WINDTREE THERAPEUTICS INC /DE/ - Quarter Report: 2018 June (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended June 30, 2018

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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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 3, 2018, there were outstanding 3,769,088 shares of the registrant’s common stock, par value $0.001 per share.

Table of Contents

PART I - FINANCIAL INFORMATION

PART II - OTHER 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, future milestones, goals and objectives, and our financial plans and future financial condition, and the time during which our existing cash and other resources may support our continued operation as a going concern. Forward-looking statements also include our expectations about our research and development programs, including planned development activities, anticipated timing of clinical trials and potential development milestones; the timing and anticipated outcomes of submitting regulatory filings in the United States and other markets; manufacturing plans for our KL4 surfactant, active pharmaceutical ingredients (APIs) and our proprietary aerosol delivery system (ADS); and our plans regarding potential collaborations and alliances, including potential licensing opportunities, and strategic transactions (including without limitation, by merger, acquisition or other corporate transaction).

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/or common law trademarks of Windtree Therapeutics, Inc. (Warrington, PA).

WINDTREE THERAPEUTICS, INC. AND SUBSIDIARY

Condensed Consolidated Balance Sheets

(in thousands, except share data)

See notes to condensed consolidated financial statements

WINDTREE THERAPEUTICS, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Operations

(Unaudited)

(in thousands, except per share data)

See notes to condensed consolidated financial statements

WINDTREE THERAPEUTICS, INC. AND SUBSIDIARY

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(in thousands)

See notes to condensed consolidated financial statements

Notes to Condensed Consolidated Financial Statements (unaudited)

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 in the Risk Factors Section and elsewhere in this Quarterly Report on Form 10-Q, which, together with the earlier Quarterly Report on Form 10-Q for the quarter ended March 31, 2018 that we filed on May 21, 2018, are in addition to and supplement the risk factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2017 that we filed with the Securities and Exchange Commission (SEC) on April 17, 2018 (2017 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.

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) and the 2017 Form 10-K. 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, including our proprietary aerosol delivery system (ADS), being developed to enable noninvasive administration of aerosolized KL4 surfactant. We recently completed design verification for our new phase 3 ADS (which we previously referred to as the “NextGen ADS”), which we plan to use in our remaining AEROSURF® clinical development activities and, if approved, initial commercial activities. We believe that our proprietary technologies 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 we are developing to improve the management of respiratory distress syndrome (RDS) in premature infants who may require surfactant therapy to sustain life. The currently-available surfactants in the United States (U.S.) are administered using invasive endotracheal intubation and mechanical ventilation, each of which may result in serious respiratory conditions and other complications. To avoid these risks, many premature infants are initially treated with noninvasive respiratory support such as nasal continuous positive airway pressure (nCPAP). Because nCPAP does not address the underlying surfactant deficiency, many premature infants respond poorly to nCPAP alone (typically within the first 72 hours of life) and may require delayed surfactant therapy administered with invasive intubation (an outcome referred to as “nCPAP failure”). If surfactant therapy could be administered noninvasively, neonatologists would be able to provide surfactant therapy to premature infants earlier in their course of treatment and without exposing them to the risks associated with invasive endotracheal intubation and mechanical ventilation.

AEROSURF is designed to administer aerosolized KL4 surfactant noninvasively and potentially meaningfully reduce the use of invasive endotracheal intubation and mechanical ventilation. We believe that AEROSURF, if approved, will allow for earlier treatment of premature infants who currently receive delayed surfactant therapy, decrease the morbidities and complications currently associated with surfactant administration, and reduce the number of premature infants who are subjected to invasive intubation and delayed surfactant therapy following nCPAP failure. We also believe that AEROSURF has the potential to address a serious unmet medical need and potentially provide transformative clinical and pharmacoeconomic benefits. Consistent with our belief, FDA has granted Fast Track designation for our KL4 surfactant (including AEROSURF) to treat RDS.

