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DARA BIOSCIENCES, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and related Notes included elsewhere in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2013, which has been filed with the Securities and Exchange Commission (the "SEC"). Forward-Looking Statements This Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. When used in this Form 10-Q, the words "believe," "anticipates," "intends," "plans," "estimates," and similar expressions are forward-looking statements. Such forward-looking statements contained in this Form 10-Q are based on management's current expectations and are subject to factors that could cause actual results to differ materially for us from those projected. Those factors include risks and uncertainties relating to our need to raise additional capital in order to be able to continue to fund its operations; the stockholder dilution that may result from future capital raising efforts and the exercise or conversion, as applicable, of our outstanding options, warrants and convertible preferred stock; full-ratchet anti-dilution protection afforded investors in prior financing transactions that may restrict or prohibit our ability to raise capital on terms favorable to the Company and its current stockholders; the potential delisting of our common stock from the NASDAQ Capital Market; our limited operating history which may make it difficult to evaluate our business and future viability; our ability to timely commercialize and generate revenues or profits from Soltamox®, Gelclair®, Bionect® or other products given that we only recently hired its initial sales force and our lack of history as a revenue-generating company; our ability to achieve the desired results from the agreements with Mission and Alamo; our ability to develop KRN5500 into a commercially viable product; FDA and other regulatory risks relating to our ability to market Soltamox®, Gelclair®, Bionect® or other products in the United States or elsewhere; our ability to in-license and/or partner products; the current regulatory environment in which we sell our products; the market acceptance of those products; dependence on partners and third-party manufacturers; successful performance under collaborative and other commercial agreements; our ability to retain its managerial personnel and to attract additional personnel; potential product liability risks that could exceed our liability coverage; potential risks related to healthcare fraud and abuse laws; competition; the strength of our intellectual property, the intellectual property of others and any asserted claims of infringement, and other risk factors identified in the documents we have filed, or will file, with the Securities and Exchange Commission ("SEC"). Copies of our filings with the SEC may be obtained from the SEC Internet site at http://www.sec.gov. We expressly disclaim any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in our expectations with regard thereto or any change in events, conditions, or circumstances on which any such statements are based. DARA BioSciences and the DARA logo are trademarks of DARA BioSciences, Inc. Overview We are a North-Carolina based specialty pharmaceutical company primarily focused on the commercialization of oncology treatment and supportive care pharmaceutical products. Through our acquisition of Oncogenerix, Inc., which occurred on January 17, 2012, we acquired exclusive U.S. marketing rights to our first commercial FDA-approved proprietary product license, SoltamoxÒ (tamoxifen citrate) oral solution. Soltamox has been approved by the U.S. Food and Drug Administration ("FDA") for the prevention and treatment of breast cancer. On September 7, 2012, we entered into a license agreement with Helsinn Healthcare SA ("Helsinn"), to distribute, promote, market and sell GelclairÒ, a unique oral gel whose key ingredients are polyvinylpyrrolidone (PVP) and sodium hyaluronate (hyaluronic acid) for the treatment of certain approved indications in the United States. Gelclair is an FDA-cleared product indicated for the treatment of oral mucositis. In addition, we have a marketing agreement with Innocutis Holdings, LLC pursuant to which we promote BionectÒ (hyaluronic acid sodium salt, 0.2%) within the U.S. oncology and radiation oncology marketplace. Bionect has been cleared by the FDA for the management of irritation of the skin as well as first and second degree burns. On October 25, 2013, we entered into an agreement with Alamo Pharma Services ("Alamo") pursuant to which Alamo now provides us with a dedicated national sales team of 20 sales representatives to promote our commercial products. In addition, we signed an agreement, exclusive to the oncology market, with Mission Pharmacal ("Mission"), Alamo's parent company, to share in the costs and expenses of the sales force. The Alamo sales team, in addition to promoting our products Soltamox (tamoxifen citrate), Gelclair and Bionect, also promotes three Mission products: Ferralet® 90, Binosto® (alendronate sodium) and Aquoral®. The agreements with Alamo and Mission expand our presence in oncology supportive care and the Mission products complement our portfolio in presenting comprehensive offerings to the oncologist. The sales force became operational and sales representatives were trained and in their assigned territories in early January, 2014. With the expansion of the sales force to 20 sales representatives, we expect our commercial costs, net of the Mission support payments to Alamo, to be significantly higher on an annualized basis than prior to our engagement of Alamo. 