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EX-10.4 - EX-10.4 - Alexza Pharmaceuticals Inc.alxa-ex104_581.htm
EX-32.1 - EX-32.1 - Alexza Pharmaceuticals Inc.alxa-ex321_183.htm
EX-31.1 - EX-31.1 - Alexza Pharmaceuticals Inc.alxa-ex311_295.htm
EX-10.2 - EX-10.2 - Alexza Pharmaceuticals Inc.alxa-ex102_578.htm
EX-10.1 - EX-10.1 - Alexza Pharmaceuticals Inc.alxa-ex101_579.htm
EX-10.3 - EX-10.3 - Alexza Pharmaceuticals Inc.alxa-ex103_580.htm
EX-31.2 - EX-31.2 - Alexza Pharmaceuticals Inc.alxa-ex312_181.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

 

FORM 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2016

or

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                      

Commission File Number 000-51820

 

ALEXZA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

77-0567768

(State or other Jurisdiction of

Incorporation or Organization)

(IRS Employer

Identification No.)

 

 

2091 Stierlin Court

Mountain View, California

94043

(Address of principal executive offices)

(Zip Code)

 

(Registrant’s telephone number, including area code): (650) 944-7000

 

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  x    No  o

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o

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

 

Large accelerated filer

o

 

Accelerated filer

o

 

 

 

 

 

Non-accelerated filer

o

  (do not check if a smaller reporting company)

Smaller reporting company

x

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x

Total number of shares of common stock outstanding as of May 11, 2016: 21,750,615.

 

 

 


ALEXZA PHARMACEUTICALS, INC.

TABLE OF CONTENTS

 

 

page

PART I. FINANCIAL INFORMATION

 

 

 

Item 1.

Financial Statements

3

 

 

 

 

Condensed Consolidated Balance Sheets as of March 31, 2016 and December 31, 2015

3

 

 

 

 

Condensed Consolidated Statements of Loss and Comprehensive Loss for the three months ended March 31, 2016 and 2015

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the nine months ended March 31, 2016 and 2015

5

 

 

 

 

Notes to Condensed Consolidated Financial Statements

6

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

22

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

35

 

 

 

Item 4.

Controls and Procedures

35

 

 

PART II. OTHER INFORMATION

37

 

 

 

Item 1A.

Risk Factors

37

 

 

 

Item 1.

Legal Proceedings

71

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

71

 

 

 

Item 3.

Defaults Upon Senior Securities

71

 

 

 

Item 4.

Mine Safety Disclosures

71

 

 

 

Item 5.

Other Information

71

 

 

 

Item 6.

Exhibits

71

 

 

SIGNATURES

72

 

 

EXHIBIT INDEX

73

 

 

 


 

 

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

ALEXZA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

 

 

 

March 31,

 

 

December 31,

 

 

 

2016

 

 

2015(1)

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

4,502

 

 

$

7,755

 

Receivables

 

 

8

 

 

 

 

Prepaid expenses and other current assets

 

 

2,933

 

 

 

3,237

 

Total current assets

 

 

7,443

 

 

 

10,992

 

Property and equipment, net

 

 

2,749

 

 

 

3,320

 

Other assets

 

 

391

 

 

 

419

 

Total assets

 

$

10,583

 

 

$

14,731

 

LIABILITIES AND STOCKHOLDERS’ DEFICIT

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

851

 

 

$

442

 

Accrued clinical trial liabilities

 

 

179

 

 

 

178

 

Other accrued liabilities

 

 

8,133

 

 

 

6,990

 

Current portion of contingent consideration liability

 

 

1,100

 

 

 

900

 

Financing obligations, net of $1,047 and $5,034 debt discounts as of March 31, 2016 and

   December 31, 2015, respectively

 

 

47,953

 

 

 

46,840

 

Current portion of deferred revenues

 

 

2,136

 

 

 

2,848

 

Total current liabilities

 

 

60,352

 

 

 

58,198

 

Deferred rent

 

 

3,066

 

 

 

3,412

 

Noncurrent portion of contingent consideration liability

 

 

1,500

 

 

 

1,900

 

Noncurrent portion of financing obligations

 

 

20,000

 

 

 

21,127

 

Other noncurrent liabilities

 

 

 

 

 

1,752

 

Stockholders’ (deficit):

 

 

 

 

 

 

 

 

Preferred stock

 

 

 

 

 

 

Common Stock

 

 

2

 

 

 

2

 

Additional paid-in capital

 

 

361,295

 

 

 

360,610

 

Accumulated other comprehensive (loss) income

 

 

 

 

 

 

Accumulated deficit

 

 

(435,632

)

 

 

(432,270

)

Total stockholders’ deficit

 

 

(74,335

)

 

 

(71,658

)

Total liabilities and stockholders’ deficit

 

$

10,583

 

 

$

14,731

 

 

(1)

The condensed consolidated balance sheet at December 31, 2015 has been derived from audited consolidated financial statements at that date.

See accompanying notes to the financial statements.

 

 

3

 


 

 

ALEXZA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF LOSS AND COMPREHENSIVE LOSS

(in thousands, except per share amounts)

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2016

 

 

2015

 

 

 

 

 

 

 

 

 

 

Revenue

 

 

 

 

 

 

 

 

Collaboration revenue

 

$

720

 

 

$

618

 

Product sales

 

 

 

 

 

87

 

Total revenues

 

 

720

 

 

 

705

 

Cost of goods sold

 

 

945

 

 

 

6,147

 

Research and development

 

 

2,438

 

 

 

3,824

 

General and administrative

 

 

2,392

 

 

 

3,737

 

Total operating expenses

 

 

5,775

 

 

 

13,708

 

Loss from operations

 

 

(5,055

)

 

 

(13,003

)

Change in fair value of contingent consideration liability

 

 

200

 

 

 

14,833

 

Gain on restructuring of financing obligations

 

 

2,506

 

 

 

 

Gain on fair value of inventory received resulting from restructuring of financing obligations

 

 

945

 

 

 

 

Interest and other income/expense, net

 

 

2

 

 

 

(5

)

Interest expense

 

 

(1,960

)

 

 

(2,229

)

Net loss

 

$

(3,362

)

 

$

(404

)

Net loss per share - basic and diluted

 

$

(0.16

)

 

$

(0.02

)

Shares used to compute net loss per share - basic and diluted

 

 

20,807

 

 

 

19,750

 

Other Comprehensive Loss

 

 

 

 

 

 

 

 

Change in unrealized (loss) income on marketable securities

 

 

 

 

 

2

 

Comprehensive loss

 

$

(3,362

)

 

$

(402

)

 

See accompanying notes to the financial statements.

 

 

4

 


 

 

ALEXZA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2016

 

 

2015

 

 

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net loss

 

$

(3,362

)

 

$

(404

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

Share-based compensation expense

 

 

110

 

 

 

388

 

Change in fair value of contingent consideration liability

 

 

(200

)

 

 

(14,833

)

Gain on restructuring of financing obligations

 

 

(2,506

)

 

 

-

 

Gain on fair value of inventory received resulting from restructuring of financing obligations

 

 

(945

)

 

 

 

 

Amortization of debt discount, deferred interest

 

 

576

 

 

 

642

 

Amortization of discount on available-for-sale securities

 

 

 

 

 

50

 

Depreciation and amortization

 

 

571

 

 

 

879

 

Impairment of property and equipment

 

 

 

 

 

1,381

 

Impairment of inventory

 

 

945

 

 

 

1,229

 

Impairment of prepaid expenses

 

 

 

 

 

1,024

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Receivables

 

 

(8

)

 

 

74

 

Inventory

 

 

 

 

 

28

 

Prepaid expenses and other current assets

 

 

95

 

 

 

(293

)

Other assets

 

 

28

 

 

 

165

 

Accounts payable

 

 

409

 

 

 

(234

)

Accrued clinical trial expense and other accrued liabilities

 

 

1,092

 

 

 

(2,140

)

Deferred revenues

 

 

(712

)

 

 

(613

)

Other liabilities

 

 

(346

)

 

 

(77

)

Net cash used in operating activities

 

 

(4,253

)

 

 

(12,734

)

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Purchase of  available-for-sale securities

 

 

 

 

 

(5,442

)

Maturities of  available-for-sale securities

 

 

 

 

 

13,540

 

Net cash (used in) provided by investing activities

 

 

 

 

 

8,098

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Payment of contingent payment to Symphony Allegro Holdings, LLC

 

 

 

 

 

 

(867

)

Change in restricted cash

 

 

 

 

 

 

1,396

 

Proceeds from financing obligations

 

 

1,000

 

 

 

 

Net cash provided by financing activities

 

 

1,000

 

 

 

529

 

Net decrease in cash and cash equivalents

 

 

(3,253

)

 

 

(4,107

)

Cash and cash equivalents at beginning of period

 

 

7,755

 

 

 

15,200

 

Cash and cash equivalents at end of period

 

$

4,502

 

 

$

11,093

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to the financial statements.

 

 

5

 


 

 

ALEXZA PHARMACEUTICALS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. The Company and Basis of Presentation

Business

We were incorporated in the state of Delaware on December 19, 2000 as FaxMed, Inc., changed our name to Alexza Corporation in June 2001 and in December 2001 became Alexza Molecular Delivery Corporation. In July 2005, we changed our name to Alexza Pharmaceuticals, Inc.

We are a pharmaceutical company focused on the research, development, and commercialization of novel proprietary products for the acute treatment of central nervous system conditions. We operate in one business segment. Our facilities and employees are currently located in the United States.

 

As further described under note 13, Subsequent Events, below, on May 9, 2016, we entered into an Agreement and Plan of Merger, or the Merger Agreement, with Grupo Ferrer Internacional, S.A., a Spanish sociedad anonima, or Ferrer, and Ferrer Pharma Inc., a Delaware corporation and a wholly owned indirect subsidiary of Ferrer, or Purchaser, and upon the terms and subject to the conditions thereof, Purchaser has agreed to commence a cash tender offer to acquire all of the shares of our common stock (excluding any shares of our common stock held, directly or indirectly, by Ferrer), or the Offer. Following the consummation of the Offer, the Merger Agreement provides that Purchaser will merge with and into us, or the Merger, and we will become a wholly owned subsidiary of Ferrer.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly our interim condensed consolidated financial information. The results for the three months ended March 31, 2016 are not necessarily indicative of the results to be expected for the year ending December 31, 2016 or for any other interim period or any other future year.