In addition to advancing AEROSURF, we are assessing potential development pathways to potentially gain marketing approval for lyophilized KL4 surfactant as an intratracheal instillate for the treatment and/or prevention of RDS. Lyophilized KL4 surfactant may potentially provide benefits related to use, including longer shelf life, reduced cold-chain requirements and lower viscosity. We have discussed with the FDA a potential development plan, trial design and regulatory plan for approval. If we can define an acceptable development program that is achievable from a cost, timing and resource perspective, we might seek approval to treat premature infants who, because they are unable to breathe on their own or other reason, cannot benefit from AEROSURF.

We also believe that our KL4 surfactant technology may potentially support a product pipeline to address a broad range of serious respiratory conditions in children and adults. We have received support, and plan to seek additional support, from the National Institutes of Health (NIH) and other government funding sources to explore the utility of our KL4 surfactant to address a variety of such respiratory conditions as acute lung injury (ALI), including acute radiation exposure to the lung (acute pneumonitis and delayed lung injury), chemical-induced ALI, and influenza-induced ALI; as well as chronic rhinosinusitis, complications of certain major surgeries, mechanical ventilator-induced lung injury (often referred to as VILI), pneumonia, and diseases involving mucociliary clearance disorders, such as chronic obstructive pulmonary disease (COPD) and cystic fibrosis (CF). Although there can be no assurance, we may in the future support development activities to establish a proof-of-concept and, if successful, thereafter determine whether to seek strategic alliances or collaboration arrangements or pursue other financial alternatives to fund further development and, if approved, commercialization of additional KL4 surfactant indications.

To leverage our capabilities, maximize the use of our resources and potentially reduce our dependency on a single product candidate, we also seek to enter into strategic alliances, collaboration agreements and other strategic transactions (including without limitation, by merger, acquisition or other corporate transaction). We are currently engaged in discussions for a potential strategic transaction that could diversify our assets and bring in additional capital. There can be no assurance, however, that we will be able to reach agreement on terms and within the time frame acceptable to all parties. Moreover, even if we reach agreement and complete a transaction, there can be no assurance that we will have sufficient resources to fund the continued development of AEROSURF or any other product candidates, that any of our development efforts would be successful, or that we would obtain regulatory approvals needed to commercialize our product candidates in the world’s markets.

In 2017, our AEROSURF phase 2b clinical trial did not meet its primary endpoint due, we believe, to a higher-than-anticipated rate of treatment interruptions experienced with the phase 2 prototype ADS.  In response we planned to conduct an additional AEROSURF bridge clinical study that is designed, among other things, to clinically evaluate the design and performance of our new phase 3 ADS.  These events and the resulting delay in the AEROSURF clinical development program have made it difficult to attract investors and raise additional capital in the securities markets at this time and, as such, we have depended primarily upon the continuing support of Lee’s Pharmaceutical Holdings Limited (Lee’s), our majority stockholder and licensee in the Asia Pacific markets, and two previously announced loans from Panacea Venture Management Company Ltd. to support our operations while we pursue the potential strategic transaction currently under discussion.  There can be no assurance that such support will continue, however. We believe that our ability to continue as a going concern in the near term is highly dependent upon continuing support from Lee’s, and our ability to continue as a going concern in the long term will be highly dependent upon our ability to secure the capital necessary to timely advance our AEROSURF development program, including plans to execute the AEROSURF bridge study and be in a position to initiate an AEROSURF phase 3 clinical program.  

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 2017 Form 10-K, which contains a discussion of our Business and Business Strategy, as well as information concerning our proprietary technologies and potential KL4 pipeline initiatives.

The following are business and development program updates for the second quarter ending June 30, 2018:

CRITICAL ACCOUNTING POLICIES

There have been no changes to our critical accounting policies since December 31, 2017. For a discussion of our accounting policies, see, “Note 4 – Summary of Significant Accounting Policies” and, in the Notes to Consolidated Financial Statements (Notes) in our 2017 Form 10-K, “Note 4 – Accounting Policies and Recent Accounting Pronouncements.”  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, 2018 and 2017 was $3.0 million and $6.1 million, respectively. The decrease in operating loss from 2017 to 2018 was due to a $3.2 million decrease in operating expenses and a $0.4 million increase in license revenue with affiliate, partially offset by a $0.5 million decrease in grant revenue.