17 -------------------------------------------------------------------------------- We have a clinical development asset, KRN5500, which is a phase 2 product candidate targeted for treating cancer patients with painful treatment-refractory chronic chemotherapy induced peripheral neuropathy (CCIPN). KRN5500 has been designated a Fast Track Drug by the FDA. On February 24, 2014 the FDA granted Orphan Drug Designation to KRN5500 for the parenteral treatment of painful CCIPN that is refractory to conventional analgesics. On June 16, 2014 the FDA granted Orphan Drug Designation to KRN5500 for treatment of multiple myeloma. Fast Track designation is intended to facilitate the development and expedite review of drugs and biologics intended to treat serious or life-threatening conditions and those products that demonstrate the potential to address unmet medical needs. Upon approval by the FDA, orphan drug designation provides extended market exclusivity, tax benefits, and the waiver of certain fees associated with the FDA approval process. We are evaluating partnership opportunities to support further development of KRN5500, and are determining whether any further internal development of KRN5500 would be beneficial to our partnering efforts. As part of our strategic plan to focus on the commercialization of oncology treatment and oncology supportive care products, on June 17, 2013, we granted T3D Therapeutics, Inc. ("T3D") the exclusive worldwide rights to develop and commercialize DB959, an oral, highly selective, dual PPAR (peroxisome proliferator activated receptor) nuclear receptor agonist, which we developed through Phase 1 clinical trials. For the license, we received a $250,000 up front payment, a second payment of $25,000 in December 2013, a third payment of $100,000 in January 2014 and a fourth payment of $125,000 in February 2014. We used the $500,000 to pay off $500,000 in existing liabilities to Bayer Healthcare LLC ("Bayer"). We are also entitled to receive milestone payments upon achievement of certain development milestones by T3D which could be in excess of our milestone and annual payment obligations to Bayer. In early May, 2014, we implemented a new "No Coupon, No Co-pay, No Hassles" retail patient cost-saving program in support of Gelclair and Soltamox. This new program is meant to reduce or eliminate financial outlays by certain patients by offsetting their out-of-pocket co-pay expenses with such reductions being applied automatically to qualified prescriptions at more than 43,000 pharmacies nationwide. No additional paperwork, coupons or electronic input are required by patients, health care providers, or pharmacists to realize the benefit of the "No Coupon, No Co-Pay, No Hassles" program. Gelclair and Soltamox are now available in over 95% of local retail pharmacies nationwide, and the retail patient cost savings program is accepted at the vast majority of national retail pharmacy chains and we believe will assist us in capturing more prescriptions written for Gelclair and Soltamox. We are employing a multi-disciplinary approach to reach and educate health care providers, dispensers, patient advocacy groups, foundations, caregivers and patients directly. We believe we can accomplish this through utilization of the contract sales organization of 20 sales representatives, innovative marketing programs, partnerships with specialty pharmacy providers, working with patient advocacy groups and foundations as well as collaborative arrangements with third party sales organizations. As we gain additional commercial experience with our products, we may modify these activities as appropriate. In order to successfully achieve these goals, having sufficient liquidity is very important since we have generated minimal revenues from operations to date. We have liquidated or distributed to our stockholders all of our investments made previously in other companies. Our primary sources of working capital have been proceeds from the sale of our securities and proceeds from the prior sales of securities held in subsidiary companies and marketable securities. We expect to continue to incur operating losses in the near-term. Our results may vary depending on many factors, including our ability to build a successful sales and marketing organization, our ability to properly anticipate customer needs, the success of our product marketing efforts and the progress of licensing activities of KRN5500 with pharmaceutical partners. We continue to pursue other in-licensing opportunities for approved products. Product Commercialization and the Mission Products Our primary focus is on the commercialization of the following oncology treatment and oncology supportive care pharmaceutical products: 18 -------------------------------------------------------------------------------- · Soltamox, an FDA-approved oral liquid solution of tamoxifen citrate; · Cancer support therapeutics, including Gelclair, an FDA-cleared product indicated for the treatment of oral mucositis and Bionect, an FDA-cleared product for the management of irritation of the skin as well as first and second degree burns; and · Three Mission Pharmacal products: Ferralet 90 (for anemia), Binosto (alendronate sodium effervescent tablet indicated for the treatment of osteoporosis), and Aquoral (for cancer related dry month). We currently have an exclusive license to a FDA approved product, Soltamox; an exclusive license to distribute, promote and market a FDA cleared product, Gelclair; a marketing agreement to promote Bionect within the oncology and radiation oncology marketplace; and a marketing agreement to copromote three Mission products: Ferralet 90, Binosto, and Aquoral. We are working to expand our portfolio to include additional products through licenses and other collaborative arrangements. Oral liquid formulations of FDA approved products Oral liquids can provide an effective alternative to solid dose formulations for those patients with dysphagia, or difficulty swallowing, or those who simply prefer to take drug products in liquid form. Those suffering from dysphagia often have difficulty or experience pain when using oral tablet or capsule products and can benefit from liquid formulations of drugs. In addition, breast cancer patients receiving chemotherapeutic agents are subject to oral mucositis, which may make liquid medical formulations preferable. Soltamox SoltamoxÒ (tamoxifen citrate) oral solution, our first proprietary FDA approved product, is a drug primarily used to treat breast cancer. Soltamox is the only liquid formulation of tamoxifen available for sale in the United States. As a result of our acquisition of Oncogenerix, we became party to an exclusive license and distribution agreement with Rosemont Pharmaceuticals, Ltd. ("Rosemont"), a U.K. based manufacturer and a subsidiary of Perrigo Company plc, for rights to market Soltamox in the United States. Previously, Soltamox was marketed only in the U.K. and Ireland by Rosemont Pharmaceuticals, Ltd. Soltamox is protected by a U.S. issued patent which expires in June, 2018. Under our license agreement with Rosemont, we are obligated to meet minimum sales thresholds during the License Agreement's seven-year term. We launched Soltamox in the U.S. in the fourth quarter of 2012. Soltamox is used primarily for the chronic treatment of breast cancer or for cancer prevention in certain susceptible breast cancer subgroups. The National Cancer Institute (NCI) estimated that in 2014, 232,670 women would be diagnosed with breast cancer and 40,000 women would die as a result of the disease. Tamoxifen therapy is generally indicated for breast cancer patients for up to 5 years. The FDA requires a Boxed Warning (sometimes referred to as a "Black Box" Warning) for products for significant risk of severe or life-threatening adverse events. Soltamox has a Black Box warning related to uterine malignances, stroke and pulmonary embolism. The FDA added this requirement for a Boxed Warning on all tamoxifen products in 2002. This warning can be found in the full Soltamox prescribing information at www.soltamox.com. In order to commercialize Soltamox, we had initially established a specialty commercial sales force to market Soltamox to oncologists, targeting physicians who prescribe tamoxifen. This initial sales force has now been replaced by the Alamo sales force. Current physicians who prescribe tablet forms of tamoxifen in the United States are well known and easily identified by data sources such as IMS and Wolters Kluwer, providers of information services for the healthcare industry. We are employing a multi-disciplinary approach to reach and educate health care providers, dispensers, patient advocacy groups, foundations, caregivers and patients directly. We believe we can accomplish this through utilization of a combination of our own specialized sales organization and independent sales representatives, tele-detailing, appropriate levels of product sampling, innovative marketing programs, partnerships with Specialty Pharmacy Providers, working with Patient Advocacy Groups and Foundations as well as collaborative arrangements with third party sales organizations. We have also recently completed a registry survey called CAPTURE to gather information on compliance, adherence and preference for a liquid therapy among current tamoxifen patients and will use the results in clinical publications to increase healthcare provider awareness of breast cancer patient profiles in this respect. Cancer support therapeutics We are also focusing on the commercialization of cancer support therapeutics. 19 -------------------------------------------------------------------------------- Gelclair On September 7, 2012, we entered into a distribution and license agreement with Helsinn Healthcare SA. We were granted an exclusive license to distribute, promote, market and sell Gelclair for treatment of certain approved indications in the United States. Gelclair, a unique oral gel whose key ingredients are polyvinlypyrrolidone (PVP) and sodium hyaluronate (hyaluronic acid), is an FDA-cleared product indicated for the treatment of oral mucositis. Gelclair is protected by a U.S. issued patent which expires in 2021. Under the license agreement with Helsinn, we are obligated to meet minimum sales thresholds during the ten-year term. The License Agreement also provides that we will receive exclusive rights to distribute, promote, market and sell Gelclair for an additional indication if Helsinn is able to obtain regulatory approval for such indication. We launched Gelclair in