The accompanying unaudited condensed consolidated financial statements and notes to condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2015 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 28, 2016.

Basis of Consolidation

The unaudited condensed consolidated financial statements include our accounts and those of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

 

 

2. Need to Raise Additional Capital

We have incurred significant losses from operations since inception and expect losses to continue for the foreseeable future. As of March 31, 2016, we had cash and cash equivalents of $4,502,000 and a working capital deficiency of $52,909,000. The working capital deficiency is primarily the result of the classification of our royalty securitization financing as a current liability. Our operating and capital plans call for cash expenditures to exceed cash and cash equivalent balances for the next twelve months.

We plan to finance our operations through partnership or licensing collaborations, the sale of equity securities, debt arrangements, a potential sale or disposition of one or more corporate assets or a strategic business combination or partnership, and we have engaged Guggenheim Securities, LLC to assist us in exploring such strategic options to enhance stockholder value. Such funding or potential transaction may not be available or may be on terms that are not favorable to us. Our inability to raise capital as and when needed could have a negative impact on our financial condition and our ability to continue as a going concern. If we become unable to continue as a going concern, we may have to liquidate our assets, and might realize significantly less than the values at which they are carried on our financial statements, and stockholders may lose all or part of their investment in our common stock. Based on our available cash resources, the additional $2,300,000 drawn in April and May 2016 under that certain promissory note we issued to

6

 


 

 

Ferrer as amended, or the Ferrer Note, and our expected cash usage, we estimate that we have sufficient capital resources to meet our anticipated cash needs until the end of June 2016.

In February 2016, we entered into a definitive agreement with Teva Pharmaceuticals USA, Inc. or Teva, whereby (i) we reacquired the ADASUVE commercial U.S. rights that we had licensed to Teva under that certain License and Collaboration Agreement we executed with Teva in May 2013, or the Teva Amendment, and (ii) restructured our obligations under the outstanding convertible promissory note from Teva, or the Amended Teva Note. The Teva Amendment is intended to allow us to continue to provide ADASUVE product to patients and health care providers either on our own or through another unaffiliated partner, at which time all Teva license rights to ADASUVE would terminate. The Amended Teva Note, provided for (i) the issuance of 2,172,886 shares of our common stock to Teva pursuant to a stock issuance agreement as consideration for a reduction in the outstanding balance of the Amended Teva Note by $5,000,000 and forgiveness of all accrued and unpaid interest under the Amended Teva Note; (ii) the contingent repayment of remaining $20,000,000 outstanding balance of the Amended Teva Note in four annual consecutive payments of $5,000,000 beginning on January 31 of the first calendar year following the calendar year in which the aggregate annual net sales of ADASUVE and any other Staccato enabled products first reach $50,000,000 in the United States; (iii) the elimination of the conversion feature and (iv) the prepayment of the outstanding balance of the Amended Teva Note at any time without penalty. Refer to Note 8 - Financing Obligations for further discussion on the Teva Note.

 

As further described under note 13, Subsequent Events, below, on May 9, 2016, we entered into the Merger Agreement pursuant to which  Purchaser  has agreed to commence a cash  tender  offer  to acquire all of the shares of our common stock (excluding  any  shares  of  our  common  stock  held,  directly  or  indirectly,  by  Ferrer)  pursuant  to  the  Offer. Following the consummation of the Offer, the Merger Agreement provides that Purchaser will merge with and into us in the Merger, and we will become a wholly owned subsidiary of Ferrer. There can be no assurance that the Offer or the Merger will be consummated.

The significant uncertainties surrounding any revenue from sales of ADASUVE, including royalties and milestone payments from our present and future collaborations, clinical development timelines and costs and the need to raise a significant amount of capital raises substantial doubt about our ability to continue as a going concern for a reasonable period of time. These consolidated financial statements have been prepared with the assumption that we will continue as a going concern and will be able to realize our assets and discharge our liabilities in the normal course of business and do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from our inability to continue as a going concern.  In order to mitigate the risk related with this uncertainty, we plan to issue debt or additional shares of our common stock for cash and services or enter into additional collaborations or a strategic transaction during the next twelve months.  There is no assurance we will able to raise sufficient capital on acceptable terms, or at all, to continue commercialization efforts for ADASUVE, continue development of our product candidates or to otherwise continue operations or that we will be able to execute any strategic transaction. Even if we are able to source additional capital, we may be forced to significantly reduce our operations if our business prospects do not improve. If we are unable to source additional capital, we may be forced to shut down operations altogether.

 

3. Summary of Significant Accounting Policies

Revenue Recognition

We recognize revenue when (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the fee is fixed or determinable; and (iv) collectability is reasonably assured.

For collaboration agreements, revenues for non-refundable upfront license fee payments, where we continue to have performance obligations, are recognized as performance occurs and obligations are completed. Revenues for non-refundable upfront license fee payments where we do not have significant future performance obligations are recognized when the agreement is signed and the payments are due.

For multiple element arrangements, such as collaboration agreements in which a collaborator may purchase several deliverables, we account for each deliverable as a separate unit of accounting if both of the following criteria are met: (i) the delivered item or items have value to the customer on a standalone basis; and (ii) for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. We evaluate how the consideration should be allocated among the units of accounting and allocate revenue to each non-contingent element based upon the relative selling price of each element. We determine the relative selling price for each deliverable using (i) vendor-specific objective evidence, or VSOE, of selling price if it exists; (ii) third-party evidence, or TPE, of selling price if it exists; or (iii) our best estimated selling price for that deliverable if neither VSOE nor TPE of selling price exists for that deliverable. We then recognize the revenue allocated to each element when the four basic revenue criteria described above are met for each element.

7

 


 

 

For milestone payments received in connection with our collaboration agreements, we have elected to adopt the milestone method of accounting under Financial Accounting Standards Board Accounting Standards Codification 605-28, Milestone Method. Under the milestone method, revenues for payments which meet the definition of a milestone will be recognized as the respective milestones are achieved.

We recognize product revenue as follows:

 

·

Persuasive Evidence of an Arrangement. We currently sell product through a license and supply agreement with our collaborator, Ferrer. Persuasive evidence of an arrangement is generally determined by the receipt of an approved purchase order from the collaborator in connection with the terms of the license and supply agreement.

 

·

Delivery. Typically, ownership of the product passes to the collaborator upon shipment. Our current license and supply agreement also provides Ferrer with an acceptance period during which they may reject any product which does not conform to agreed-upon specifications. Because ADASUVE is a new product, a new technology and our first product to be commercialized, and because we do not have a history of producing product to collaborator specifications, we will not consider delivery to have occurred until after the collaborator acceptance period has ended or the collaborator has positively accepted the product. Once we have demonstrated over the course of time an ability to reliably produce the product to collaborator specifications, we will consider delivery to have occurred upon shipment in the absence of any other relevant shipment or acceptance terms.

 

·

Sales Price Fixed or Determinable. Sales prices for product shipments are determined by the license and supply agreement and documented in the purchase orders. After the collaborator acceptance period has ended or the collaborator has positively accepted the product, our collaborator does not have any product return or replacement rights, including for expired products.

 

·

Collectability. Payment for the product is contractually obligated under the license and supply agreement. We will monitor payment histories for our collaborator and specific issues as they arise to determine whether collection is probable for a specific transaction and defer revenue as necessary.

Royalty revenue from our collaboration agreement will be recognized as we receive information from our collaborator regarding product sales and collectability is reasonably assured.

Significant management judgment is used in the determination of revenue to be recognized and the period in which it is recognized.

Inventory

Inventory is stated at standard cost, which approximates actual cost, determined on a first-in first-out basis, not in excess of market value. Inventory includes the direct costs incurred to manufacture products combined with allocated manufacturing overhead, which consists of indirect costs, including labor and facility overhead. The carrying cost of inventory is reduced so as to not be in excess of the market value of the inventory as determined by the contractual transfer prices to Ferrer and Teva. The excess over the market value is expensed to cost of goods sold. If information becomes available that suggests that all or certain of the inventory may not be realizable, we may be required to expense a portion, or all, of the capitalized inventory into cost of goods sold.

We have fulfilled all of the orders we received from Teva and Ferrer for commercial units of ADASUVE for the near and medium term. As a result, we have suspended our commercial production operations (Refer to Note 3 – Summary of Significant Accounting Policies) and there is no certainty as to when we will resume ADASUVE commercial production or if we can secure additional resources to fund our future operations.

In February 2016, we reacquired the ADASUVE commercial U.S. rights under the Teva Amendment through an exclusive, royalty-free sub-license arrangement in exchange for the termination of all future milestone and royalty obligations that Teva had under the original agreement. As part of this exchange, all remaining ADASUVE inventory held by Teva was transferred to us along with a right to resell such inventory for up to one year. The Teva Amendment is intended to allow us to continue to provide ADASUVE product to patients and health care providers either on our own or through another unaffiliated partner, at which time the all Teva license rights to ADASUVE would terminate. We accounted for the sub-license rights and the receipt of inventory under ASC 845, Nonmonetary Transaction. We concluded that the cost of the inventory transferred to us shall be based on the fair value of the inventory received as its fair value is more clearly evident than the fair value of the future milestone and royalty obligations relinquished. The fair value of the inventory received was determined to be $945,000 with an offsetting gain on exchange that is

8

 


 

 

reflected as a non-operating line item within our consolidated statements of loss and comprehensive loss. However, given our continued operating losses, the uncertainty of when we will resume commercial production, the limited ability to sell the inventory, the twelve-month expiration of this inventory, and our ability to continue as a going concern, we subsequently fully impaired the inventory we received by recording a $945,000, or $0.05 per share, impairment charge that was included in our cost of goods sold within our consolidated statements of loss and comprehensive loss for the three months ended March 31, 2016. Our inventory was fully reserved as of December 31, 2015 and March 31, 2016.