The operating loss for the six months ended June 30, 2018 and 2017 was $7.9 million and $14.3 million, respectively. The decrease in operating loss from 2017 to 2018 was due to a $6.5 million decrease in operating expenses and a $0.6 million increase in license revenue with affiliate, partially offset by a $0.7 million decrease in grant revenue.

The net loss for the three months ended June 30, 2018 and 2017 was $3.1 million and $6.8 million, respectively. Included in the net loss is interest expense of $0.1 million and $0.6 million in 2018 and 2017, respectively.

The net loss for the six months ended June 30, 2018 and 2017 was $7.6 million and $15.5 million, respectively. Included in the net loss is interest expense of $0.2 million and $1.2 million in 2018 and 2017, respectively.

The net loss attributable to common shareholders for the three and six months ended June 30, 2018 was $3.1 million (or $0.81 basic net loss per common share) and $7.6 million (or $2.17 basic net loss per common share). The net loss attributable to common shareholders for the three and six months ended June 30, 2017 was $7.3 million (or $14.37 basic net loss per common share) and $19.6 million (or $40.96 basic net loss per common share). 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 4 – Summary of Significant Accounting Policies – Beneficial Conversion Feature”).

Grant revenue

For the three months ended June 30, 2018 and 2017, we recognized grant revenue of $0.7 million and $1.1 million, respectively. 

Grant revenue for the three months ended June 30, 2018 consists of $0.7 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 (AEROSURF Grant). Grant revenue for the three months ended June 30, 2017 includes $0.9 million of funds received and expended under the AEROSURF Grant and $0.2 million of funds under a Phase II SBIR grant from the National Institute of Allergy and Infectious Diseases (NIAID) to support continued development of our aerosolized KL4 surfactant as a potential medical countermeasure to mitigate acute and chronic/late-phase radiation-induced lung injury (Radiation Grant).

For the six months ended June 30, 2018 and 2017, we recognized grant revenue of $0.7 million and $1.4 million, respectively. Grant revenue for the six months ended June 30, 2018 consists of $0.7 million of funds received and expended under the AEROSURF Grant. Grant revenue for the six months ended June 30, 2017 includes $1.1 million of funds received and expended under the AEROSURF Grant and $0.3 million of funds under the Radiation Grant.

As of June 30, 2018, all funding under the AEROSURF Grant and the Radiation Grant has been received and $0.1 million related to the Radiation Grant is currently recorded as deferred revenue and will be recognized as grant revenue when the funds are expended.

License Revenue with Affiliate

Effective January 1, 2018, we adopted Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers, using the modified retrospective transition method. Under this method, we recognize the cumulative effect of initially adopting ASC Topic 606, if any, as an adjustment to the opening balance of retained earnings.  Additionally, under this method of adoption, we apply the guidance to all incomplete contracts in scope as of the date of initial application. This standard applies to all contracts with customers, except for contracts that are within the scope of other standards, such as leases, insurance, collaboration arrangements and financial instruments.

In accordance with ASC Topic 606, we recognize revenue when the customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services. To determine revenue recognition for arrangements that the we determine are within the scope of ASC Topic 606, we perform the following five steps:

We only apply the five-step model to contracts when we determine that it is probable that we will collect the consideration we are entitled to in exchange for the goods or services we transfer to the customer. At contract inception, once the contract is determined to be within the scope of ASC Topic 606, we assess the goods or services promised within a contract and determine those that are performance obligations, and assesses whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

For the three and six months ended June 30, 2018, we recognized license revenue with affiliates of $0.4 million and $0.6 million, respectively, which had previously been included in deferred revenue – current portion.

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) clinical, medical and regulatory operations, and (c) direct preclinical and clinical development programs. We also account for research and development and report annually 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, 2018 and 2017 are as follows: 

Research and development expenses include non-cash charges associated with stock-based compensation and depreciation of $0.1 and $0.2 million for the three months ended June 30, 2018 and 2017, respectively, and $0.2 and $0.4 million for the six months ended June 30, 2018 and 2017, 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 $0.1 million for the three months ended June 30, 2018 and $0.4 million for the six months ended June 30, 2018 compared to the same periods in 2017 due to (i) our ongoing efforts to conserve cash and reduce costs and (ii) a July 2017 workforce reduction.