the U.S. in April, 2013. Bionect On March 23, 2012, we entered into an Exclusive Marketing Agreement with Innocutis Holdings, LLC pursuant to which we promote Bionect (hyaluronic acid sodium salt, 0.2%) within the U.S. oncology and radiation oncology marketplace. Bionect has been approved by the FDA for the management of irritation of the skin as well as first and second degree burns. Previously, Bionect was promoted and sold by Innocutis only in the dermatology market. Innocutis continues to promote and sell Bionect in the dermatology market. Bionect is protected by a U.S. issued patent that expires in 2016. We are compensated by Innocutis for each unit sold in the U.S. oncology and radiation oncology market. We began promoting Bionect in the U.S. oncology and radiation oncology market in the second quarter of 2012. The term of the agreement will continue until April 1, 2015 and will be automatically renewed in yearly increments unless notice is given by either party 30 days prior to the expiration of the term or extended term. Mission Pharmacal Products On October 25, 2013, we entered into an agreement with Alamo Pharma Services, a subsidiary of Mission Pharmacal, for a twenty (20) person national sales team in the U.S. oncology market. Pursuant to the agreement and a shared sales force agreement with Mission, the Alamo sales team, in addition to promoting our Soltamox, Gelclair and Bionect products, also carries three Mission Pharmacal products: Ferralet 90 (for anemia), Binosto (alendronate sodium effervescent tablet indicated for the treatment of osteoporosis), and Aquoral (for cancer related dry mouth). Mission's products are concurrently being promoted by Mission Pharmacal in other non-oncology related therapeutic markets and all are under patent protection throughout the term of our agreement. The agreements with Alamo and Mission expand our presence in oncology supportive care to address ongoing areas of unmet medical need. As consideration for the Alamo sales team's promotion of the Mission products, we currently receive a fixed reduction in the fees we pay for the Alamo services. The net fees paid to Alamo are recorded as part of our Selling, General and Administrative expenses and is not recorded as revenue. However, our Alamo promotion agreement provides that, if a specified revenue milestone is achieved, rather than receiving such discount, we would share in the revenue generated by the Alamo sales team's promotion of the Mission products. Clinical Stage Asset KRN5500 KRN5500 is a novel, non-narcotic/non-opioid intravenous product for the treatment of painful CCIPN in patients with cancer. The drug has successfully completed a Phase 2a proof of concept study in patients with advanced cancer and analgesia-resistant neuropathic pain where it showed statistically-significant pain reduction versus placebo (p = 0.03) using standardized pain test scores. There were no major safety concerns although nausea and vomiting were a common occurrence. The FDA has designated KRN5500 a Fast Track drug, based on its potential usefulness in treating a serious medical condition and in fulfilling an unmet medical need. We have improved and simplified the formulation and manufactured new drug substance for the next clinical trial. Since KRN5500 would complement our portfolio of oncology treatment and supportive care pharmaceuticals, we are evaluating partnership opportunities to support further development of KRN5500, as well as determing whether any further internal development of KRN5500 would be beneficial to our partnering efforts. We have been in communication with the FDA with regard to the remainder of the clinical and technical development program for KRN5500 and hope to receive feedback from them before the end of the year. We believe that this feedback will help advance our conversations with potential partners. On February 24, 2014 the FDA granted Orphan Drug Designation to KRN5500 for the parenteral treatment of painful, chronic, chemotherapy-induced peripheral neuropathy that is refractory to conventional analgesics. On June 16, 2014 the FDA granted Orphan Drug Designation to KRN5500 for treatment of multiple myeloma. Upon approval by the FDA, orphan drug designation provides extended market exclusivity, tax benefits, and the waiver of certain fees associated with the FDA approval process. 20 -------------------------------------------------------------------------------- Critical Accounting Policies and Significant Judgments and Estimates Our management's discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments, including those related to clinical trial expenses, stock-based compensation and asset impairment and significant judgments and estimates. We base our estimates on historical experience and on various other factors that are believed to be appropriate under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included in this report, we believe the following accounting policies are most critical to aid in fully understanding and evaluating our reported financial results. Revenue Recognition We recognize revenue when there is persuasive evidence that an arrangement exists, title has passed, collection is reasonably assured and the price is fixed or determinable We sell Soltamox mostly to wholesalers who, in-turn, sell the product to hospitals and other end-user customers. Sales to wholesalers provide for selling prices