Accordingly, management has concluded that substantial doubt exists with respect to our ability to continue as a going concern through one year after the issuance of these financial statements.

In connection with the License Agreement with Lee’s that we announced in June 2017 (see, “– Note 1 – The Company and Description of Business”), we received an upfront license fee of $1.0 million in July 2017 and also are eligible to receive up to $35.8 million in contingent clinical, regulatory and commercialization milestone payments, and royalties at an escalating high single digit to mid-teens percentage across all products.  In addition, Lee’s will be responsible for all development costs in the licensed territory.  In addition to the License Agreement, Lee’s also invested $2 million in our February 2017 private placement offering.

Under a Loan Agreement dated as of August 14, 2017, Lee’s agreed to lend us up to a potential $3.9 million (Lee’s Loan) that will be funded in Lee’s sole discretion in three equal installments on August 15, September 10 and October 10, 2017, and will be used to support our AEROSURF development activities and sustain our operations through October 31, 2017, while we negotiate a potential share purchase agreement (Share Purchase) and related agreements.  The Lee’s Loan will accrue interest at a rate of 12% per annum.  We received the initial installment of $1.3 million from Lee's on August 15, 2017.  Under the Share Purchase as currently contemplated, but subject to further negotiation, Lee’s would invest $10 million and acquire a controlling interest in our Company.  The outstanding principal balance of the Lee’s Loan would be applied to the Share Purchase and the Lee’s Loan would be discharged in full at the closing.  In addition, to facilitate the Share Purchase, we are negotiating with Deerfield to restructure the Deerfield Loan (Loan Restructuring), effective as of the closing of the Share Purchase.  Under the Loan Restructuring as currently contemplated, but subject to further negotiation, the notes issued in connection with the Deerfield Loan would be retired in exchange for (i) $2.5 million of cash paid out of the proceeds of the Share Purchase, (ii) a number of newly-issued shares of our common stock equal to 2% of our outstanding common stock on a fully-diluted basis (to be defined) as of the closing date, and (iii) future regulatory and commercial milestones related to the development and commercialization of AEROSURF potentially totaling $15 million. (See, “– Note 9 – Subsequent Events”).

While we believe that we will be able to reach agreement with Lee’s and Deerfield and close the Share Purchase and Loan Restructuring, there can be no assurance that we will be successful.  At this time, we do not have an alternative source of funding available, such that, if we are unable to complete these transactions for any reason on or before October 31, 2017, we may be forced to curtail all of our activities and, ultimately, cease operations.  In addition, if we are unable to finalize and close the Loan Restructuring and thereafter fail to make any required payment under the Deerfield Loan, or fail to comply with any commitments contained in the Deerfield Loan documents, Deerfield would be able to declare a default under the Deerfield Loan agreement, accelerate our payment obligations under all or a portion of our indebtedness, and, since we have pledged substantially all of our assets to secure the Deerfield Loan, foreclose on our assets, which could significantly diminish the market value and marketability of our assets and common stock and render us unable to continue as a going concern. Moreover, even if we are successful in completing these transactions, we will continue to require significant additional capital to support our research and development activities going forward, including the AEROSURF development program, and our operations.

As of August 15, 2017, after receipt of the initial advance under the Lee's Loan, we had cash and cash equivalents of $2.9 million and believe that, assuming receipt of the two additional installments under the Lee's Loan, and before any additional financings, we will have sufficient cash resources to fund our operations through November 2017. 

These financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business, and do not include any adjustments relating to recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.

Our ability to secure the needed capital through equity financings and other similar transactions is subject to regulatory and other constraints discussed in this Quarterly Report on Form 10-Q and we cannot be certain that we will be able to raise a sufficient amount when needed, if at all, on favorable terms or otherwise. In the event that we cannot raise sufficient capital, we may be forced to consider transactions on less-than-favorable terms, or limit or cease our development activities. If we are unable to raise the required capital, we may be forced to curtail all of our activities and, ultimately, cease operations. Even if we are able to raise sufficient capital, such financings may only be available on unattractive terms, or result in significant dilution of stockholders’ interests and, in such event, the market price of our common stock may decline.

In addition, our ability to secure additional capital at a time when we would like or require may be affected by the following factors: (i)  our common stock is currently trading on the OTCQB® Market (OTCQB), which is operated by OTC Markets Group Inc., under the symbol “WINT” and may experience periods of illiquidity; (ii) our common stock is currently considered a “penny stock,” such that brokers are required to adhere to more stringent market rules, which could result in reduced trading activity and trading levels in our common stock and limited or no analyst coverage; (iii) we are no longer eligible to use a Form S-3 registration statement; (iv) we are no longer able to use our ATM Program; (v)  our stockholders may not approve proposals to increase the number of shares of common stock authorized under our Amended and Restated Certificate of Incorporation, as amended, which could impair our ability to conduct equity financings or enter into certain strategic transactions; (vi) our stockholders may not approve, to the extent required under Delaware law, strategic transactions (mergers and acquisitions) recommended by our Board; (vii) our capital structure, which currently consists of common stock, convertible preferred stock, pre-funded warrants and warrants to purchase common stock, and $25 million of debt, may make it difficult to conduct equity-based financings; and (viii) negative conditions in the broader financial and geopolitical markets.  In light of the foregoing restrictions, we will be required to seek other methods of completing primary offerings, including, for example, under a registration statement on Form S-1, the preparation and maintenance of which would be more time-consuming and costly, and private placements, potentially with registration rights or priced at a discount to the market value of our stock, or other transactions, any of which could result in substantial equity dilution of stockholders’ interests.

We have from time to time collaborated with research organizations and universities to assess the potential utility of our KL4 surfactant in studies funded in part through non-dilutive grants issued by U.S. Government-sponsored drug development programs, including grants in support of initiatives related to our AEROSURF clinical development program. In late May 2017, we announced that we have been awarded $0.9 million under a previously announced Phase II Small Business Innovation Research Grant (SBIR) valued at up to $2.6 million from the National Heart, Lung, and Blood Institute (NHLBI) of the National Institutes of Health (NIH) to support the AEROSURF phase 2b clinical trial.  We also have received from time to time grants that support medical and biodefense-related initiatives under programs that encourage private sector development of medical countermeasures against chemical, biological, radiological and nuclear terrorism threat agents, and pandemic influenza, and provide a mechanism for federal acquisition of such countermeasures. Although there can be no assurance, we expect to pursue potential additional funding opportunities as they arise and expect that we may qualify for similar programs in the future.