Clinical, Medical and Regulatory Operations

Clinical, medical and regulatory operations include (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 $0.6 million for the three months ended June 30, 2018 and $1.2 million for the six months ended June 30, 2018 compared to the same periods in 2017 due to (i) our ongoing efforts to conserve cash and reduce costs and (ii) a July 2017 workforce reduction.

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 for the three months ended June 30, 2018 and $4.3 million for the six months ended June 30, 2018 compared to the same periods in 2017 due to a decrease in AEROSURF phase 2 clinical development program costs following the completion of enrollment in the phase 2a and phase 2b clinical trials during the second quarter of 2017.

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 $0.6 million in each of the three and six month periods ended June 30, 2018 compared to the same periods in 2017 due to (i) our ongoing efforts to conserve cash and reduce costs and (ii) a July 2017 workforce reduction.

Other Income and (Expense) 

For 2018, interest expense consists of interest expense associated with the Battelle payables and on the $2.5 million in Loans Payable. For 2017, interest expense primarily consists of interest expense associated with the Deerfield Loan (see, “Note 9 – Restructured debt liability”).

Other income primarily consists of proceeds from the sale of Commonwealth of Pennsylvania research and development tax credits.

LIQUIDITY AND CAPITAL RESOURCES 

As of June 30, 2018, we had cash and cash equivalents of $0.6 million and current liabilities of $15.2 million. On July 2, 2018, we secured $1.5 million in additional capital, and as of August 3, 2018, we had cash and cash equivalents of $0.7 million, which we believe is sufficient to maintain our operations through mid-August 2018.  We are currently engaged in discussions for a potential strategic transaction that could diversify our assets and bring in additional capital to fund our activities. As we seek to finalize that transaction, Lee’s Pharmaceutical Holdings Limited (Lee’s), the majority holder of our common stock, has indicated to us that it will provide us interim financial support while we work to complete the strategic transaction; however, we have not executed agreements for any additional advances at this time and there can be no assurance that additional interim support will be forthcoming.  Moreover, in connection with these activities, we are incurring and will continue to incur potentially significant legal, accounting, and other professional fees that represent an additional financial burden for which we will require additional capital.

We expect to continue to incur significant losses and will require significant additional capital to support our operations, advance our AEROSURF clinical development program, and satisfy existing obligations, and we do not currently have sufficient cash and cash equivalents for at least the next year following the date that the 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 financial statements are issued.

To alleviate the conditions that raise substantial doubt about our ability to continue as a going concern, management plans to raise additional capital through one or more of the following: (i) strategic transactions, including 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 private placements of our equity securities, although there can be no assurance that we will be able to secure such transactions or complete a private placement on acceptable terms, if at all. Although we are currently engaged in active diligence and discussions for a potential strategic transaction, there is no guarantee we will be able to complete the strategic transaction. In addition, if none of the other alternatives is available, or if available, we are unable to raise sufficient capital through such transactions, 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 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.

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.

In April 2018, we completed a $2.6 million private placement offering with LPH II Investments Limited (LPH II), a wholly-owned subsidiary of Lee’s, from which we received net proceeds of approximately $2.5 million. In June 2018, we entered into a Guaranty and Replenishment Agreement with Lee’s pursuant to which Lee’s agreed to replenish amounts expended by us that reduce our cash resources to an amount that is less than our planned minimum cash (the amount that would otherwise be required to cover estimated wind-down costs should we be unable at any time to continue as a going concern). Lee’s secured its obligation to us by delivering an Irrevocable Stand-by Letter of Credit (the Letter of Credit) in the amount of $1 million in favor of the Company, which expires on October 31, 2018.  As of August 3, 2018, we have not drawn on the Letter of Credit.