that are fixed on the date of sale, although we offer certain discounts to group purchasing organizations and governmental programs. The wholesalers take title to the product, bear the risk of loss of ownership, and have economic substance to the inventory. We allow for product to be returned beginning prior to and following product expiration. We do not believe that we have sufficient sales and returns history with Soltamox and the related wholesaler distribution channel at this time to reasonably estimate product returns from our wholesalers while they are still holding inventory. Therefore, we are deferring the recognition of Soltamox revenue until the wholesalers sell their product to retail and specialty pharmacies or other end-user customers. We will continue to defer revenue recognition until the point at which we have obtained sufficient sales history to reasonably estimate returns from the wholesalers and inventory levels are reduced to normalized amounts. Shipments of Soltamox that are not recognized as revenue are treated as deferred revenue until evidence exists to confirm that pull through sales to retail and specialty pharmacies or other end-user customers have occurred. Soltamox revenue is recognized from product sales directly to hospitals, clinics, pharmacies and other end-user customers at the time of direct shipment. Revenue from Gelclair sales is generally recognized when the merchandise is shipped to both wholesalers and direct sales to hospitals, clinics, pharmacies and other end user customers as we believe that we have achieved normalized inventory levels for Gelclair. In September 2014, we increased the WAC pricing on Gelclair and offered our customers, including the wholesalers, the ability to purchase the product at the old price through the end of the month. As a result of purchases made by the wholesalers during the month, we have deferred recognition on a portion of those purchases to only recognize sales which the Company believes represent normal purchasing activity. We recognize sales allowances as a reduction of revenues in the same period the related revenue is recognized. Sales allowances are based on amounts owed or to be claimed on the related sales. These estimates take into consideration the terms of our agreements with wholesale distributors and the levels of inventory within the distribution channels that may result in future discounts taken. We must make significant judgments in determining these allowances. If actual results differ from our estimates, we will be required to make adjustments to these allowances in the future, which could have an effect on revenue in the period of adjustment. The following briefly describes the nature of each provision and how such provisions are estimated: · Payment discounts are reductions to invoiced amounts offered to customers for payment within a specified period and are estimated upon shipment utilizing historical customer payment experience. 21-------------------------------------------------------------------------------- · Although we do not have significant experience with its current products, the returns provision is based on management's return experience for similar products and is booked as a percentage of product sales recognized during the period. These recognized sales include shipments that have occurred out of wholesalers as well as direct shipments made by us to other third party purchasers. As the we gain greater experience with actual returns related to its specific products the returns provisions and related reserves will be adjusted accordingly. The returns reserve is recorded as a reduction of revenue in the same period the related product sales revenue is recognized and is included in accrued expenses. · Generally, credits may be issued to wholesalers for decreases that are made to selling prices for the value of inventory that is owned by the wholesaler at the date of the price reduction. Price adjustment credits are estimated at the time the price reduction occurs and the amount is calculated based on the level of the wholesaler inventory at the time of the reduction. · There are arrangements with certain parties establishing prices for products for which the parties independently select a wholesaler from which to purchase. Such parties are referred to as indirect customers. A chargeback represents the difference between the sales invoice price to the wholesaler and the indirect customer's contract price, which is lower. Provisions for estimating chargebacks are calculated primarily using historical chargeback experience, contract pricing and sales information provided by wholesalers and chains, among other factors. We recognize chargebacks in the same period the related revenue is recognized. Inventories Inventories at September 30, 2014 and December 31, 2013 were $242,057 and $104,089, respectively and consisted of finished goods. We state finished goods inventories at the lower of cost (which approximates actual cost on a first-in, first-out cost method) or market value. In evaluating whether inventories are stated at the lower of cost or market, management considers such factors as the amount of inventory on hand and in the distribution channel, estimated time required to sell such inventory, remaining shelf life, and current and expected market conditions, including levels of competition. Inventory adjustments are measured as