Contingencies

From time to time, we are involved in lawsuits, arbitrations, claims, investigations and proceedings that arise in the ordinary course of business. We make provisions for liabilities when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. No such provisions have been made for the periods presented herein. Litigation and related matters are inherently unpredictable. If any unfavorable ruling were to occur in any specific period, there exists the possibility of a material adverse impact on the results of operations of that period or on our cash flows and liquidity.

Recent Accounting Pronouncements

In August 2014, the Financial Accounting Standards Board issued the Accounting Standards Update, or ASU, No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 requires management to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. In doing so, companies will have reduced diversity in the timing and content of footnote disclosures than under the current guidance. Refer to Note 2 – Need to Raise Additional Capital regarding our discussion on our ability to continue as a going concern.

In May 2014, the Financial Accounting Standards Board issued the ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), that will supersede nearly all existing revenue recognition guidance under US GAAP. The core principle of the guidance is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. The standard will be effective for public entities for annual and interim periods beginning after December 15, 2017. Entities can choose to apply the standard using either the full retrospective approach or a modified retrospective approach. Entities electing the full retrospective adoption will apply the standard to each period presented in the financial statements. This means that entities will have to apply the new guidance as if it had been in effect since the inception of all its contracts with customers presented in the financial statements. Entities that elect the modified retrospective approach will apply the guidance retrospectively only to the most current period presented in the financial statements. This means that entities will have to recognize the cumulative effect of initially applying the new standard as an adjustment to the opening balance of retained earnings at the date of initial application. The new revenue standard will be applied to contracts that are in progress at the date of initial application.

In April 2015, the Financial Accounting Standards Board issued ASU 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 simplifies the presentation of debt issuance costs by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This new guidance is effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years. This guidance has no material impact on the results of our consolidated financial position, results of operations and cash flows. We have presented our financing obligations net of the related debt issuance costs as of March 31, 2016 and December 31, 2015.

In July 2015, the Financial Accounting Standards Board issued ASU No. 2015-14, which delays the effective date of the standard for one year to annual periods beginning after December 15, 2017, with early adoption permitted for annual periods beginning after December 15, 2016. We are evaluating the requirements of this guidance and have not yet determined the impact of its adoption on our consolidated financial position, results of operations and cash flows.

In February 2016, the Financial Accounting Standards Board issued ASU 2016-02, Leases (Topic 842) which supersedes FASB ASC Topic 840, Leases (Topic 840) - and provides principles for the recognition, measurement, presentation and disclosure of leases for both lessees and lessors. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee, which will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than twelve months regardless of classification. Leases with a term of twelve months or less will be accounted for similar to existing

9

 


 

 

guidance for operating leases. The standard is effective for annual and interim periods beginning after December 15, 2018, with early adoption permitted upon issuance. We are evaluating the requirements of this guidance and have not yet determined the impact of its adoption on our consolidated financial position, results of operations and cash flows.

 

 

4. Fair Value Accounting

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Three levels of inputs, of which the first two are considered observable and the last unobservable, may be used to measure fair value. The three levels are:

 

·

Level 1 — Quoted prices in active markets for identical assets or liabilities.

 

·

Level 2 — Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

·

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table represents the fair value hierarchy for our financial assets (cash equivalents, marketable securities and restricted cash) by major security type and contingent consideration liability measured at fair value on a recurring basis as of March 31, 2016 and December 31, 2015 (in thousands):

 

March 31, 2016

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

4,408

 

 

$

 

 

$

 

 

$

4,408

 

Total assets

 

$

4,408

 

 

$

 

 

$

 

 

$

4,408

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contingent consideration liability

 

$

 

 

$

 

 

$

2,600

 

 

$

2,600

 

Total liabilities

 

$

 

 

$

 

 

$

2,600

 

 

$

2,600

 

 

December 31, 2015

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Total

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

6,806

 

 

$

 

 

$

 

 

$

6,806

 

Total assets

 

$

6,806

 

 

$

 

 

$

 

 

$

6,806

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contingent consideration liability

 

$

 

 

$

 

 

$

2,800

 

 

$

2,800

 

Total liabilities

 

$

 

 

$

 

 

$

2,800

 

 

$

2,800

 

 

Cash equivalents and marketable securities

The amortized cost, fair value and unrealized gain/(loss) for our financial assets by major security type as of March 31, 2015 and December 31, 2015 are as follows (in thousands):

 

 

 

Amortized

 

 

 

 

 

 

Unrealized

 

March 31, 2016

 

Cost

 

 

Fair Value

 

 

Gain/(Loss)

 

Money market funds

 

$

4,408

 

 

$

4,408

 

 

$

 

Total

 

 

4,408

 

 

 

4,408

 

 

 

 

Less amounts classified as cash equivalents

 

 

(4,408

)

 

 

(4,408

)

 

 

 

Total marketable securities

 

$

 

 

$

 

 

$

 

 

10

 


 

 

 

 

Amortized

 

 

 

 

 

 

Unrealized

 

December 31, 2015

 

Cost

 

 

Fair Value

 

 

Gain/(Loss)

 

Money market funds

 

$

6,806

 

 

$

6,806

 

 

$

 

Total

 

 

6,806

 

 

 

6,806

 

 

 

 

Less amounts classified as cash equivalents

 

 

(6,806

)

 

 

(6,806

)

 

 

 

Total marketable securities

 

$

 

 

$

 

 

$

 

 

We had no sales of marketable securities during the three months ended March 31, 2016 or 2015.

Contingent Consideration Liability

In connection with the exercise of our option to purchase all of the outstanding equity of Symphony Allegro, Inc., or Allegro, in 2009, we are obligated to make contingent cash payments to the former Allegro stockholders related to certain payments received by us from future collaboration agreements pertaining to ADASUVE/AZ-104 (Staccato loxapine) or AZ-002 (Staccato alprazolam). In order to estimate the fair value of the liability associated with the contingent cash payments, we prepared several cash flow scenarios for ADASUVE, AZ-104 and AZ-002, which are subject to the contingent payment obligation. Each potential cash flow scenario consisted of assumptions of the range of estimated milestone and license payments potentially receivable from such collaborations and assumed royalties received from future product sales. Based on these estimates, we computed the estimated payments to be made to the former Allegro stockholders. Payments were assumed to terminate in accordance with current agreement terms or, if no agreements exist, upon the expiration of the related patents.

The projected cash flow assumptions for ADASUVE in the United States are based on internally and externally developed product sales forecasts. The timing and extent of the projected cash flows for ADASUVE for the territories in which ADASUVE is licensed to Ferrer, or the Ferrer Territories are based on a Collaboration, License and Supply Agreement we executed with Ferrer in October 2011, or the Ferrer Agreement. The timing and extent of the projected cash flows for the remaining territories for ADASUVE and worldwide territories for AZ-002 and AZ-104 were based on internal estimates for potential milestones and multiple product royalty scenarios and are also consistent in structure to the most recently negotiated collaboration agreements.

We then assigned a probability to each of the cash flow scenarios based on several factors, including: the product candidate’s stage of development, preclinical and clinical results, technological risk related to the successful development of the different drug candidates, estimated market size, market risk and potential collaboration interest to determine a risk adjusted weighted average cash flow based on all of these scenarios. These probability and risk adjusted weighted average cash flows were then discounted utilizing our estimated weighted average cost of capital, or WACC. Our WACC considered our cash position, competition, risk of substitute products, and risk associated with the financing of the development projects. We have used a discount rate of 20% since the fourth quarter of 2014 to reflect our current estimated WACC based on our current financial condition, market capitalization and our estimated increase in borrowing costs.

The fair value measurement of the contingent consideration liability is based on significant inputs not observed in the market and thus represents a Level 3 measurement. Level 3 measurements are valued based on unobservable inputs that are supported by little or no market activity and reflect our assumptions in measuring fair value.

We record any changes in the fair value of the contingent consideration liability in earnings in the period of the change. Certain events including, but not limited to, the timing and terms of any collaboration agreement, clinical trial results, approval or non-approval of any future regulatory submissions and the commercial success of ADASUVE, AZ-104 or AZ-002 could have a material impact on the fair value of the contingent consideration liability, and as a result, our results of operations and financial position for the impacted period.

During the three months ended March 31, 2016, we updated the discounted cash flow model to reflect adjusted U.S. ADASUVE milestones and royalties with any future U.S. collaborator and adjusted sales milestones for ADASUVE in the Ferrer Territories. These changes resulted in our recognizing a non-operating, non-cash gain of $200,000, or $0.009 per share during the three months ended March 31, 2016.

During the three months ended March 31, 2015, we updated the discounted cash flow model to reflect adjusted ADASUVE sales projections and the projected timing of the receipt of certain milestone payments. As part of this process, we received updated projections from our collaboration partners in late March, 2015 that indicated sales of ADASUVE would be lower in 2015 and 2016 than had been anticipated in the various projections and scenarios used to estimate the contingent consideration liability in previous

11

 


 

 

periods. As a result of these lower projected sales and the decision to suspend our commercial production operations (see Note 12), we reevaluated the rate at which we believe sales will increase, the amount of peak sales, the period of time it will take to reach peak sales, the number of years at which peak sales would be achieved, and the related impact on the amount and timing of related royalties and milestones to be received. This evaluation resulted in a decrease to projected sales and the related milestones and royalties under the high, medium, and low sales scenarios and a heavier weighting to the lower sales scenario. These changes on the discounted cash flow model resulted in a decrease to our net loss of $14,833,000, or $0.75 per share, for the three months ended March 31, 2015. A payment of $867,000 was made during the same period to the former Allegro stockholders.