As of June 30, 2017, we had outstanding 2.9 million pre-funded warrants issued in a July 2015 public offering, of which the entire exercise price was prepaid upon issuance, and 6,213 convertible preferred shares issued in the February 2017 private placement offering.  Each preferred share is convertible into 1,000 shares of common stock. Upon exercise of the pre-funded warrants and conversion of the convertible preferred shares, we would issue common shares to the holders and receive no additional proceeds.  

As of August 15, 2017, 2.5 million pre-funded warrants and 3,203 convertible preferred shares, convertible into 3.2 million shares of common stock, remained outstanding.

In addition, as of June 30, 2017, there were 120 million shares of common stock and 5 million shares of preferred stock authorized under our Amended and Restated Certificate of Incorporation, as amended, and approximately 85.7 million shares of common stock and approximately 5 million shares of preferred stock available for issuance and not otherwise reserved.  

These interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (U.S. GAAP) for interim financial information in accordance with the instructions to Form 10-Q.  Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated 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 six months ended June 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. There have been no changes to our critical accounting policies since December 31, 2016. For a discussion of our accounting policies, see, “Note 4 – Accounting Policies and Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements in our 2016 Form 10-K.  Readers are encouraged to review those disclosures in conjunction with this Quarterly Report on Form 10-Q.

February 2017 Private Placement

On February 15, 2017, we completed a private placement offering of 7,049 Series A Convertible Preferred Stock units at a price per unit of $1,495, for an aggregate purchase price of approximately $10.5 million, including $1.6 million of non-cash consideration representing a reduction in amounts due and accrued as of December 31, 2016 for current development services that otherwise would have become payable in cash in the first and second quarters of 2017. Each unit consists of: (i) one share of Series A Convertible Preferred Stock, par value $0.001 per share (Preferred Shares); and (ii) 1,000 Series A-1 Warrants (Warrants) to purchase one share of common stock at an exercise price equal to $1.37 per share. Each Preferred Share may be converted at the holder's option at any time into 1,000 shares of common stock at a conversion price of $1.37 per share. The Warrants may be exercised beginning August 15, 2017 and through February 15, 2024. The Preferred Shares and the Warrants may not be converted or exercised to the extent that the holder would, following such exercise or conversion, beneficially own more than 9.99% (or other lesser percent as designated by each holder) of our outstanding shares of common stock. In addition to the offering, the securities purchase agreement also provides that, until February 13, 2018, the investors are entitled to participate in subsequent bona fide capital raising transactions that we may conduct. 

As of August 15, 2017, 3,846 Preferred Shares have been converted into 3,846,000 shares of common stock and 3,203 Preferred Shares remain outstanding.

At-the-Market (ATM) Program

During the three and six months ended June 30, 2017, we completed offerings of our common stock under our ATM Program of 41,231 shares and 847,147 shares, respectively. This resulted in an aggregate purchase price of approximately $48,000 ($46,000 net) and $1,082,000 ($1,036,000 net), respectively, for the three and six month periods ended June 30, 2017.  During the three months ended June 30, 2016, there were no offerings under our ATM Program.  During the six months ended June 30, 2016, we completed offerings of our common stock under our ATM Program of 27,971 shares for an aggregate purchase price of approximately $71,000 ($69,000 net).

Effective May 5, 2017, we were no longer able to make use of our ATM Program (see, “–Note 2 – Liquidity Risks and Management’s Plans”).

Use of Estimates

The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Severance

Effective February 1, 2016, we terminated the Employment Agreement between ourselves and our then-President and Chief Executive Officer (Former CEO). During the first quarter of 2016, we incurred a severance charge of $1.2 million in general and administrative expense under the terms of the Former CEO’s employment agreement, including $0.2 million related to stock option expense for certain options that will continue to vest through August 1, 2017. Of the $1.0 million in severance not related to stock-based compensation, $0.9 million was paid as of June 30, 2017. 

During the second quarter of 2016, we incurred a severance charge of $0.4 million related to a May 2016 workforce reduction that was a component of a broader effort to initiate cash conservation and other cost reduction measures.

Research and Development Expense

We account for research and development expense by the following categories: (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.

Net Loss per Common Share

Basic net loss per 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.

As of June 30, 2017 and 2016, the number of shares of common stock potentially issuable upon the conversion of preferred stock or exercise of stock options and warrants was 23.4 million and 9.1 million shares, respectively. For the three and six months ended June 30, 2017 and 2016, all potentially dilutive securities were anti-dilutive and therefore have been excluded from the computation of diluted net loss per share.

In accordance with Accounting Standards Codification Topic 260, Earnings per Share, when calculating diluted net loss per common share, a gain associated with the decrease in the fair value of warrants classified as derivative liabilities results in an adjustment to the net loss; and the dilutive impact of the assumed exercise of these 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 warrants classified as derivative liabilities. For the three and six months ended June 30, 2017 and 2016, the effect of the adjustments for warrants classified as derivative liabilities was anti-dilutive.

We do not have any components of other comprehensive income (loss).

Beneficial Conversion Feature

The issuance of our Preferred Shares in the first quarter of 2017 (see, “– Note 4 – Stockholders’ Equity”) resulted in a beneficial conversion feature, which arises when a debt or equity security is issued with an embedded conversion option that is beneficial to the investor (or in the money) at inception due to the conversion option having an effective conversion price that is less than the fair value of the underlying stock at the commitment date. We recognized the beneficial conversion feature by allocating the relative fair value of the conversion option, which is the number of shares of common stock available upon conversion multiplied by the difference between the effective conversion price per share and the fair value of common stock per share on the commitment date, to additional paid-in capital, resulting in a discount on the Preferred Shares. As the Preferred Shares are immediately convertible by the holders, the discount allocated to the beneficial conversion feature was immediately accreted and recognized as a $3.6 million one-time, non-cash deemed dividend to the preferred shareholders during the first quarter of 2017.