the difference between the cost of the inventory and estimated market value based upon assumptions about future demand and charged to the provision for inventory, which is a component of cost of sales. At the point of the loss recognition, a new, lower-cost basis for that inventory is established, and any subsequent improvements in facts and circumstances do not result in the restoration or increase in that newly established cost basis. Income Taxes We use the liability method in accounting for income taxes as required by FASB ASC 740, Income Taxes. Under this method, deferred tax assets and liabilities are recognized for operating loss and tax credit carry forwards and for the future tax consequences attributable to the differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results of operations in the period that includes the enactment date. A valuation allowance is recorded to reduce the carrying amounts of deferred tax assets unless it is more likely than not that such assets will be realized. At September 30, 2014 and December 31, 2013 a valuation allowance has been recorded to reduce the net deferred tax asset to zero. Our policy for recording interest and penalties is to record them as a component of interest income (expense), net. The Internal Revenue Code provides limitations on utilization of existing net operating losses and tax credit carryforwards against future taxable income based upon changes in share ownership. We believe it is highly likely these changes have occured, and a significant portion of the net operating loss and R&D credit carryforwards could be impaired. Sales and Marketing Costs Sales and marketing costs consist of salaries, commissions, and benefits to sales and marketing personnel, sales personnel travel and operating costs, contract sales force costs including pass-throughs, marketing programs, administration costs and advertising costs. Research and Development Expenses We expense research and development costs as incurred. Research and development costs include personnel and personnel related costs, formulation and active pharmaceutical ingredient, "API", manufacturing costs, process development, research costs, patent costs, pharmacovigilence costs, PDUFA fees, regulatory costs and other consulting and professional services 22 -------------------------------------------------------------------------------- Valuation of Goodwill and Acquired Intangible Assets We have recorded goodwill and acquired intangible assets related to our 2012 acquisition of Oncogenerix and Soltamox. We have also recorded product license fees related to the Gelcair license. When identifiable intangible assets are acquired, we determine the fair values of the assets as of the acquisition date. The estimated residual value of our intangible assets with definite useful lives are amortized over their estimated useful lives and reviewed for impairment if certain events occur. Goodwill represents the excess of purchase price over fair value of net assets acquired in a business combination and is not amortized. Goodwill is subject to impairment testing at least annually or when a triggering event occurs that could indicate a potential impairment. We are organized as a single reporting unit and therefore the goodwill impairment test is done using our overall market value, as determined by our traded share price, as compared to our book value of net assets. We completed an impairment test as of September 30, 2014 and determined the carrying value of goodwill was not impaired. When we determine that the carrying value of long-lived assets may not be recoverable based upon the existence of one or more of the above indicators of impairment, we test for any impairment based on a projected undiscounted cash flow method. Projected future operating results and cash flows of the asset or asset group are used to establish the fair value used in evaluating the carrying value of long-lived and intangible assets. We estimate the expected future cash flows of the long-lived assets using current and long-term financial forecasts. Due to delays in execution of the original marketing plan, we determined that events and circumstances indicated that the Soltamox products rights intangible might be impaired as of September 30, 2014. The sum of the expected future net undiscounted cash flows to be generated from use of the product rights, over the remaining useful life of the asset (the same period over which the intangible is being amortized, or 3.8 years), was less than the carrying amount of the asset as of September 30, 2014. However, utilizing a probability weighted present value analysis, we determined that the fair value of the Soltamox product rights exceeded the carrying amount of the asset as of September 30, 2014. Accordingly, we have not recognized an impairment to the Soltamox product rights for the three and nine months ended September 30, 2014. Significant management judgment is required in the forecasting of future operating results that are used in our impairment evaluations. The estimates we have used are consistent with the plans and estimates that we use to manage our business. It is possible, however, that the plans may change and estimates used may prove to be inaccurate. If our actual results, or the plans and estimates used in future impairment analyses, are lower than the original estimates used to determine the fair value