The following table represents a reconciliation of the change in the fair value measurement of the contingent consideration liability for the three months ended March 31, 2016 and 2015 (in thousands):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2016

 

 

2015

 

Beginning balance

 

$

2,800

 

 

$

30,800

 

Payments made

 

 

 

 

 

(867

)

Adjustments to fair value measurement

 

 

(200

)

 

 

(14,833

)

Ending balance

 

$

2,600

 

 

$

15,100

 

 

Financing Obligations

We have estimated the fair value of our financing obligations (Refer to Note 8 –Financing Obligations) using the net present value of the payments discounted at an interest rate that is consistent with our estimated current borrowing rate for similar long-term debt. We believe the estimates used to measure the fair value of the financing obligations constitute Level 3 inputs.

At March 31, 2016 and December 31, 2015, the estimated fair value of our financing obligations was $50,028,000 and $52,151,000, respectively, and had book values of $67,953,000 and $67,967,000, respectively. Our payment commitments associated with these debt instruments may vary with changes in interest rates and are comprised of interest payments and principal payments. The estimated fair value of our debt will fluctuate with movements of interest rates, increasing in periods of declining rates of interest and declining in periods of increasing rates of interest. In addition, the fair value of our royalty securitization financing will be affected by the timing and amount of U.S. ADASUVE royalties and milestones.

 

 

5. Share-Based Compensation Plans

2015 Equity Incentive Plan

 

In April 2015, our Board of Directors approved the 2015 Equity Incentive Plan, or the 2015 Plan, and authorized for issuance thereunder (i) an additional 1,000,000 shares of common stock plus (ii) the number of shares available for issuance pursuant to the grant of future awards under our 2005 Equity Incentive Plan determined as of the effective date of the 2015 Plan; plus (iii) the number of shares underlying outstanding stock awards granted under our previous stock option plans prior to the effective date of the 2015 Plan that expire or terminate for any reason prior to exercise or settlement, are forfeited or repurchased because of the failure to meet a contingency or condition required to vest such shares, or are reacquired, withheld (or not issued) to satisfy a tax withholding obligation in connection with an award. The 2015 Plan became effective upon the approval of the plan by our stockholders on June 23, 2015. Due to the effectiveness of our 2015 Plan, no additional awards will be made under our previous stock option plans. All outstanding awards under our previous stock option plans will continue to be subject to the terms and conditions as set forth in the agreements evidencing such stock awards and the terms of the applicable plan. Stock options issued under the 2015 Plan generally vest over 4 years; vesting is generally based on service time, and have a maximum contractual term of 10 years.

 

2015 Non-Employee Directors’ Stock Option Plan

 

In April 2015, our Board of Directors adopted the 2015 Non-Employee Directors’ Stock Option Plan, or the 2015 Directors’ Plan, and authorized for issuance thereunder and (i) an additional 250,000 shares of common stock plus (ii) the number of shares available for issuance pursuant to the grant of future awards under our previous non-employee directors stock option plan determined as of the effective date of the 2015 Directors’ Plan; plus (iii) the number of shares underlying outstanding stock awards granted under our previous non-employee directors stock option plan prior to the effective date of the 2015 Directors’ Plan that expire or terminate for any reason prior to exercise or settlement, are forfeited or repurchased because of the failure to meet a contingency or condition

12

 


 

 

required to vest such shares, or are reacquired, withheld (or not issued) to satisfy a tax withholding obligation in connection with an award. The 2015 Directors’ Plan became effective upon the approval of the plan by our stockholders on June 23, 2015. Due to the effectiveness of our 2015 Directors’ Plan, no additional awards will be made under our previous non-employee directors’ stock option plan. The 2015 Directors’ Plan provides for the automatic grant of nonstatutory stock options to purchase shares of common stock to our non-employee directors, which vest over approximately one year and have a term of 10 years.

The following table sets forth the summary of option activity under our share-based compensation plans (the 2015 Plan, the 2005 Equity Incentive Plan, the 2015 Directors’ Plan and the 2005 Non-Employee Directors’ Stock Option Plan) for the three months ended March 31, 2016:

 

 

 

Outstanding Options

 

 

 

Number of

 

 

Weighted Average

 

 

 

Shares

 

 

Exercise Price

 

Outstanding at January 1, 2016

 

 

2,326,401

 

 

$

4.23

 

Options granted

 

 

27,500

 

 

 

0.69

 

Options exercised

 

 

 

 

 

 

Options forfeited

 

 

 

 

 

 

Options cancelled

 

 

(214,482

)

 

 

(9.73

)

Outstanding at March 31, 2016

 

 

2,139,419

 

 

$

3.64

 

 

There were no options exercised during the three months ended March 31, 2016 and 2015.

The following table sets forth the summary of restricted stock units, or RSUs, activity under our share-based compensation plans for the three months ended March 31, 2016:

 

 

 

 

 

 

 

Weighted Average

 

 

 

Number of

 

 

Grant Date

 

 

 

Shares

 

 

Fair Value

 

Outstanding at January 1, 2016

 

 

36,950

 

 

$

4.67

 

Granted

 

 

 

 

 

 

Released

 

 

 

 

 

 

Forfeited

 

 

(3,250

)

 

 

4.67

 

Outstanding at March 31, 2016

 

 

33,700

 

 

$

4.67

 

 

At March 31, 2016, RSUs to purchase 13,725 shares of common stock were vested but unreleased. These RSUs will be released upon opening of the trading window.

As of March 31, 2016, 2,683,289 and 410,000 shares remained available for issuance under the 2015 Plan and the 2015 Directors’ Plan, respectively.

2015 Employee Stock Purchase Plan

In April 2015, our Board of Directors adopted the 2015 Employee Stock Purchase Plan, or 2015 ESPP, and authorized for issuance thereunder (i) an additional 500,000 shares of our common stock plus (ii) the 128,249 additional shares, that remained available for issuance under our previous employee stock purchase plan after all outstanding purchase rights under such plan were exercised in October 2015. The 2015 ESPP allows eligible employee participants to purchase shares of our common stock at a discount through payroll deductions. The terms of any offering period under the 2015 ESPP will be determined by our Board of Directors. Purchases are generally made on the last trading day of each November and May. Employees may purchase shares at each purchase date at 85% of the market value of our common stock at either the beginning of the offering period or the end of the purchase period, whichever price is lower. Our previous employee stock purchase plan remained in effect until the conclusion of our previous offering, which concluded in October 2015.

As of March 31, 2016, 628,249 shares were available for issuance under the 2015 ESPP.

 

 

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6. Share-Based Compensation

Employee Share-Based Awards

Compensation cost for employee share-based awards is based on the grant-date fair value and is recognized over the vesting period of the applicable award on a straight-line basis. We issue employee share-based awards in the form of stock options and restricted stock units under our equity incentive plans, and stock purchase rights under the 2015 ESPP (see Note 5).

Valuation of Stock Options, Stock Purchase Rights and Restricted Stock Units

During the three months ended March 31, 2016 and 2015, the per share weighted average fair value of employee stock options granted were as follows:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2016

 

 

2015

 

Stock Options

 

$

0.44

 

 

$

1.29

 

Restricted Stock Units

 

 

 

 

 

 

Stock Purchase Rights

 

 

0.41

 

 

 

0.67

 

 

The estimated grant date fair values of the stock options and stock purchase rights were calculated using the Black-Scholes valuation model, and the following weighted average assumptions:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2016

 

 

2015

 

Stock Option Plans

 

 

 

 

 

 

 

 

Weighted-average expected term

 

5.0 Years

 

 

5.0 Years

 

Expected volatility

 

 

80%

 

 

 

85%

 

Risk-free interest rate

 

 

1.52%

 

 

 

1.40%

 

Dividend yield

 

 

0%

 

 

 

0%

 

 

 

 

 

 

 

 

 

 

Employee Stock Purchase Plan

 

 

 

 

 

 

 

 

Weighted-average expected term

 

0.6 Years

 

 

0.5 Years

 

Expected volatility

 

 

75%

 

 

 

60%

 

Risk-free interest rate

 

 

0.33%

 

 

 

1.62%

 

Dividend yield

 

 

0%

 

 

 

0%

 

 

The estimated fair value of restricted stock unit awards is calculated based on the market price of our common stock on the date of grant, reduced by the present value of dividends expected to be paid on our common stock prior to vesting of the restricted stock unit. Our estimate assumes no dividends will be paid prior to the vesting of the restricted stock unit.

As of March 31, 2016, there was $1,478,000, $70,000, and $1,000 of total unrecognized compensation expense related to unvested stock option awards, unvested restricted stock units and stock purchase rights, respectively, which are expected to be recognized over a weighted average period of 2.8 years, 1.0 years, and 0.02 years, respectively.

We had no share-based compensation capitalized at March 31, 2016 and it was immaterial at March 31, 2015.

 

 

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7. Net Loss per Share

Basic and diluted net loss per share is calculated by dividing the net loss by the weighted-average number of common shares outstanding for the period. The following items were excluded in the net loss per share calculation for the three months ended March 31, 2016 and 2015 because the inclusion of such items would have had an anti-dilutive effect:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2016

 

 

2015

 

Stock Options

 

 

2,168,917

 

 

 

1,913,263

 

Restricted stock units

 

 

48,745

 

 

 

79,588

 

Warrants to purchase common stock

 

 

5,688,278

 

 

 

5,918,943

 

Convertible debt

 

 

4,422,222

 

 

 

5,382,363

 

 

 

8. Financing Obligations

Teva Pharmaceuticals USA, Inc.

In May 2013, concurrent with our execution of a License and Collaboration Agreement with Teva, or the Teva Agreement (refer to Note 9 – License Agreements), we entered into a Convertible Promissory Note and Agreement to Lend with Teva, or the Teva Note. Under the terms of the Teva Note, we had the ability, upon written notice to Teva, to draw upon the Teva Note to fund agreed operating budgets related to ADASUVE. As of December 31, 2015, the aggregate drawdowns totaled $25,000,000 and are due and payable, together with all interest, on the fifth anniversary of the signing of the Teva Note. Under the Teva Note, at any time prior to five days before the maturity date, Teva has the right to convert the then outstanding amounts into shares of our common stock at a conversion price of $4.4833 per share. The Teva Note bears simple interest of 4% per year.