An additional discount to the Preferred Shares of $4.5 million was created due to the allocation of proceeds to the Warrants which were issued with the Preferred Shares.  This discount is amortized proportionately as the Preferred Shares are converted.  For the three months ended June 30, 2017, we recognized a non-cash deemed dividend to the preferred shareholders of $0.5 million related to the Preferred Shares converted during the period. 

Recently Adopted Accounting Standards

In August 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which defines management's responsibility to evaluate whether there is substantial doubt about an organization's ability to continue as a going concern and to provide related footnote disclosures. Substantial doubt about an entity's ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued (or are available to be issued). We adopted ASU 2014-15 effective December 31, 2016. Management has concluded that substantial doubt exists with respect to our ability to continue as a going concern through one year after the issuance of these financial statements (see, “ – Note 2 – Liquidity Risks and Management's Plans”).

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This update addresses the income tax effects of stock-based payments and eliminates the windfall pool concept, as all of the tax effects related to stock-based payments will now be recorded at settlement (or expiration) through the income statement. The new guidance also permits entities to make an accounting policy election for the impact of forfeitures on the recognition of expense for stock-based payment awards. Forfeitures can be estimated or recognized when they occur. We adopted ASU 2016-09 during the three months ended March 31, 2017 and will continue to recognize stock compensation expense with estimated forfeitures. The adoption did not have a material impact on our unaudited condensed consolidated financial statements and is not expected to have an impact on the annual 2017 financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The new standard requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Entities will also be required to reconcile such total to amounts on the balance sheet and disclose the nature of the restrictions. We adopted ASU 2016-18 on March 31, 2017 on a retrospective basis. As a result, beginning-of-period cash, cash equivalents and restricted cash in the statement of cash flows increased by $0.2 million for each of the six-month periods ended June 30, 2017 and 2016.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entity to recognize revenue at an amount that reflects the consideration to which the entity expects to be entitled in exchange for transferring goods or services to customers.  The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective.  The new standard is effective for the annual period ending December 31, 2018 and interim periods within that annual period.  An entity can elect to apply the guidance under one of the following two methods: (i) retrospectively to each prior reporting period presented, referred to as the full retrospective method or (ii) retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application in retained earnings, referred to as the modified retrospective method.  The Company has not yet completed its final review of the impact of this guidance including the new disclosure requirements, as it is continuing to evaluate the impacts of adoption and the implementation approach to be used. The Company plans to adopt the new standard effective January 1, 2018. The Company continues to monitor additional changes, modifications, clarifications or interpretations being undertaken by the FASB, which may impact its current conclusions. 

In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting. This ASU clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The ASU is effective prospectively for the annual period ending December 31, 2018 and interim periods within that annual period. Early adoption is permitted. We are currently evaluating the effect that ASU 2017-09 may have on our consolidated financial statements and related disclosures.

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:

Fair Value on a Recurring Basis

The tables below categorize assets and liabilities measured at fair value on a recurring basis for the periods presented:

The following table summarizes changes in the fair value of common stock warrant liability measured on a recurring basis using Level 3 inputs for the six months ended June 30, 2016 representing the write-off of the remaining liability upon expiration of the underlying warrants in February 2016.

 Fair Value of Long-Term Debt

At June 30, 2017, the estimated fair value of the Deerfield Loan (see, “– Note 7 – Long-term Debt”) was $22.4 million, compared to a carrying value for current and non-current portions of $25.0 million. The estimated fair value of the Deerfield Loan is based on discounting the future contractual cash flows to the present value at the valuation date. This analysis utilizes certain Level 3 unobservable inputs, including 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 that could be realized 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.  The methodology and assumptions do not take into consideration the potential restructuring of the Deerfield Loan (see, “– Note 9 – Subsequent Events”).

Long-term debt consists solely of amounts due under the Deerfield Loan for the periods presented:

The principal amount of the loan is payable in two equal annual installments of $12.5 million, payable in each of February 2018 and 2019. See, “Note 9 – Long-term Debt” in the Notes to Consolidated Financial Statements in our 2016 Form 10-K.

The following amounts comprise the Deerfield Loan interest expense for the periods presented:

Amortization of prepaid interest expense represents non-cash amortization of $5 million of units purchased by Deerfield in our July 2015 public offering and accepted in satisfaction of $5 million of future interest payments calculated at an interest rate of 8.75% under the Deerfield Loan. Cash interest expense represents interest at an annual rate of 8.25% on the outstanding principal amount, paid in cash on a quarterly basis.

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

A summary of activity under our long-term incentive plans is presented below:

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing formula based on the following weighted average assumptions:

The table below summarizes the total stock-based compensation expense included in the statements of operations for the periods presented:

On July 13, 2017, we implemented a reduction in workforce by 20 employees, representing approximately 42% of our total workforce, from 48 to 28 employees. The reduction was across all functions of the Company. Affected employees are eligible for certain severance and other benefits. In addition, the Company expects to record a one-time charge of approximately $0.2 million in the third quarter of 2017.

Effective as of August 14, 2017, we entered into a loan agreement with Lee’s, pursuant to which Lee’s has agreed to lend us up to a potential $3.9 million that will be funded in Lee’s sole discretion in three equal installments on August 15, September 10 and October 10, 2017, and will be used to support our AEROSURF development activities and sustain our operations through October 31, 2017, while we negotiate the potential Share Purchase and related agreements.  The Lee's Loan will accrue interest at a rate of 12% per annum.  We received the initial installment of $1.3 million from Lee's on August 15, 2017.  Under the Share Purchase as currently contemplated, but subject to further negotiation, Lee’s would invest $10 million in our Company and acquire a controlling interest of a majority of the outstanding shares of our common stock at a price per share based on the average 10-day volume-weighted average price per share (VWAP) up to and including the closing date, plus a premium up to, but not exceeding 15%, but in no event greater than $0.25 per share.  As partial consideration for the Share Purchase, the outstanding principal balance of the Lee's Loan would be applied in full satisfaction of a like amount of cash consideration payable by Lee’s at the closing of such Share Purchase, and the Lee's Loan would be discharged in full. In connection with the Lee's Loan, Deerfield, which holds a security interest in substantially all of our assets to secure its $25 million Deerfield Loan, entered into a Subordination Agreement, dated as of August 14, 2017, with us and Lee’s generally granting Lee’s a first right through October 31, 2017, to any cash payments (other than regularly scheduled interest payments under the Deerfield Loan) and to the proceeds of sales of assets in a bankruptcy proceeding for up to $3.9 million principal amount plus related interest and expenses, subject to the exceptions set forth in the Subordination Agreement.