of these assets, we could incur future impairment charges. The impairment loss that could be recognized is the amount by which the carrying amount exceeds the fair value. Accrued Expenses As part of the process of preparing financial statements, we are required to estimate accrued expenses. This process involves reviewing open contracts and purchase orders, communicating with applicable personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when invoices have not yet been sent and we have not otherwise been notified of actual cost. The majority of our service providers invoice monthly in arrears for services performed. We make estimates of accrued expenses as of each balance sheet date in our financial statements based on facts and circumstances known to us. We periodically confirm the accuracy of our estimates with the service providers and make adjustments if necessary. Examples of estimated accrued expenses include: · fees paid to distribution providers; · fees paid to contract manufacturers in connection with the production of raw materials, drug substance and drug products; and · professional service fees. Share-Based Compensation Share-based compensation is accounted for using the fair value based method prescribed by Financial Accounting Standards Board Accounting Standards Codification 718 ("ASC 718, Compensation-Stock Compensation"). For stock and stock-based awards issued to employees, a compensation charge is recorded against earnings based on the fair value of the award. For transactions with non-employees in which services are performed in exchange for our common stock or other equity instruments, the transactions are recorded on the basis of the fair value of the service received or the fair value of the equity instruments issued, whichever is more readily measurable at the date of issuance. Please refer to Note 5 - Share Based Compensation, included in the condensed consolidated financial statements appearing elsewhere in this report, for additional information regarding our adoption of ASC 718. 23 -------------------------------------------------------------------------------- Significant Judgments and Estimates The preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles requires that we make estimates and assumptions that affect the reported amounts and disclosure of certain assets and liabilities at our balance sheet date. Such estimates include the carrying value of property and equipment and the value of certain liabilities. Actual results may differ from such estimates. Results of Operations Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013 Net revenues and cost of goods sold increased by $458,891 and $1,812 respectively from $138,886 and $124,052 respectively for the three months ended September 30, 2013, to $597,777 and $125,864 respectively for the three months ended September 30, 2014, due to increased sales and related cost of sales associated with the launch of the new Alamo salesforce in the first quarter of 2014. The cost of sales amount for the three months ended September 30, 2013 included approximately $81,000 of inventory write down costs associated with expiring inventory. Sales and marketing costs consist of salaries, commissions, and benefits to sales and marketing personnel, sales personnel travel and operating costs, contract sales force costs including pass-throughs, marketing programs, administration costs and advertising costs. Sales and marketing expense increased $15,200 from $1,084,731 for the three months ended September 30, 2013 to $1,099,931 for the corresponding 2014 period primarily as a result of the increase in sales force costs related to the sales force expansion with Alamo in the first quarter of 2014, offset by a reduction in marketing program costs. Research and development costs include personnel and personnel related costs, formulation and API manufacturing costs, process development, research costs, patent costs, pharmacovigilance costs, PDUFA fees, regulatory costs and other consulting and professional services. Research and development expenses decreased $69,865 from $453,024 for the three months ended September 30, 2013 to $383,159 for the corresponding 2014 period, primarily as a result of a decrease in formulation and API manufacturing costs associated with the KRN5500 program. The reformulation and manufacturing was completed during 2013 and there have been no related costs to date in 2014. General and administrative expenses consist primarily of salaries and benefits, professional fees and other costs related to administrative, finance, human resource, legal and information technology functions as well as the costs associated with listing, stock transfer and filings as a public company. In addition, general and administrative expenses include facility, basic operational and support costs and insurance costs. General and administrative expenses increased $66,460 from $937,621 for the three months ended September 30, 2013 to $1,004,081 for the corresponding 2014 period, primarily as a result of increased Nasdaq fees related to the issuance of shares during the year. Depreciation and amortization expense increased $213 from $159,577 for the three months ended September 30, 2013 to $159,790 for the corresponding 2014 period, primarily as a result of higher depreciation expense. Other (expense) income reflects non-operating activities associated with investments and dispositions on investments made in collaborations with other companies, as well as interest earned and expensed and other revenues not related to normal basic operations. Other (expense) income decreased $704 from $16,358 in expense for the three months ended September 30, 2013 to $15,654 in expense for the corresponding 2014 period as a result of a reduction in interest expense. Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013 Net revenues and cost of goods sold increased by $931,671 and $120,071 respectively from $237,002 and $150,313 respectively for the nine months ended September 30, 2013, to $1,168,673 and $270,384 for the nine months ended September 30, 2014, respectively due to increased sales and related cost of sales associated with the launch of the new Alamo sales force in the first quarter of 2014. Sales and marketing expense increased $1,032,551 from $2,669,882 for the nine months ended September 30, 2013 to $3,702,433 for the corresponding 2014 period primarily as a result of the increase in sales force costs related to the sales force expansion with Alamo in the first quarter of 2014. 24 -------------------------------------------------------------------------------- Research and development expenses decreased $584,086 from $1,646,425 for the nine months ended September 30, 2013 to $1,062,339 for the corresponding 2014 period, primarily as a result of a decrease in formulation and API manufacturing costs associated with the KRN5500 program. General and administrative expenses decreased $18,265 from $3,382,633 for the nine months ended September 30, 2013 to $3,364,368 for the corresponding 2014 period, primarily as a result of decreased professional services costs. Depreciation and amortization expense increased $6,320 from $471,500 for the nine months ended September 30, 2013 to $477,820 for the corresponding 2014 period, primarily as a result of higher amortization expense. Other (expense) income, net reflects non-operating activities associated with investments and dispositions on investments made in collaborations with other companies, as well as interest earned and expensed and other revenues not related to normal basic operations. Other income increased $36,933 from $141,787 for the nine months ended September 30, 2013 to $178,720 for the corresponding 2014 period, primarily as a result of approximately $147,000 in net increased license revenue recognized in other income during the first quarter of 2014 related to the sublicense of DB959 to T3D Therapeutics, Inc., partially offset by the 2013 gain of approximately $72,000 on the sale of the remainder of its marketable securities and the 2013 proceeds from an insurance policy of approximately $37,000. Liquidity and Capital Resources Overview From inception on June 22, 2002 through September 30, 2014, we have financed our operations primarily from the net proceeds of (1) registered direct offerings and private placements of equity securities, through which we raised $70,123,367 in net proceeds, and (2) the sale of marketable securities and securities held in subsidiary companies through which we raised $2,045,216 and $5,152,388, respectively. At September 30, 2014, our principal sources of liquidity were our cash and cash equivalents which totaled $14,002,175. As of September 30, 2014, we had net working capital of $12,629,435. Our cash resources have been used to acquire licenses, and to fund our working capital needs including financing of inventory purchases and accounts receivable, wholesaler and distribution costs, as well as research and development activities, capital expenditures, sales and marketing and general and administrative expenses. Cash Flows During the nine months ended September 30, 2014, cash used in our operating activities was $6,053,774. Cash used in operating activities was primarily due to the $7,529,951 consolidated net loss, an increase in accounts receivable of $288,683 and an increase in inventory of $137,968, which was partially offset by an increase in accounts payable and accrued liabilities of $544,918, a decrease in prepaid expenses and other assets of $180,743, non-cash stock-based compensation of $648,538 and depreciation and amortization of $477,821. During the nine months ended September 30, 2014, cash used in investing activities was $2,134 related to the purchase of fixed assets. During the nine months ended September 30, 2014, cash provided by financing activities was $16,632,540. We generated $16,777,425 of net cash from the offering of common stock, preferred stock and warrants during the period, which was partially offset by $144,880 of payments on capital leases and other financing agreements. Financial Condition and Outlook We believe we have sufficient working capital to continue our operations through 2015. However, we expect to require additional investment capital to pursue our future business plan. Our capital requirements will depend upon numerous factors, including our ability to generate revenue through our sales and marketing efforts as well as the level of costs we incur in building our portfolio of products and expanding our sales and marketing organization and our ability to license our technologies to third parties. Off-Balance Sheet Arrangements We had no off-balance sheet arrangements as of September 30, 2014. 25 -------------------------------------------------------------------------------- |