On July 2, 2018, we issued to Panacea Venture Management Company Ltd. (Panacea), a Secured Convertible Promissory Note (the Note) with respect to a loan facility in the aggregate amount of up to $1.5 million. In connection with the issuance of the Note, Panacea made two loans (individually, each a Loan and collectively, the Loans) to us, the first of which was in the amount of $1.0 million and paid on the date of the Note and the second of which was in the amount of $500,000 and received on July 23, 2018. The Loans bear interest on the outstanding principal amount at a rate of 15% per annum until the Note is paid in full or converted into shares of our common stock at a price per share of $4.00. In addition, in lieu of converting the Note, Panacea may deliver the Note into a private placement in which Panacea Venture Healthcare Fund I L.P., an affiliate of Panacea, may participate. There can be no assurance that such a private placement will be completed. In connection with these Loans, we granted to Panacea a security interest in substantially all our assets. The proceeds of these Loans are being used to support our operations while we pursue a potential strategic transaction that could diversify our assets and bring in additional capital.

In 2017, our AEROSURF phase 2b clinical trial did not meet its primary endpoint due, we believe, to a higher-than-anticipated rate of treatment interruptions experienced with the phase 2 prototype ADS.  In response, in November 2017, we planned to conduct an additional AEROSURF bridge clinical study that is designed, among other things, to clinically evaluate the design and performance of our new phase 3 ADS.  These events and the resulting delay in the AEROSURF clinical development program have made it difficult to attract investors and raise additional capital in the securities markets at this time and, as such, we have depended primarily upon the continuing support of Lee’s Pharmaceutical Holdings Limited (Lee’s), our majority stockholder and licensee in the Asia Pacific markets, and two previously announced loans from Panacea Venture Management Company Ltd. to support our operations while we pursue the potential strategic transaction currently under discussion.  There can be no assurance that such support will continue, however. We believe that our ability to continue as a going concern in the near term is highly dependent upon continuing support from Lee’s, and our ability to continue as a going concern in the long term will be highly dependent upon our ability to secure the capital necessary to timely advance our AEROSURF development program, including plans to execute the AEROSURF bridge study and be in a position to initiate an AEROSURF phase 3 clinical program, and achieve results that can attract investor interest. Our AEROSURF development program activities are subject to significant risks and uncertainties, such that there can be no assurance that we will be successful in completing these activities in accordance with our plans, or at all. If our AEROSURF development program activities should be delayed for any reason, we may be forced to implement cost-saving measures that may potentially have a negative impact on our activities and potentially the results of our clinical programs. Even if we complete our AEROSURF development program activities as planned, if the results are inconclusive, or present an unacceptable benefit/risk profile, we may be unable to secure the additional capital that we will require to continue our development activities and operations, which could have a material adverse effect on our business.  In that event, 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.

As we seek to secure the needed capital through strategic transactions and private placement equity offerings,  we will be subject to regulatory and other restrictions, including that our status as a smaller reporting company makes us ineligible to use a registration statement on Form S‑3 to register our securities and will have to use a long-form Form S-1, the preparation of which would be more time-consuming and costly; our controlling stockholder may not approve a strategic transaction recommended by our Board, or agree to increase the number of shares of common stock authorized under our Certificate of Incorporation, which could impair our ability in the future to conduct equity financings or enter into certain strategic transactions; and our efforts may be adversely affected by potentially unfavorable credit and financial markets.  Under these circumstances, we cannot be certain that we will be able to raise a sufficient amount when needed, if at all, on favorable terms or otherwise.

As of June 30, 2018, there were 120 million shares of common stock and 5 million shares of preferred stock authorized under our Certificate of Incorporation, and approximately 113.5 million shares of common stock and 5.0 million shares of preferred stock available for issuance and not otherwise reserved. 

Cash Flows 

Cash outflows for the six months ended June 30, 2018, consist of $6.3 million used for ongoing operating activities offset by cash inflows for the six months ended June 30, 2018 of $5.0 million for financing activities.

Operating Activities

Net cash used in operating activities for the six months ended June 30, 2018 and 2017 was $6.3 million and $12.9 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. The decrease in net cash used in operating activities is due to our ongoing efforts to conserve cash as well the completion of enrollment in the phase 2a and phase 2b clinical trials during the second quarter of 2017.

Investing Activities

Net cash provided by investing activities for the six months ended June 30, 2018 represents $9,000 in proceeds from the sale of property and equipment.