As partial consideration for the Lee's Loan, we and Lee’s also entered into Amendment No. 1 to the License Agreement (Amendment) pursuant to which reductions have been made to certain of the milestone and royalty payments.  As a result, we may receive up to $35.8 million (previously, $37.5 million) in potential clinical, regulatory and commercial milestone payments.  The options to add Japan to the Licensed Territory (as defined in the License Agreement) and to manufacture our aerosol delivery device in and for the Licensed Territory have been made effective immediately.  In addition, Zhaoke Pharmaceutical (Hefei) Co. Ltd., an affiliate of Lee’s, has been made a party to the License Agreement. Except as set forth in the Amendment, all other terms and conditions of the License Agreement shall remain in full force and effect.

In addition, to facilitate the Share Purchase, we are negotiating with Deerfield to restructure the Deerfield Loan (Loan Restructuring), effective as of the closing of the Share Purchase.  Under the Loan Restructuring as currently contemplated, but subject to further negotiation, the notes issued in connection with the Deerfield Loan would be retired in exchange for (i) $2.5 million of cash, which would be paid out of the proceeds of the Share Purchase, and (ii) a number of newly-issued shares of our common stock that equals 2% of our outstanding common stock on a fully-diluted basis (to be defined) as of the closing of the Share Purchase and Loan Restructuring.  In addition, Deerfield would be entitled to receive future regulatory and commercial milestones related to the development and commercialization of AEROSURF potentially totaling $15 million.

The Share Purchase and Loan Restructuring agreements are expected to include such customary representations, warranties, covenants, conditions and indemnities for certain losses and other terms as are acceptable to the parties. While we believe that we will be able to reach agreement with Lee’s and Deerfield and close the Share Purchase and Loan Restructuring agreements in a timely manner, there can be no assurance that we will be successful.

Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations

Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans and strategy for our business and related financing activities, includes forward-looking statements that involve risks and uncertainties. The reader should review the “Forward-Looking Statements” section, and risk factors discussed elsewhere in this Quarterly Report on Form 10-Q, which are in addition to and supplement the risk factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2016 that we filed with the Securities and Exchange Commission (SEC) on March 31, 2017 (2016 Form 10-K,) and our other filings with the SEC, and any amendments thereto, for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis or elsewhere in this Quarterly Report on Form 10-Q. The disclosure in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) of this Quarterly Report on Form 10-Q includes information on preclinical studies supported in part from funds from the National Institutes of Health (NIH). Such information is solely our responsibility and does not necessarily represent the official views of the NIH.

This MD&A is provided as a supplement to the accompanying unaudited condensed consolidated financial statements and footnotes to help provide an understanding of our financial condition, the changes in our financial condition and our results of operations. This item should be read in connection with our accompanying interim unaudited Condensed Consolidated Financial Statements (including the notes thereto). Unless otherwise specified, references to Notes in this MD&A shall refer to the Notes to Condensed Consolidated Financial Statements (unaudited) in this Quarterly Report on Form 10-Q.

OVERVIEW

Windtree Therapeutics, Inc. (referred to as “we,” “us,” or the “Company”) is a biotechnology company focused on developing novel KL4 surfactant therapies for respiratory diseases and other potential applications. Surfactants are produced naturally in the lung and are essential for normal respiratory function and survival. Our proprietary technology platform includes a synthetic, peptide-containing surfactant (KL4 surfactant) that is structurally similar to endogenous pulmonary surfactant, and novel drug delivery technologies being developed to enable noninvasive administration of aerosolized KL4 surfactant. We believe that our proprietary technology platform may make it possible to develop a pipeline of surfactant products to address a variety of respiratory diseases for which there are few or no approved therapies.

Our lead development program is AEROSURF® (lucinactant for inhalation), an investigational combination drug/device product that combines our KL4 surfactant with our novel aerosol delivery system (ADS). We are developing AEROSURF to improve the management of respiratory distress syndrome (RDS) in premature infants. RDS is a serious respiratory condition caused by a deficiency of natural lung surfactant in lungs of premature infants, and the most prevalent respiratory disease in the neonatal intensive care unit. By enabling administration of aerosolized KL4 surfactant, AEROSURF may reduce or eliminate the need for invasive endotracheal intubation and mechanical ventilation, which currently are required to administer life-saving surfactant therapy, but which are associated with serious respiratory conditions and other complications. To avoid the risks of surfactant administration, many neonatologists initially delay surfactant therapy and treat premature infants with noninvasive respiratory support (such as nasal continuous positive airway pressure (nCPAP)). We believe that AEROSURF, if approved, has the potential to address a serious unmet medical need by enabling earlier KL4 surfactant therapy for infants receiving nCPAP alone, reducing the number of premature infants who are subjected to invasive surfactant administration, and potentially providing transformative clinical and pharmacoeconomic benefits.

We recently completed an AEROSURF phase 2b clinical trial that was designed to evaluate aerosolized KL4 surfactant administered to premature infants 28 to 32 week gestational age receiving nCPAP, in two dose groups (25 and 50 minutes) with up to two potential repeat doses, compared to infants receiving nCPAP alone.  This trial was conducted in approximately 50 clinical sites in the U.S., Canada, the European Union and Latin America.  Based on the planned top-line results, data show that AEROSURF did not meet the primary endpoint of a reduction in nCPAP failure at 72 hours, which we believe was due in large part to an unexpected rate of treatment interruptions.  Such interruptions occurred in about 24% of active enrollments, predominantly in the 50 minute dose group, and were primarily related to specific lots of disposable cartridge filters in our proprietary ADS that had a tendency to clog.  After excluding the patients whose dose was interrupted in the 50 minute dose group, the data show an nCPAP failure rate of 32% compared to 44% in the control group which is a 12% absolute reduction or a 27% relative reduction in nCPAP failure compared to control. These data suggest a meaningful treatment effect in line with our targeted outcome.