At the time of the drawdowns, the contractual conversion price was less than the value of our common stock. As a result, at each draw down date, we calculated the value of the beneficial conversion feature of the convertible note and recorded an increase to additional paid-in-capital and a discount on the Teva Note which was being amortized to interest expense over the life of the borrowing. Additionally, at each draw, we reclassified the relative portion of the unamortized right-to-borrow asset, classified as an Other Asset, against the Teva Note, which was also being amortized to interest expense over the life of the borrowing.

As we drew on the Teva Note, the relative portion of the unamortized right-to-borrow was accounted for as a discount on the borrowing and was amortized to interest expense over the life of the borrowing. The right-to-borrow asset had been fully reclassified against the Teva Note in 2014.

In February 2016, we entered into the Amended Teva Note, which provided for (i) the issuance of 2,172,886 shares of our common stock to Teva pursuant to a stock issuance agreement as consideration for a reduction in the outstanding balance of the Amended Teva Note by $5,000,000 and forgiveness of all accrued and unpaid interest under the Amended Teva Note; (ii) the contingent repayment of the remaining $20,000,000 outstanding balance of the Amended Teva Note in four annual consecutive payments of $5,000,000 on January 31 of the calendar year following the calendar year in which the aggregate annual net sales of ADASUVE and any other Staccato enabled products first reach $50,000,000 in the United States; and (iii) we may prepay the outstanding balance of the Amended Teva Note. We assessed the note restructuring under ASC 470, Debt, and concluded that the transaction qualified as a troubled debt restructuring as defined by the accounting literature, as we are experiencing financial difficulty and the Amended Teva Note contained a concession through a reduction in the effective interest rate from 5.2 percent to zero percent. At the date of restructuring, the carrying amount of the Teva Note was $23,081,000. As the restructuring involved a partial settlement by us granting Teva an equity interest and a modification of the terms of the remaining Teva Note, we reduced the carrying amount of the Amended Teva Note by $575,000, which represents the fair value of the 2,172,886 shares of our common stock granted to Teva based on the $0.28 per share price as of the restructuring date, net of $33,000 in direct issuance costs. The remaining carrying amount of $22,506,000 was then written down to $20,000,000, which represents the total future undiscounted cash payments of the Amended Teva Note and consist entirely of the contingent repayments, resulting in a restructuring gain of $2,506,000, or $0.12 per share as reflected on our consolidated statements of loss and comprehensive loss. The remaining outstanding balance of $20,000,000 of the Amended Teva Note is classified as a non-current liability as of March 31, 2016.

Royalty Securitization Financing

In March 2014, we completed a royalty securitization financing, or the royalty securitization financing, which consisted of a private placement to qualified institutional investors of $45,000,000 of non-recourse notes, or the Notes, issued by Atlas U.S. Royalty,

15

 


 

 

LLC, a Delaware limited liability company and our wholly-owned subsidiary, or Atlas, and warrants to purchase 345,661 shares of our common stock at a price of $0.01 per share exercisable for five years from the date of issuance, or the 2014 Warrants. The Notes bear interest at 12.25% per annum payable quarterly beginning June 15, 2014. All U.S. ADASUVE royalty and milestone payments, after paying interest, administrative fees, and any applicable taxes, will be applied to principal and interest payments on the Notes until the Notes have been paid in full.

From the proceeds of the transaction, we established a $6,890,000 interest reserve account, which is classified as a noncurrent asset, to cover any potential shortfall in interest payments. The interest reserve account was fully utilized in 2015 to pay for interest related to our royalty securitization financing.

In connection with our royalty securitization financing, we sold and contributed to Atlas all of our rights to U.S. ADASUVE royalty and milestone payments. The Notes are secured by all of the assets of Atlas (including the right to receive royalty and milestone payments based on commercial sales of ADASUVE in the U.S.) and our equity ownership in Atlas. The Notes have no other recourse to us. The Notes may not be redeemed at our option until after March 18, 2016, and may be redeemed after that date subject to the achievement of certain milestones and the payment of a redemption premium for any redemption occurring prior to March 19, 2019. The Notes are not convertible into Alexza equity, nor have we guaranteed them.

 

In connection with the execution of the Merger Agreement, the holders of the Notes each entered into a participation agreement with Atlas pursuant to which Atlas agreed to grant to the holders of the Notes contractual rights to receive payments from Atlas upon the receipt of certain payments and achievement of certain milestones in respect of the commercialization of ADASUVE within the Unites States.

We valued the 2014 Warrants utilizing the Black-Scholes valuation model with an assumed volatility of 87%, an estimated life of 5 years, a 1.54% risk-free interest rate and a dividend rate of 0%. The total value of the 2014 Warrants, $1,721,000, was recognized as an increase to additional paid in capital and as a discount to the Notes. The discount on the Notes is being amortized into interest expense over five-years. We incurred total fees and expenses of $4,171,000, which we recorded as a noncurrent Other Asset, and are amortizing into interest expense over a five-year period.

 

In the fourth quarter of 2015, we did not make the quarterly interest payment due on December 15, 2015 for the Notes.  As a result, we received a notice of event of default from the trustee. The aggregate interest payments that were in default were approximately $4,262,000, which includes the interest due and payable since September 15, 2015. In January 2016, we entered into a forbearance agreement with the holders of the Notes whereby such holders would generally forbear from delivering an acceleration notice and exercising other remedies under the Notes for thirty day renewing periods through June 15, 2016. In connection with the execution of the Merger Agreement, we entered into a Forbearance and Waiver Agreement, or the Second Forbearance Agreement, with Atlas, Purchaser and the holders of the 2014 Warrants and the Notes. Pursuant to the terms of  the Second Forbearance Agreement, the holders of the Notes agreed (i) to forbear on exercising all rights and remedies under that certain Indenture by and between Atlas and U.S. Bank National Association, as the trustee, or the Indenture, and the other documentation  relating  to the Notes and  Atlas through  the earlier  of November  9, 2016 (subject to extension under certain circumstances) and the termination  of the Merger Agreement and (ii) to ratify certain amendments to the Teva Agreement. Pursuant to the terms of the Second Forbearance Agreement, the holders of the Notes also agreed to the cancellation of the Notes and the discharge of the Indenture in connection with the consummation of the Offer and to take any and all actions necessary to effect the foregoing.   In addition, the holders of the 2014 Warrants agreed to the treatment of the 2014 Warrants in connection with the Offer as described in the Merger Agreement effective as of the Merger. Each of the holders of the Notes, the holders of the 2014 Warrants, Atlas and us also agreed to certain releases of claims effective upon the consummation of the Offer or, in the case of claims with respect to Purchaser and its affiliates, upon the execution of the Second Forbearance Agreement.

As a result of our default and the short forbearance time period, the principal balance of $45,000,000 and the amortization of the debt discounts of $1,021,000 related to the 2014 Warrants were reclassified from non-current liabilities to current liabilities since the fourth quarter of 2015. Additionally, the deferred interest charges associated with the royalty securitization financing that were being amortized over five years were reclassified from non-current assets to other current assets as of March 31, 2016, consistent with the related debt.

Ferrer Promissory Note

In September 2015, we issued the Ferrer Note to Ferrer. The terms of the Ferrer Note provided that (i) Ferrer would loan us up to $5,000,000 in tranches, (ii) the initial tranche of $3,000,000 was received by us on September 28, 2015, (iii) another tranche of $1,000,000 was received by us on March 21, 2016, (iv) the third tranche of $1,000,000 was received by us on April 15, 2016, (v) interest accrues on the outstanding principal at the rate of 6% per annum, compounded monthly, through May 31, 2016, (vi) all outstanding principal and accrued interest under the Ferrer Note became due and payable upon Ferrer’s demand on May 31, 2016, (vii) we could prepay the Ferrer Note at any time without premium or penalty, and (viii) we issue 125,000 shares of our common stock

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to Ferrer as partial consideration for the loan. The common stock was issued to Ferrer pursuant to a stock issuance agreement and was not registered at the time of issuance under the Securities Act of 1933, as amended.

On May 9, 2016, we amended and restated the Ferrer Note in order to, among other things (i) increase the maximum principal amount of the Ferrer Note to $6,300,000, (ii) extend the maturity date of the Ferrer Note to September 30, 2016 and (iii) provide for certain events of default under the Ferrer Note in connection with the Merger. As of May 11, 2016, the outstanding principal amount of the Ferrer Note was $6,300,000.

We valued the common stock issued to Ferrer at approximately $144,000 using the closing price of our common stock on the date we issued the stock to Ferrer. Based on the percent of the maximum principal amount of the Ferrer Note drawdown through March 31, 2016, 80% of the value of the common stock issued to Ferrer was proportionately recorded as a discount to the Ferrer Note and 20% was capitalized as a current asset on our consolidated Balance Sheet as of March 31, 2016. With the third tranche and the final tranche of the Ferrer Note drawn in April 2016 and May 2016, respectively, the remaining balance of the capitalized amount will be reclassified as a debt discount against the remaining tranches. The amount of $144,000 is being amortized over the life of the Ferrer Note. The effective interest rate of the Ferrer Note, including the value of the shares issued, is 10.5%.

Future Scheduled Payments

Future scheduled principal payments under our various debt obligations as of March 31, 2016 are as follows (in thousands):

 

 

 

Total

 

2016 - remaining 9 months

 

$

4,000

 

2017

 

 

 

2018

 

 

 

2019

 

 

 

Thereafter

 

 

20,000

 

Total

 

$

24,000

 

 

 

The above table excludes the third tranche of $1,000,000 and the final tranche of $1,300,000 from the Ferrer Note that we received in April and May 2016, respectively, plus any payments pursuant to the Notes issued by Atlas, which have a legal maturity date in 2027. The principal payments by Atlas under the royalty securitization financing will be dependent upon the timing and amounts of royalties and milestone payments received from any future U.S. collaborator. We are obligated to repay the remaining $20,000,000 outstanding balance of the Amended Teva Note in four annual consecutive payments of $5,000,000 beginning on January 31 of the first calendar year following the calendar year in which the aggregate annual net sales of ADASUVE and any other Staccato enabled products first reach $50,000,000 in the United States.