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

Financing Activities

Net cash provided by financing activities for six months ended June 30, 2018 was $5.0 million and represents loan proceeds of $1.5 million and $1.0 million related to loan agreements with LPH, an affiliate of Lee’s, and $2.6 million from a private placement offering with LPH II, a wholly-owned subsidiary of Lee’s, from which we received net proceeds of approximately $2.5 million.

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.

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

Private Placement Offerings

April 2018 Private Placement

In April 2018, we completed a private placement with LPH II Investments Limited (LPH II), a wholly-owned subsidiary of Lee’s, for the purchase of $2.6 million of our common stock and warrants at a purchase price per share of $4.80. In connection with this offering, we issued 541,667 shares of common stock and warrants to purchase 135,417 shares of common stock at an exercise price of $5.52 per share. The warrants are exercisable after 6 months and through the seventh anniversary of the issue date.

Loan Payable

In January 2018 and March 2018, we entered into loan agreements with LPH, an affiliate of Lee’s, for loan proceeds of $1.5 million and $1.0 million, respectively, to support our AEROSURF development activities and sustain its operations while the parties seek to identify and advance one or more potential strategic initiatives (Funding Event). To secure our obligations under these loans, we granted LPH a security interest in substantially all of our assets. The loans will accrue interest at a rate of 6% per annum and mature upon the earlier of the closing date of the Funding Event or December 31, 2018. The parties expect that, upon the closing of the Funding Event, the outstanding principal balance of the loans will be applied in full satisfaction of a like amount of cash consideration payable by LPH for its participation in such Funding Event, and the loans will be discharged in full thereby.

On July 2, 2018, we issued to Panacea Venture Management Company Ltd. (Panacea), a Secured Convertible Promissory Note (the Note) with respect to Loans (defined below) in the aggregate amount of up to $1.5 million. In connection with the issuance of the Note, Panacea made two loans (individually, each a Loan and collectively, the Loans) to us, the first of which was in the amount of $1.0 million and paid on the date of the Note, and the second of which was in the amount of $500,000 and received on July 23, 2018.  The Loans bear interest on the outstanding principal amount at a rate of 15% per annum until the Note is paid in full or converted into shares of our common stock at a price per share of $4.00. In addition, in lieu of converting the Note, Panacea may deliver the Note into a private placement in which Panacea Venture Healthcare Fund I L.P., an affiliate of Panacea, may participate. There can be no assurance that such a private placement will be completed.  In connection with these Loans, we granted to Panacea a security interest in substantially all our assets. The proceeds of these Loans are being used to support our operations while we pursue the potential strategic transaction that could diversify our assets and bring in additional capital. (See, “– Overview – Business and Pipeline Program Updates.”)

Not applicable.

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, 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

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.

Investing in our securities involves risks. In addition to any risks and uncertainties described elsewhere in this Quarterly Report on Form 10-Q, stockholders and potential investors should carefully consider the risks and uncertainties discussed in "Item 1A. Risk Factors" in our 2017 Form 10-K. The risks and uncertainties described in our 2017 Form 10-K and as may be supplemented in our Quarterly Reports on Form 10-Q 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. Should any of the risks and uncertainties described in our 2017 Form 10-K and Quarterly Reports on Form 10-Q 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.”

If we do not secure additional capital to support our future activities before our existing cash resources are exhausted, we likely will be unable to continue as a going concern.

As of June 30, 2018, we had cash and cash equivalents of $0.6 million and current liabilities of $15.2 million.  In early July 2018, we issued a Secured Convertible Promissory Note to Panacea Venture Management Company Ltd. (Panacea) with respect to two loans in the aggregate totaling $1.5 million.  As of August 3, 2018, and before any additional financings, including in connection with potential strategic transactions, we believe that we will only have sufficient cash resources available to support our operations through mid-August 2018. We are currently engaged in discussions for a potential strategic transaction that could provide additional capital to fund our activities. Lee’s Pharmaceutical Holdings Limited (Lee’s), the majority holder of our common stock, has indicated to us that it will provide us interim financial support while we work to complete the strategic transaction; however, we have not executed agreements for any additional advances at this time and there can be no assurance that additional interim support will be forthcoming.  Moreover, in connection with these activities, we are incurring and will continue to incur potentially significant legal, accounting, and other professional fees that represent an additional financial burden for which we will require additional capital.