Business and Pipeline Program Updates

The reader is referred to, and encouraged to read in its entirety, “Item 1 – Business – Company Overview” and “– Business Strategy,” in the 2016 Form 10-K, which contains a discussion of our Business and Business Strategy, as well as information concerning our proprietary technologies and our current and planned KL4 pipeline programs.

The following are updates to our business and development programs since filing the 2016 Form 10-K on March 31, 2017:

CRITICAL ACCOUNTING POLICIES

There have been no changes to our critical accounting policies since December 31, 2016. For a discussion of our accounting policies, see, “Note 4 – Accounting Policies and Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements (Notes) in our 2016 Form 10-K.  Readers are encouraged to review those disclosures in conjunction with this Quarterly Report on Form 10-Q.

RESULTS OF OPERATIONS

Operating Loss and Net Loss

The operating loss for the three months ended June 30, 2017 and 2016 was $6.1 million and $10.0 million, respectively. The decrease in operating loss from 2016 to 2017 was due to a $1.0 million increase in grant revenue and a $2.8 million decrease in operating expenses.

The operating loss for the six months ended June 30, 2017 and 2016 was $14.3 million and $23.9 million, respectively. The decrease in operating loss from 2016 to 2017 was due to a $1.2 million increase in grant revenue and an $8.5 million decrease in operating expenses.

The net loss for the three months ended June 30, 2017 and 2016 was $6.8 million and $10.6 million, respectively. Included in the net loss is (i) interest expense of $0.6 million in both 2017 and 2016; and (ii) for 2016, $1.2 million for a severance charge related to the termination of our Former CEO.

The net loss for the six months ended June 30, 2017 and 2016 was $15.5 million and $24.5 million, respectively. Included in the net loss is (i) interest expense of $1.2 million and $1.3 million for 2017 and 2016, respectively; and (ii) for 2016, $1.2 million for a severance charge related to the termination of our Former CEO, $0.4 million for a severance charge related to our May 2016 workforce reduction, and the change in fair value of certain common stock warrants classified as derivative liabilities, resulting in non-cash income of $0.2 million.

The net loss attributable to common shareholders for the three and six months ended June 30, 2017 was $7.3 million (or $0.76 basic net loss per common share) and $19.6 million (or $2.10 basic net loss per common share), respectively. The net loss attributable to common shareholders for the three and six months ended June 30, 2016 was $10.6 million (or $1.29 basic net loss per common share) and $24.5 million (or $2.99 basic net loss per common share), respectively. Included in the net loss attributable to common shareholders for the three and six months ended June 30, 2017 is a $0.5 million and a $4.1 million non-cash deemed dividend on preferred stock, respectively (see, “Note 5 – Summary of Significant Accounting Policies”).

Grant Revenue 

We recognize grant revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed and determinable, and collectability is reasonably assured.

For the three months ended June 30, 2017 and 2016, we recognized grant revenue of $1.1 million and $0.1 million, respectively.  For the six months ended June 30, 2017 and 2016, we recognized grant revenue of $1.4 million and $0.2 million, respectively.

Grant revenue for the three months ended June 30, 2017 includes $0.9 million of funds received and expended under a Phase II Small Business Innovation Research Grant (SBIR) from the National Heart, Lung, and Blood Institute (NHLBI) of the NIH to support the AEROSURF phase 2b clinical trial.

Research and Development Expenses

Our research and development expenses are charged to operations as incurred and we account for such costs by category rather than by project. As many of our research and development activities form the foundation for the development of our KL4 surfactant and drug delivery technologies, they are expected to benefit more than a single project. For that reason, we cannot reasonably estimate the costs of our research and development activities on a project-by-project basis. We believe that tracking our expenses by category is a more accurate method of accounting for these activities. Our research and development costs consist primarily of expenses associated with (a) product development and manufacturing, (b) medical and regulatory operations, and (c) direct preclinical and clinical development programs. We also account for research and development and report by major expense category as follows: (i) salaries and benefits, (ii) contracted services, (iii) raw materials, aerosol devices and supplies, (iv) rents and utilities, (v) depreciation, (vi) contract manufacturing, (vii) travel, (viii) stock-based compensation and (ix) other. 

Research and development expenses by category for the three and six months ended June 30, 2017 and 2016 are as follows:

Research and development expenses include non-cash charges associated with stock-based compensation and depreciation of $0.2 million for both the three months ended June 30, 2017 and 2016, and of $0.4 million and $0.5 million for the six months ended June 30, 2017 and 2016, respectively.

Product Development and Manufacturing

Product development and manufacturing includes (i) manufacturing operations, both in-house and with contract manufacturing organizations (CMOs), validation activities, quality assurance and analytical chemistry capabilities that support the manufacture of our KL4 surfactant used in research and development activities, and our medical devices, including our ADS; (ii) design and development activities related to our ADS for use in our AEROSURF clinical development program; and (iii) pharmaceutical and manufacturing development activities, including development of a lyophilized dosage form of our KL4 surfactant. These costs include employee expenses, facility-related costs, depreciation, costs of drug substances (including raw materials), supplies, quality control and assurance activities, analytical services, and expert consultants and outside services to support pharmaceutical and device development activities.

Product development and manufacturing expenses decreased $0.5 million for the three months ended June 30, 2017 compared to the same period in 2016 due to our efforts in the second quarter of 2016 to initiate cash conservation and other cost reduction measures.

Product development and manufacturing expenses decreased $2.4 million for the six months ended June 30, 2017 compared to the same period in 2016 due to (i) our efforts in the second quarter of 2016 to initiate cash conservation and other cost reduction measures, (ii) a $0.8 million decrease in costs related to development activities under our collaboration agreement with Battelle Memorial Institute (Battelle), and (iii) a $0.5 million decrease in costs associated with the technology transfer of our lyophilized surfactant manufacturing facility process to a new facility at our CMO.