 

 

9. Facility Leases

We lease a building in Mountain View, California which we began to occupy in the fourth quarter of 2007. We recognize rental expense on the facility on a straight line basis over the initial term of the lease. Differences between the straight line rent expense and rent payments are classified as deferred rent liability on the balance sheet. The lease for the building expires on March 31, 2018, and we have two options to extend the lease for five years each.

 

 

10. License Agreements

Grupo Ferrer Internacional, S.A.

On October 5, 2011, we and Ferrer entered into the Ferrer Agreement to commercialize ADASUVE in the Ferrer Territories (Europe, Latin America, the Commonwealth of Independent States countries, the Middle East and North Africa countries, Korea, Philippines and Thailand). Under the terms of the Ferrer Agreement, we received an upfront cash payment of $10,000,000, of which $5,000,000 was paid to the former stockholders of Allegro. The Ferrer Agreement provided for up to an additional $51,000,000 in additional milestone payments, contingent on approval of the EU Marketing Authorization Application, or MAA, certain individual country commercial sales initiations and royalty payments based on cumulative net sales targets in the Ferrer Territories. The MAA was submitted to the European Medicines Agency, or EMA, and was approved in February 2013 by the European Commission, or the EC. Ferrer has the exclusive rights to commercialize the product in the Ferrer Territories. We supply ADASUVE to Ferrer for all of its commercial sales, and receive a specified per-unit transfer price paid in Euros. Either party may terminate the Ferrer Agreement for

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the other party’s uncured material breach or bankruptcy. The Ferrer Agreement continues in effect on a country-by-country basis until the later of the last to expire patent covering ADASUVE in such country or 12 years after first commercial sale. The Ferrer Agreement is subject to earlier termination in the event the parties mutually agree, by a party in the event of an uncured material breach by the other party or upon the bankruptcy or insolvency of either party.

In October 2014, we entered into an amendment to the Ferrer Agreement. We and Ferrer agreed to eliminate certain individual country commercial sales initiation milestone payments in exchange for Ferrer’s purchase of 2,000,000 shares of our common stock for $4.00 per share for a total of $8,000,000, which reflected a premium on the fair value of our common stock of approximately $2,400,000. In January 2015, we paid the former shareholders of Allegro $865,000 related to this stock sale.

In June 2015, we entered into another amendment to the Ferrer Agreement. We and Ferrer agreed to: (i) transfer ownership of the MAA to Ferrer, whereby Ferrer becomes responsible for all post-approval requirements of the MAA, including the post-authorization safety study, the drug utilization study and the Phase 3 clinical trial for adolescents and all other related regulatory activities and costs associated with the ADASUVE MAA, (ii) provide Ferrer an option to manufacture ADASUVE in the Ferrer Territories as well as for use by us in territories other than the U.S., Canada, China, Hong Kong, Taiwan and Macao, and if Ferrer does not exercise this option, we have the right to assign the ADASUVE manufacturing right to a third party, subject to Ferrer’s written consent, not to be unreasonably withheld, (iii) eliminate the remaining milestones related to first commercial sales in selected countries, and (iv) provide Ferrer with the right to access technology and develop a Staccato product of their choice to commercialize in the Ferrer Territories, with Ferrer paying a fixed royalty percentage on all sales of new Staccato products developed by Ferrer. The transfer of the MAA for ADASUVE to Ferrer was completed in August 2015.

We evaluated whether the delivered elements under the Ferrer Agreement, as amended, have value on a stand-alone basis and allocated revenue to the identified units of accounting based on relative fair value. We determined that the license and the development and regulatory services are a single unit of accounting as the licenses were determined not to have stand-alone value. We have begun to deliver all elements of the arrangement and are recognizing the $10,000,000 upfront payment as revenue ratably over the estimated performance period of the agreement of four years. The $1,452,000 and $2,400,000 premiums received from the sales of common stock to Ferrer are additional consideration received pursuant to the Ferrer Agreement and does not pertain to a separate deliverable or element of the arrangement, and thus is being deferred and recognized as revenue in a manner consistent with the $10,000,000 upfront payment.

The Ferrer Agreement, as amended, provides for us to receive up to $40,000,000 of additional payments related to cumulative net sales targets in the Ferrer Territories. The cumulative net sales targets will be recognized as royalty revenue when each target is earned and payable to us. We believe each of these milestones is substantive as there is uncertainty that the milestones will be met, the milestone can only be achieved as a result of our past performance and the achievement of the milestone will result in additional payment to us. In January 2014, we recognized revenue in the amount of $1,000,000 from a milestone payment for the first product sale in Spain, of which $250,000 was paid to the former stockholders of Allegro (Refer to Note 3 – Summary of Significant Accounting Policies).

We recognized $712,000 and $612,000 of revenue related to the Ferrer Agreement, as amended, in the three months ended March 31, 2016 and 2015, respectively. At March 31, 2016 we had deferred revenue of $2,136,000 related to the Ferrer Agreement, as amended.

Teva Pharmaceuticals USA, Inc.

In May 2013, we entered into the Teva Agreement to provide Teva with an exclusive license to develop and commercialize ADASUVE in the United States.

In February 2016, we entered into the Teva Amendment which is intended to allow us to continue to provide ADASUVE product to patients and health care providers and provides for (i) the transfer of the New Drug Application, or NDA, and related regulatory filings for ADASUVE to us and the assumption of responsibility by us for all regulatory activities related to ADASUVE in the U.S. as soon as practicable; (ii) an exclusive license of Teva intellectual property with respect to ADASUVE, which intellectual property will be assigned to us in connection with a change of control or an exclusive license to ADASUVE in the U.S. from us to a third party; (iii) our undertaking of responsibility for the ADASUVE United States Phase 4 study, product pharmacovigilance, medical services, and REMS compliance, either through Teva’s vendors or a vendor otherwise selected by us; (iv) the transfer from Teva of existing supplies of ADASUVE as well as all commercial, medical and academic materials, documents and relationships; (v) our right to sell Teva-labeled products in accordance with all applicable laws and Teva policies; (vi) the satisfaction and termination of all payment obligations of the parties with respect to the commercialization of ADASUVE except with respect to the Amended Teva

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Note and our issuance of 2,172,886 shares of our common stock to Teva; and (vii) a mutual release between the parties with respect to claims under the Teva Agreement.

 

 

11. Autoliv Manufacturing and Supply Agreement

In November 2007, we entered into a Manufacturing and Supply Agreement, or the Manufacture Agreement, with Autoliv relating to the commercial supply of chemical heat packages that can be incorporated into our Staccato device, or the Chemical Heat Packages. Autoliv had developed these Chemical Heat Packages for us pursuant to a development agreement between Autoliv and us.

Subject to certain exceptions, Autoliv has agreed to manufacture, assemble and test the Chemical Heat Packages solely for us in conformance with our specifications. We pay Autoliv a specified purchase price, which varies based on annual quantities we order, per Chemical Heat Package delivered. Upon termination of the Manufacture Agreement, we were to retain full ownership of the production equipment for commercial manufacture of the Chemical Heat Packages developed for us by Autoliv, and Autoliv’s obligations under the Manufacture Agreement will terminate in full. In December 2014, we amended the Manufacture Agreement with Autoliv, or the 2014 Amendment through which we and Autoliv are extending the Manufacturing Agreement through 2018. In addition, we have the right to engage a second source supplier and implement a manufacturing line transfer from Autoliv to manufacture and supply the Chemical Heat Packages to us or our licensees.

We have contracted with Autoliv, through a third-party supplier, to build one additional manufacturing cell to manufacture chemical heat packages at a cost of approximately $2.4 million, or the New Cell. The New Cell was expected to be installed at Autoliv with the cell currently being utilized by Autoliv, or the Original Cell, to be installed at a second source supplier. Due to the Original Cell no longer being utilized and the uncertainty of the timing of engaging a second source supplier (see Note 12), we recorded additional cost of goods sold of $1,381,000 in the three months ended March 31, 2015 due to the impairment of the Original Cell. The $1,381,000 impairment reduced the carrying amount of this cell to $0, which we believe is the fair value of this equipment and is a level 3 fair value measurement. The equipment is specialized and was developed specifically for the manufacture of ADASUVE and would be of limited, if any, utility to a third-party. Thus, we concluded that given the decreased projections of ADASUVE sales and the related decline in production noted below in Note 12, as well as the limited ability to sell this equipment, that its fair value is $0. The New Cell will be utilized if and when commercial production resumes. We did not record additional impairment charges during the three months ended March 31, 2016.

 

 

12. Restructuring

As of December 31, 2015, we completed the commercial production and shipment of all ADASUVE orders received from Teva and Ferrer. With commercial production completed, we suspended our ADASUVE commercial manufacturing operations.

During the fiscal year ended December 31, 2015, we concluded that due to (i) the suspension of the ADASUVE commercial production operations during the third quarter of 2015, (ii) our continued operating losses and poor cash flows, (iii) the uncertainty of when we will resume commercial production, (iv) the limited ability to sell the capitalized equipment, and (v) our basic ability to continue as a going concern,  the carrying amounts of our long-lived assets including the first and second manufacturing cells from Autoliv ASP, Inc., or Autoliv, exceeded their fair values based on a Level 3 fair value measurement. We recognized non-cash impairment charges of approximately $1,381,000 on our long-lived assets, $1,229,000 of related inventory with fixed expiration dates, and $1,024,000 on prepayments made to the supplier of our lower housing assembly for fiscal year 2015. During the fourth quarter of 2015, we had recognized an additional $7,210,000 of impairment charges on our long-lived assets.

We did not record any long-lived asset impairment during the three months ended March 31, 2016.