We have not yet established an ongoing source of revenue sufficient to cover our operating costs and allow us to continue as a going concern. Our ability to continue as a going concern is dependent on our ability to raise additional capital, to fund our research and development programs, support our business operations and pay our existing obligations on a timely basis. However, in 2017, our AEROSURF phase 2b clinical trial did not meet its primary endpoint due, we believe, to a higher-than-anticipated rate of treatment interruptions experienced with the phase 2 prototype ADS.  In response, we planned to conduct an additional AEROSURF bridge clinical study that is designed, among other things, to clinically evaluate the design and performance of our new phase 3 ADS.  These events and the resulting delay in the AEROSURF clinical development program have made it difficult to attract investors and raise additional capital in the securities markets at this time and, as such, we have depended primarily upon the continuing support of Lee’s Pharmaceutical Holdings Limited (Lee’s), our majority stockholder and licensee in the Asia Pacific markets, and two previously announced loans from Panacea Venture Management Company Ltd. while we pursue the potential strategic transaction currently under discussion. 

We believe that our ability to continue as a going concern in the near term is highly dependent upon continuing support from Lee’s, and our ability to continue as a going concern in the long term will be highly dependent upon our ability to secure the capital necessary to timely advance our AEROSURF development program, including plans to execute the AEROSURF bridge study and be in a position to initiate an AEROSURF phase 3 clinical program.  Our longer-term plans include securing the additional capital through a combination of public or private equity offerings, and strategic transactions, including potential alliances and collaborations focused on various individual markets, as well as potential combinations (including by merger or acquisition) or other corporate transactions. We are currently engaged in discussions with respect to a specific strategic transaction.  If such transactions are not available, or if available, we are unable to raise sufficient capital through such transaction, we likely will not have sufficient cash resources and liquidity to fund our business operations, which could significantly limit our ability to continue as a going concern. 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.

We seek to enter into strategic alliances, collaboration agreements and other strategic transactions (including without limitation, by merger, acquisition or other corporate transaction) that could potentially provide additional capital and access to additional pipeline products under development that we believe could diversify our portfolio, leverage our capabilities, and improve our ability to attract renewed investor interest and the significant capital that we will require to advance our development programs.  Such strategic transactions expose us to risks and uncertainties that could have a material adverse effect on our business and the AEROSURF® development program.

We seek to enter into strategic alliances, collaboration agreements and other strategic transactions that potentially could provide the additional capital that we need, leverage our capabilities, maximize the use of our resources and reduce our dependency on a single product candidate. We also seek licensing arrangements for AEROSURF and our other KL4 surfactant products in select geographic markets that could bring strategic partners with local development and commercial expertise to support development of AEROSURF in various markets outside the U.S., and financial resources to support our AEROSURF development program. We are currently focused on completing a strategic transaction that could allow us to diversify our product offerings and provide additional capital.

The identification, evaluation, and negotiation of potential strategic transactions may divert the attention of management and entail various expenses, whether or not such transactions are ultimately completed. We also have limited experience in acquiring other businesses. In addition to transaction and opportunity costs, these transactions involve large challenges and risks, whether or not such transactions are completed, any of which could harm our business and our results of operations, including risks that:

The occurrence of any of these risks could have a material adverse effect on our business, operations, financial condition, or cash flows.  In addition, we may enter into strategic partnerships with third parties with the goal of gaining access to new and innovative products and technologies. Strategic partnerships pose many of the same risks as acquisitions or investments.

We cannot guarantee that we will be able to complete the strategic transaction on which we are currently focused or that we will realize any anticipated benefits if we do complete it.  If we do not complete the strategic transaction, it is unlikely that we would be able to find another suitable opportunity that is available at attractive valuations, if at all, within a time for which we may have adequate funding.  Moreover, the relative illiquidity of our common stock may make it more difficult and expensive to initiate or complete any strategic transaction on commercially acceptable terms.

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.