Clinical, Medical and Regulatory Operations

Clinical, medical and regulatory operations includes (i) medical, scientific, preclinical and clinical, regulatory, data management and biostatistics activities in support of our research and development programs; and (ii) medical affairs activities to provide scientific and medical education support for our KL4 surfactant and aerosol delivery systems under development. These costs include personnel, expert consultants, outside services to support regulatory and data management, symposiums at key medical meetings, facilities-related costs, and other costs for the management of clinical trials.

Clinical, medical and regulatory operations expenses decreased $0.4 million and $0.7 million, respectively, for the three and six months ended June 30, 2017 compared to the same period in 2016 due to our efforts in the second quarter of 2016 to initiate cash conservation and other cost reduction measures.

Direct Preclinical and Clinical Development Programs

Direct preclinical and clinical development programs include: (i) development activities, toxicology studies and other preclinical studies; and (ii) activities associated with conducting clinical trials, including patient enrollment costs, clinical site costs, clinical device and drug supply, and related external costs, such as consultant fees and expenses.

Direct preclinical and clinical development programs expenses decreased $1.9 million and $3.7 million, respectively, for the three and six months ended June 30, 2017 compared to the same period in 2016 due to a decrease in AEROSURF phase 2 clinical development program costs as many upfront site initiation costs and manufacturing costs related to ADS delivery, site set-up and training were completed during the three and six months ended June 30, 2016 and are not ongoing clinical trial costs.

General and Administrative Expenses

General and administrative expenses consist of costs for executive management, business development, intellectual property, finance and accounting, legal, human resources, information technology, facility, and other administrative costs.

General and administrative expenses decreased $1.7 million for the six months ended June 30, 2017 compared to the same period in 2016 due to (i) our efforts in the second quarter of 2016 to initiate cash conservation and other cost reduction measures and (ii) $1.6 million of severance charges during the six months ended June 30, 2016 (see, “Note 5 – Summary of Significant Accounting Policies”).

Other Income and (Expense)

Interest expense consists of interest expense associated with the Deerfield Loan (see, “Note 7 – Long-term Debt”) and under our collaboration agreement with Battelle (see, “Note 7 – Collaboration Payable and Accrued Expenses” in the Notes to Consolidated Financial Statements in our 2016 Form 10-K).

Other income / (expense) primarily consists of proceeds from the sale of Commonwealth of Pennsylvania research and development tax credits.  The decrease in tax credits for the six months ended June 30, 2017 to the same period in 2016 is due to the timing of the sale of the tax credits.  The 2015 tax credits were sold in the first quarter of 2016 while the 2016 tax credits were sold in the fourth quarter of 2016.

The following amounts comprise the Deerfield Loan interest expense for the periods presented:

Amortization of prepaid interest expense represents non-cash amortization of $5 million of units that Deerfield purchased in our July 2015 public offering and accepted in satisfaction of $5 million of future interest payments calculated at an interest rate of 8.75% under the Deerfield Loan. Cash interest expense represents interest at an annual rate of 8.25% on the outstanding principal amount, paid in cash on a quarterly basis.

LIQUIDITY AND CAPITAL RESOURCES 

As of June 30, 2017, we had cash and cash equivalents of $2.5 million, current liabilities of $25.4 million (including $12.5 million of long-term debt, current portion) and $12.5 million of long-term debt, non-current portion.  Total long-term debt of $25 million is with Deerfield, who hold a security interest in substantially all of our assets related to the Deerfield Loan.    

We expect to continue to incur significant losses and require significant additional capital to further advance our AEROSURF clinical development program, support our operations and meet our debt service obligations for the next several years, and we do not have sufficient existing cash and cash equivalents for at least the next year following the date that the accompanying financial statements are issued. These conditions raise substantial doubt about our ability to continue as a going concern within one year after the date that the accompanying financial statements are issued.

To potentially alleviate the conditions that raise substantial doubt about our ability to continue as a going concern, management plans to seek additional capital through the following: (i) all or a combination of strategic transactions, including other potential alliances and collaborations focused on markets outside the U.S., as well as potential combinations (including by merger or acquisition) or other corporate transactions; and (ii) through public or private equity offerings. However, there can be no assurance that these alternatives will be available, or if available, that we will be able to raise sufficient capital through such transactions. If we are unable to raise the required capital, we will not have sufficient cash resources and liquidity to fund our business operations for at least the next year following the date that the accompanying financial statements are issued. Accordingly, management has concluded that substantial doubt exists with respect to our ability to continue as a going concern through one year after the issuance of the accompanying financial statements.

In connection with the License Agreement with Lee’s that we announced in June 2017 (see, “Note 1 – The Company and Description of Business”), we received an upfront license fee of $1.0 million in July 2017 and also are eligible to receive up to $35.8 million in contingent clinical, regulatory and commercialization milestone payments, and royalties at an escalating high single digit to mid-teens percentage across all products.  In addition, Lee’s will be responsible for all development costs in the licensed territory.  In addition to the License Agreement, Lee’s also invested $2 million in our February 2017 private placement offering.

Under a Loan Agreement dated as of August 14, 2017, Lee’s agreed to lend us up to a potential $3.9 million (Lee's Loan) that will be funded in Lee’s sole discretion in three equal installments on August 15, September 10 and October 10, 2017, and will be used to support our AEROSURF development activities and sustain our operations through October 31, 2017, while we negotiate the potential Share Purchase and related agreements. The Lee’s Loan will accrue interest at a rate of 12% per annum.  We received the initial installment of $1.3 million from Lee's on August 15, 2017.  Under the Share Purchase as currently contemplated, but subject to further negotiation, Lee’s would invest $10 million and acquire a controlling interest in our Company.  The outstanding principal balance of the Lee’s Loan would be applied to the Share Purchase and the Lee’s Loan would be discharged in full at the closing.  In addition, to facilitate the Share Purchase, we are negotiating the Loan Restructuring with Deerfield to restructure the Deerfield Loan, effective as of the closing of the Share Purchase.  Under the Loan Restructuring as currently contemplated, but subject to further negotiation, the notes issued in connection with the Deerfield Loan would be retired in exchange for (i) $2.5 million of cash paid out of the proceeds of the Share Purchase, (ii) a number of newly-issued shares of our common stock equal to 2% of our outstanding common stock on a fully-diluted basis (to be defined) as of the closing date, and (iii) future regulatory and commercial milestones related to the development and commercialization of AEROSURF potentially totaling $15 million.  (See, “Note 9 – Subsequent Events”).