Due to our reacquisition of the ADASUVE commercial U.S. rights under the Teva Amendment, all remaining ADASUVE inventory held by Teva was transferred to us along with a right to resell such inventory for up to one year. The Teva Amendment is intended to allow us to continue to provide ADASUVE product to patients and health care providers either on our own or through another unaffiliated partner, at which time all Teva license rights to ADASUVE would terminate. We accounted for the sub-license rights and the receipt of inventory under ASC 845, Nonmonetary Transaction. We concluded that the cost of the inventory transferred to us shall be based on the fair value of the inventory received as its fair value is more clearly evident than the fair value of the future milestone and royalty obligations relinquished. The fair value of the inventory was determined to be $945,000 recorded as a gain on exchange that is reflected as a non-operating line item within our consolidated statements of loss and comprehensive loss. However, given our continued operating losses, the uncertainty of when we will resume commercial production, the limited ability to sell the inventory, the twelve-month expiration of this inventory and our ability to continue as a going concern, we subsequently fully

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impaired the inventory we received by recording a $945,000, or $0.05 per share, impairment charge that was included in our cost of goods sold within our consolidated statements of loss and comprehensive loss. Our inventory was fully reserved as of December 31, 2015 and March 31, 2016.

As part of our restructuring plan, we eliminated 33 employees during 2015. Each affected employee received (i) severance payments equal to three months of salary plus an additional amount equal to one week of salary for each year of Alexza service in excess of five years; and (ii) three months of paid medical insurance premiums and outplacement services, or in total, the Severance Package. In addition, our remaining employees have received notification that their positions may be eliminated. If we are unable to obtain additional financing and further restructure our operations, the remaining employees will receive benefits substantially equivalent to the Severance Package. The aggregate cost of the Severance Package for these employees is being amortized over the period in which the employees are expected to provide service. During the three months ended March 31, 2016, we recognized $235,000 of severance related expenses and none in first quarter of 2015. We have accrued $1,707,000 in severance related expenses as of March 31, 2016.

 

 

13. Subsequent Events

On April 15, 2016, we received the third tranche of $1,000,000 from the Ferrer Note. On May 9, 2016, we amended and restated the Ferrer Note in order to, among other things (i) increase  the maximum principal amount of the Ferrer Note to $6,300,000, (ii) extend the maturity date of the Ferrer Note to September 30, 2016, and (iii) provide for certain events of default under the Ferrer Note in connection with the Merger. We received the final tranche of $1,300,000 on May 11, 2016 which brought the principal balance outstanding on the Ferrer Note to $6,300,000.

On May 9, 2016, we entered into the Merger Agreement with Ferrer and Purchaser. Pursuant to the Merger Agreement, and upon the terms and subject to the conditions thereof, Purchaser has agreed to commence the Offer for a purchase price of $0.90 per share, net to the holders thereof in cash, subject to reduction for any applicable withholding taxes in respect thereof, without interest, or the Cash Consideration, plus one contractual contingent value right per share of our common stock, or a CVR, which shall represent the right to receive a pro-rata share of up to four payment categories in an aggregate (i.e., to all CVR holders assuming all four payments are made) maximum amount of $35,000,000 (subject to certain deductions) if certain licensing payments and revenue milestones are achieved and subject to the terms and conditions of the contingent value rights agreement to be entered into by Ferrer and the rights agent thereunder prior to the closing of the Offer, net to the holder thereof in cash, subject to reduction for any applicable withholding taxes in respect thereof, without interest, or together with the Cash Consideration, the Offer Price. On May 9, 2016, both our board of directors and the board of directors of Ferrer approved the terms of the Merger Agreement. Prior to entering into the Merger Agreement, Ferrer was the holder of greater than 10% of our outstanding voting securities and the Ferrer Note and our commercial partner for ADASUVE in the Ferrer Territories.

 

The consummation of the Offer will be conditioned on (i) at least a number of shares of our common stock having been validly tendered into and not withdrawn from the Offer which equals, when added to any shares of our common stock owned by Ferrer or Purchaser or any of their respective subsidiaries, at least a majority of the then outstanding shares of our common stock, (ii) the accuracy of the representations and warranties contained in the Merger Agreement, subject to certain qualifications, (iii) our performance certain covenants contained in the Merger Agreement, subject to certain conditions, (iv) the Second Forbearance Agreement  continuing in full force and effect, without any default, and performance of any required condition thereunder, as of the closing of the Offer, (v) the aggregate number of shares of our common stock held by persons who properly exercise appraisal rights under Section 262 of the Delaware General Corporate Law represents no more than 20% of the shares of our common stock then outstanding and (vi) other customary conditions. The Offer is not subject to a financing condition.

 

Following the consummation of the Offer, the Merger Agreement provides that Purchaser will merge with and into us in the Merger, and we will become a wholly owned subsidiary of Ferrer Therapeutics, Inc., a Delaware corporation and subsidiary of Ferrer. In the Merger, each outstanding share of our common stock (other than shares owned by Ferrer, us or Purchaser or any of their direct or indirect wholly owned subsidiaries and shares with respect to which appraisal rights are properly exercised in accordance with Delaware law) will be converted into the right to receive the Offer Price. The consummation of the Merger is subject to certain closing conditions.

 

The transactions described above are expected to close in the second quarter of 2016 and are subject to customary closing conditions.

 

In addition, in connection with the transactions contemplated by the Merger Agreement, the vesting of all our unvested options and unvested restricted stock units will be accelerated to be vested in full and, with respect to the options, immediately exercisable at

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least six days prior to the closing of the Offer.  Any options that are not exercised prior to the closing of the Offer will be cancelled. Additionally, pursuant to the terms of the Merger Agreement, (i) each holder of a warrant originally issued by us on October 5, 2009 or February 23, 2012 will receive a lump-sum cash payment equal to (A) the total number of shares of our common stock issuable to such holder upon the exercise of the applicable warrant, multiplied by (B) the value of such warrant to purchase one share of our common stock, calculated in accordance with Appendix B of such warrant; and (ii) each holder of the 2014 Warrants will receive (A) a lump-sum cash payment equal to (1) the total number of shares of our common stock issuable to such holder upon the exercise of the applicable warrant, multiplied by (2) the excess of (x) the Cash Consideration over (y) the per-share exercise price for such warrant and (B) one CVR for each share of our common stock underlying such warrant.

 

The Merger Agreement contains customary representations, warranties and covenants of the parties. We have agreed to refrain from engaging in certain activities until the effective time of the Merger. In addition, under the terms of the Merger Agreement, we have agreed not to solicit or support any alternative acquisition proposals, subject to customary exceptions for us to respond to and support unsolicited proposals in the exercise of the fiduciary duties of our board of directors. We are obligated to pay a termination fee of $1,000,000 to Ferrer in certain circumstances following termination of the Merger Agreement.  Additionally, if either we or Ferrer terminate the Merger Agreement in accordance with its terms, then all outstanding unpaid principal and accrued interest owed on the Ferrer Note by us will become immediately due and payable to Ferrer.

 

In connection with the execution of the Merger Agreement, we entered into the Second Forbearance Agreement with Atlas, Purchaser and the holders of the 2014 Warrants and the Notes. Pursuant to the terms of the Second Forbearance Agreement, the holders of the Notes agreed (i) to forbear on exercising all rights and remedies under the Indenture and the other documentation relating to the Notes and Atlas through the earlier of November 9, 2016 (subject to extension under certain circumstances) and the termination of the Merger Agreement and (ii) to ratify certain amendments to the Teva Agreement.  Pursuant to the terms of the Second Forbearance Agreement, the holders of the Notes also agreed to the cancellation of the Notes and the discharge of the Indenture in connection with the consummation of the Offer and to take any and all actions necessary to effect the foregoing.  In addition, the holders of the 2014 Warrants agreed to the treatment of the 2014 Warrants in connection with the Offer as described in the Merger Agreement effective as of the Merger.  Each of the holders of the Notes, the holders of the 2014 Warrants, Atlas and us also agreed to certain releases of claims effective upon the consummation of the Offer or, in the case of claims with respect to Purchaser and its affiliates, upon the execution of the Second Forbearance Agreement.

In connection with the execution of the Merger Agreement, the holders of the Notes each entered into a participation agreement with Atlas pursuant to which Atlas agreed to grant to the holders of the Notes contractual rights to receive payments from Atlas upon the receipt of certain payments and achievement of certain milestones in respect of the commercialization of ADASUVE within the Unites States.

 

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Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. In some cases, you can identify forward-looking statements by the following words: “may,” “will,” “could,” “would,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue,” “ongoing” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. Examples of these statements include, but are not limited to, statements regarding: our ability and the ability of Purchaser and Ferrer to complete the transactions contemplated by the Merger Agreement, including the parties’ ability to satisfy the conditions to the consummation of the Merger, the possibility of any termination of the Merger Agreement and the timing and completion of the Merger, the adequacy of our capital to support our operations through June 2016, the ability of us and our collaborator to effectively and profitably commercialize ADASUVE estimated product revenues and royalties associated with the sales of ADASUVE, the timing of the commercial launch of ADASUVE in various countries, our ability to raise additional funds and the potential terms of such potential financings, our collaborators’ ability to implement and assess the ADASUVE REMS program, the timing and outcome of the ADASUVE post-marketing studies, the prospects of our receiving approval to market ADASUVE in additional Latin American countries, the Commonwealth of Independent States countries and other countries, our ability to identify and complete a new commercial agreement for ADASUVE in the U.S., the efficiencies to be gained by the suspension of certain manufacturing operations, the implications of interim or final results of our other clinical trials, the progress and timing of our research programs, including clinical testing, the extent to which our issued and pending patents may protect our products and technology, the potential of our product candidates to lead to the development of safe or effective therapies, our ability to enter into collaborations, our future operating expenses, our future losses, our future expenditures and the sufficiency of our cash resources. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. While we believe that we have a reasonable basis for each forward-looking statement contained in this Quarterly Report, we caution you that these statements are based on a combination of facts and factors currently known by us and our projections of the future, about which we cannot be certain.

The following discussion and analysis should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

The names “Alexza Pharmaceuticals,” “Alexza,” “Staccato” and “ADASUVE” are trademarks of Alexza Pharmaceuticals, Inc. We have registered these trademarks with the U.S. Patent and Trademark Office and other international trademark offices. All other trademarks, trade names and service marks appearing in this Quarterly Report on Form 10-Q are the property of their respective owners.