While we believe that we will be able to reach agreement with Lee’s and Deerfield and close the Share Purchase and Loan Restructuring, there can be no assurance that we will be successful.  At this time, we do not have an alternative source of funding available, such that, if we are unable to complete these transactions for any reason on or before October 31, 2017, we may be forced to curtail all of our activities and, ultimately, cease operations.  In addition, if we are unable to finalize and close the Loan Restructuring and thereafter fail to make any required payment under the Deerfield Loan, or fail to comply with any commitments contained in the Deerfield Loan documents, Deerfield would be able to declare a default under the Deerfield Loan agreement, accelerate our payment obligations under all or a portion of our indebtedness, and, since we have pledged substantially all of our assets to secure the Deerfield Loan, foreclose on our assets, which could significantly diminish the market value and marketability of our assets and common stock and render us unable to continue as a going concern. Moreover, even if we are successful in completing these transactions, we will continue to require significant additional capital to support our research and development activities going forward, including the AEROSURF development program, and our operations.

As of August 15, 2017, after receipt of the initial advance under the Loan Agreement, we had cash and cash equivalents of $2.9 million and believe that, assuming receipt of the two additional installments under the Lee's Loan and before any additional financings, we will have sufficient cash resources to fund our operations through November 2017. 

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business, and do not include any adjustments relating to recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.

Our ability to secure the needed capital through equity financings and other similar transactions is subject to regulatory and other constraints discussed in this Quarterly Report on Form 10-Q and we cannot be certain that we will be able to raise a sufficient amount when needed, if at all, on favorable terms or otherwise. In the event that we cannot raise sufficient capital, we may be forced to consider transactions on less-than-favorable terms, or limit or cease our development activities. If we are unable to raise the required capital, we may be forced to curtail all of our activities and, ultimately, cease operations. Even if we are able to raise sufficient capital, such financings may only be available on unattractive terms, or result in significant dilution of stockholders’ interests and, in such event, the market price of our common stock may decline.

Cash Flows

As of June 30, 2017, we had cash and cash equivalents of $2.5 million compared to $5.6 million as of December 31, 2016.  Cash outflows for the six months ended June 30, 2017 consist of $12.9 million used for ongoing operating and investing activities offset by cash inflows for the six months ended June 30, 2017 of $9.8 million for financing activities.

Operating Activities

Net cash used in operating activities for the six months ended June 30, 2017 and 2016 was $12.9 million and $18.3 million, respectively. Net cash used in operating activities is a result of our net losses for the period, adjusted for non-cash items and changes in working capital.

Investing Activities

Net cash used in investing activities for the six months ended June 30, 2017 and 2016 represents capital expenditures of $24,000 and $149,000, respectively.

Financing Activities

Net cash provided by financing activities for six months ended June 30, 2017 was $9.8 million and represents net cash proceeds from both the February 2017 private placement of $8.8 and the use of the ATM Program of $1.0 million.

Net cash provided by financing activities for the six months ended June 30, 2016 was $0.1 million and represents proceeds from the use of the ATM Program.

The following sections provide a more detailed discussion of our available financing facilities.

Private Placement Offering

On February 15, 2017, we completed a private placement offering of 7,049 Series A Convertible Preferred Stock units at a price per unit of $1,495, for an aggregate purchase price of approximately $10.5 million, including $1.6 million of non-cash consideration representing a reduction in amounts due and accrued as of December 31, 2016 for current development services that otherwise would have become payable in cash in the first and second quarters of 2017.  Each unit consists of: (i) one share of Series A Convertible Preferred Stock, par value $0.001 per share (Preferred Shares); and (ii) 1,000 Series A-1 Warrants (Warrants) to purchase one share of common stock at an exercise price equal to $1.37 per share.  Each Preferred Share may be converted at the holder's option at any time into 1,000 shares of common stock at a conversion price of $1.37 per share. The Warrants may be exercised beginning August 15, 2017 and through February 15, 2024.  The Preferred Shares and the Warrants may not be converted or exercised to the extent that the holder would, following such exercise or conversion, beneficially own more than 9.99% (or other lesser percent as designated by each holder) of our outstanding shares of common stock. In addition to the offering, the securities purchase agreement also provides that, until February 13, 2018, the investors are entitled to participate in subsequent bona fide capital raising transactions that we may conduct. 

As of August 15, 2017, 3,846 Preferred Shares have been converted into 3,846,000 shares of common stock and 3,203 Preferred Shares remain outstanding.

At-the-Market Program (ATM Program)

ATM Program

During the three and six months ended June 30, 2017, we completed offerings of our common stock under our ATM Program of 41,231 shares and 847,147 shares, respectively. This resulted in an aggregate purchase price of approximately $48,000 ($46,000 net) and $1,082,000 ($1,036,000 net), respectively, for the three and six month periods ended June 30, 2017. During the three months ended June 30, 2016, there were no offerings under our ATM Program. During the six months ended June 30, 2016, we completed offerings of our common stock under our ATM Program of 27,971 shares for an aggregate purchase price of approximately $71,000 ($69,000 net).

Effective May 5, 2017, we were no longer able to make use of our ATM Program (see, “– Liquidity Risks and Management’s Plans”).

ITEM 3.        QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

Item 4.         Controls and Procedures

Evaluation of disclosure controls and procedures 

Our management, including our President and Chief Executive Officer (principal executive officer) and our Senior Vice President and Chief Financial Officer (principal financial officer), does not expect that our disclosure controls or our internal control over financial reporting will prevent all error and all fraud. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our President and Chief Executive Officer and our Senior Vice President and Chief Financial Officer, to allow for timely decisions regarding required disclosures, and recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Changes in internal control

There were no changes in our internal control over financial reporting identified in connection with the evaluation described above that occurred during the quarter ended June 30, 2017 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.         Legal Proceedings

We are not aware of any pending legal actions that would, if determined adversely to us, have a material adverse effect on our business and operations.

We have from time to time been involved in disputes and proceedings arising in the ordinary course of business, including in connection with the conduct of our clinical trials. In addition, as a public company, we are also potentially susceptible to litigation, such as claims asserting violations of securities laws. Any such claims, with or without merit, if not resolved, could be time-consuming and result in costly litigation. There can be no assurance that an adverse result in any future proceeding would not have a potentially material adverse effect on our business, results of operations and financial condition.

ITEM 1A.       RISK FACTORS

Investing in our securities involves risks. In addition to the other information in this Quarterly Report on Form 10-Q, stockholders and potential investors should carefully consider the risks and uncertainties discussed in the section "Item 1A. Risk Factors" in our 2016 Form 10-K, as supplemented by the risks and uncertainties discussed below and elsewhere in this Quarterly Report on 10-Q. The risks and uncertainties set forth below and discussed elsewhere in this Quarterly Report on Form 10-Q and described in our 2016 Form 10-K are not the only ones that may materialize. Additional risks and uncertainties not presently known to us or that we currently consider to be immaterial may also impair our business operations. If any of the risks and uncertainties set forth below or in our 2016 Form 10-K actually materialize, our business, financial condition and/or results of operations could be materially adversely affected, the trading price of our common stock could decline and a stockholder could lose all or part of his or her investment. In particular, the reader’s attention is drawn to the discussion in “Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Overview.” In addition, risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our business operations.

To be able to secure the additional capital that we will require, we are substantially dependent upon our ability to successfully initiate, enroll and complete our planned clinical trials on a timely basis. If we are unable to successfully complete enrollment and release top line data in accordance with our plan, or if the results of our clinical trial are inconclusive, or present an unacceptable benefit/risk profile due to suboptimal efficacy and/or safety profile, we may be unable to secure the additional capital that we will require to support our research and development activities and operations and have sufficient cash resources to service and repay debt, which could have a material adverse effect on our business and our ability to continue as a going concern.

Our business and our ability to secure the significant additional capital that we will require to support our research and development activities and operations and have sufficient cash resources to service and repay debt is highly dependent upon our ability to successfully develop our AEROSURF® combination drug/device product candidate for the treatment of respiratory distress syndrome (RDS) in premature infants.  We recently announced in late June 2017 that the top-line results of our AEROSURF phase 2b clinical trial did not meet the primary endpoint of reduction in nasal continuous positive airway pressure (nCPAP) failure at 72 hours due in part, we believe, to device-related dose interruptions.  Although, when the data from patients with dose interruptions is removed, the results appear to show a potential meaningful effect, our failure to demonstrate a meaningful effect in the top-line results, has and is expected to make it more difficult to secure the additional capital that we require.  In addition, because the market value of our common stock dropped significantly when we announced our phase 2b results, to raise the additional capital we require, we may have to issue a significantly greater number of shares of capital stock than we originally planned, which could have a dilutive impact on our stockholders.  We are assessing the results of our trial in the context of our development and regulatory plans and expect that the regulatory requirements to secure approval for AEROSURF may have changed.  To the extent any such change involves unforeseen additional, potentially time-consuming and expensive development work, we may be unable to secure the additional required capital that may be required or, even if we are able to raise sufficient capital, such financings may only be available on unattractive terms, or result in significant dilution of stockholders’ interests and, in such event, the market price of our common stock may further decline.

Failure to complete the development of our NextGen ADS intended for future development activities and, if approved, initial commercial activities, in a timely manner, if at all, would have a material adverse effect on our efforts to develop AEROSURF as well as our other aerosolized KL4 surfactant products, and our business strategy.

We have developed a clinic-ready ADS that is suitable for use in our ongoing phase 2 clinical development program and currently are working with Battelle Memorial Institute (Battelle) to further develop a version of the ADS (NextGen) potentially for use in our remaining AEROSURF development activities and, if approved, initial commercial activities. Our device development activities are generally directed to controlling risks of mechanical and other failures, assuring consistency of performance and low variability machine to machine, and rigorous testing and verification processes to avoid design defects.  In particular, we are currently assessing the dose interruptions that occurred with the phase 2 ADS and taking steps to assure that we have mitigated the chances of such failures occurring in the NextGen ADS.

Our development activities are subject to certain risks and uncertainties, including, without limitation:

The realization of any of the foregoing risks would have a material adverse effect on our business.

We currently require significant additional capital to support our research and development activities and operations and have sufficient cash resources to pay our vendors and service providers and service and repay debt.  As such, we routinely closely monitor and control our cash resources to assure that investment and spending decisions advance our corporate objectives at any time.  While we seek to raise the additional capital that we require, our relationships with important vendors and service providers may be adversely impacted.  If any of our key vendors and service providers cease working with us or subject the delivery of product or services to challenging and expensive preconditions, our development activities would be adversely affected, which could have a material adverse effect on our business and operations.

During and since the period in which we completed enrollment of our AEROSURF phase 2b clinical trial and analyzed and announced the results, our cash resources have been constrained.  To manage our cash, we have and plan to operate under processes to tightly control purchasing and retention of consultants, monitor the release of funds and defer payment on invoices to conserve cash availability. While proceeds from the Lee’s Loan and potential Share Purchase may provide capital in the short-term to support research and development activities and operations and pay our vendors and service providers, we will still require significant additional capital. As a consequence, our aged accounts payables are expected to increase and our relationships with key vendors and service providers may be strained.  While we seek the additional capital that we require, we are working closely with our vendors and service providers to preserve our key relationships.  Failure to retain such key relationships could have a material adverse effect on our development activities and our business and operations.

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

As of June 30, 2017, we issued 10,000 unregistered shares of common stock to a consultant as compensation for management consulting services rendered during the period from January 13, 2017 through May 30, 2017.  The shares were issued in reliance upon the exemption from securities registration provided by Section 4(2) of the Act.

Item 6.     Exhibits

Exhibits are listed on the Index to Exhibits at the end of this Quarterly Report. The exhibits required by Item 601 of Regulation S-K, listed on such Index in response to this Item, are incorporated herein by reference.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

INDEX TO EXHIBITS

The following exhibits are included with this Quarterly Report on Form 10-Q.

+Confidential treatment requested as to certain portions of this exhibit. Such portions have been redacted and filed separately with the Commission.

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