We are a pharmaceutical company focused on the research, development and commercialization of novel proprietary products for the acute treatment of central nervous system conditions. The Staccato® system, our proprietary technology, is the foundation for our first approved product, ADASUVE® (Staccato loxapine), and all of our product candidates. The Staccato system vaporizes excipient-free drugs to form a condensation aerosol that, when inhaled, allows for rapid systemic drug delivery. Because of the particle size of the aerosol, the drug is quickly absorbed through the deep lung into the bloodstream, providing speed of therapeutic onset that is comparable to intravenous, or IV, administration but with greater ease, patient comfort and convenience.

ADASUVE has been developed for the treatment of agitation associated with schizophrenia or bipolar disorder and has been approved for marketing in the United States by the U.S. Food and Drug Administration, or FDA, in the European Union, or EU, by the European Commission, or the EC, and in certain countries in Latin America. In the United States, the EU and Latin America, ADASUVE is approved for similar indications. It is approved with a different number of dose strengths and has different risk mitigation and management plans in the United States, the EU and Latin America. ADASUVE is our only approved product.

We have two product candidates in active development. AZ-002 (Staccato alprazolam) is being developed for the management of epilepsy patients with acute repetitive seizures, sometimes called cluster seizures, or ARS. A Phase 2a proof-of-concept study for AZ-002 in patients with epilepsy was initiated in January 2015. AZ-007 (Staccato zaleplon) is being developed for the treatment of patients with middle of the night insomnia. We do not anticipate further clinical development of AZ-007 without obtaining additional capital resources..

We have retained all rights to the Staccato system and to our product candidates other than ADASUVE and AZ-104 (Staccato loxapine, low-dose). In May 2013, we licensed the exclusive rights for the U.S. markets to commercialize ADASUVE and AZ-104, or

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the Teva Agreement, to Teva Pharmaceuticals USA, Inc., or Teva. In February 2016, we amended the Teva Agreement, or the Teva Amendment, whereby we reacquired the ADASUVE U.S. commercial rights through an exclusive, royalty-free sub-license arrangement in exchange for the termination of all future milestone and royalty obligations that Teva had under the original agreement. As part of this exchange, all remaining ADASUVE inventory held by Teva was transferred to us along with a right to resell such inventory for up to one year. The Teva Amendment is intended to allow us to continue to provide ADASUVE product to patients and health care providers either on our own or through another unaffiliated partner, at which time all Teva license rights to ADASUVE would terminate.

For Europe, Latin America and the Commonwealth of Independent States countries, or the Ferrer Territories, we have licensed the exclusive rights to commercialize ADASUVE to Grupo Ferrer Internacional S.A., or Ferrer. We intend to develop certain product candidates internally and to identify external resources or collaborators to develop and commercialize other product candidates.

On May 9, 2016, we entered into an Agreement and Plan of Merger, or the Merger Agreement, with Ferrer and Ferrer Pharma Inc., a Delaware corporation and a wholly owned indirect subsidiary of Ferrer, or Purchaser, and upon the terms and subject to the conditions thereof, Purchaser has agreed to commence a cash tender offer to acquire all of the shares of our common stock (excluding any shares of our common stock held, directly or indirectly, by Ferrer), or the Offer, for a purchase price of $0.90 per share, net to the holders thereof in cash, subject to reduction for any applicable withholding taxes in respect thereof, without interest, or the Cash Consideration, plus one contractual contingent value right per share of our common stock, or a CVR, which shall represent the right to receive a pro-rata share of up to four payment categories in an aggregate (i.e., to all CVR holders assuming all four payments are made) maximum amount of $35.0 million (subject to certain deductions) if certain licensing payments and revenue milestones are achieved and subject to the terms and conditions of the contingent value rights agreement to be entered into by Ferrer and the rights agent thereunder prior to the closing of the Offer, net to the holder thereof in cash, subject to reduction for any applicable withholding taxes in respect thereof, without interest, or together with the Cash Consideration, the Offer Price. On May 9, 2016, both our board of directors and the board of directors of Ferrer approved the terms of the Merger Agreement. Prior to entering into the Merger Agreement, Ferrer was the holder of greater than 10% of the Company’s outstanding voting securities and the Ferrer Note and our commercial partner for ADASUVE in the Ferrer Territories.

 

The consummation of the Offer will be conditioned on (i) at least a number of shares of our common stock, having been validly tendered into and not withdrawn from the Offer which equals, when added to any shares of our common stock owned by Ferrer or Purchaser or any of their respective subsidiaries, at least a majority of the then outstanding shares of our common stock, (ii) the accuracy of the representations and warranties contained in the Merger Agreement, subject to certain qualifications, (iii) our performance certain covenants contained in the Merger Agreement, subject to certain conditions, (iv) the Second Forbearance Agreement (as defined below) continuing in full force and effect, without any default, and performance of any required condition thereunder, as of the closing of the Offer, (v) the aggregate number of shares of our common stock held by persons who properly exercise appraisal rights under Section 262 of the Delaware General Corporate Law represents no more than 20% of the shares of our common stock then outstanding and (vi) other customary conditions. The Offer is not subject to a financing condition.

 

Following the consummation of the Offer, the Merger Agreement provides that Purchaser will merge with and into us in the Merger and we will become a wholly owned subsidiary of Ferrer Therapeutics, Inc., a Delaware corporation and subsidiary of Ferrer. In the Merger, each outstanding share of our common stock (other than shares owned by Ferrer, us or Purchaser or any of their direct or indirect wholly owned subsidiaries and shares with respect to which appraisal rights are properly exercised in accordance with Delaware law) will be converted into the right to receive the Offer Price. The consummation of the Merger is subject to certain closing conditions.

 

In addition, in connection with the transactions contemplated by the Merger Agreement, the vesting of all our unvested options and unvested restricted stock units will be accelerated to be vested in full and, with respect to the options, immediately exercisable at least six days prior to the closing of the Offer.  Any options that are not exercised prior to the closing of the Offer will be cancelled. Additionally, pursuant to the terms of the Merger Agreement, (i) each holder of a warrant originally issued by us on October 5, 2009 or February 23, 2012 will receive a lump-sum cash payment equal to (A) the total number of shares of our common stock issuable to such holder upon the exercise of the applicable warrant, multiplied by (B) the value of such warrant to purchase one share of our common stock, calculated in accordance with Appendix B of such warrant; and (ii) each holder of a warrant originally issued by us on March 8, 2014, or the 2014 Warrants, will receive (A) a lump-sum cash payment equal to (1) the total number of shares of our common stock issuable to such holder upon the exercise of the applicable warrant, multiplied by (2) the excess of (x) the Cash Consideration over (y) the per-share exercise price for such warrant and (B) one CVR for each share of our common stock underlying such warrant.

 

The Merger Agreement contains customary representations, warranties and covenants of the parties. We have agreed to refrain from engaging in certain activities until the effective time of the Merger. In addition, under the terms of the Merger Agreement, we

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have agreed not to solicit or support any alternative acquisition proposals, subject to customary exceptions for us to respond to and support unsolicited proposals in the exercise of the fiduciary duties of our board of directors. We are obligated to pay a termination fee of $1.0 million to Ferrer in certain circumstances following termination of the Merger Agreement.  Additionally, if either the us or Ferrer terminates the Merger Agreement in accordance with its terms, then all outstanding unpaid principal and accrued interest owed on the Ferrer Note by us will become immediately due and payable to Ferrer.

 

The Merger is expected to close in the second quarter of 2016 and is subject to customary closing conditions. However, we have prepared this Management’s Discussion and Analysis of Financial Condition and Results of Operations and the forward-looking statements contained in this report as if we were going to remain an independent company. If the Merger is consummated, many of the forward-looking statements contained in this report would no longer be applicable.

 

For more information related to the Merger Agreement, please refer to our May 10, 2016 Current Report on Form 8-K. The foregoing description of the Merger Agreement is qualified in its entirety by reference to the full text of the Merger Agreement attached as Exhibit 2.1 to our May 10, 2016 Current Report on Form 8-K.

We believe that, based on our cash and cash equivalent balances at March 31, 2016, the additional $2.3 million drawn in April and May 2016 under that certain promissory note we issued to Ferrer in September 2015, or the Ferrer Note and our expected cash usage, we have sufficient capital resources to meet our anticipated cash needs until the end of June 2016. Changing circumstances may cause us to consume capital significantly faster or slower than we currently anticipate, or to alter our operations. Even if circumstances do not cause us to consume capital significantly faster or slower than we currently anticipate, we may be forced to significantly reduce our operations if our business prospects do not improve. If we are unable to source additional capital, we may be forced to shut down operations altogether.

AGITATION — ADASUVE (Staccato loxapine)

Episodes of agitation afflict many people suffering from major psychiatric disorders, including schizophrenia and bipolar disorder. In the United States, approximately 2.4 million adults have schizophrenia and approximately 5.7 million adults have bipolar disorder. Of these patients, approximately 900,000 adult patients with schizophrenia and 5 million adult patients with bipolar disorder are currently receiving pharmaceutical treatment and are the target patient population for ADASUVE. More than 90% of patients with schizophrenia and bipolar disorder will experience agitation in their lifetimes. Our primary market research indicates that approximately 50% of treated acute agitation episodes are treated in a hospital setting. In the hospital setting, patients are routinely treated in medical emergency departments, psychiatric emergency services and inpatient psychiatric units, which are the settings where ADASUVE may be used if such facilities are enrolled in the ADASUVE Risk Evaluation and Mitigation Strategy, or REMS, program.

Commercialization Strategy Overview

Our global commercialization strategy for ADASUVE is to use strategic collaborations to commercialize ADASUVE. We currently have one commercialization collaboration with Ferrer for the Ferrer Territories. We have reacquired the commercial rights for ADASUVE in the United States and are working to identify a new commercialization collaboration partner for the United States.  In the interim, we expect to provide product to the customers already purchasing ADASUVE, through distribution systems established by Teva.  The Teva Amendment gives us the ability to promote and distribute ADASUVE under the currently approved label for up to twelve months. We are continuing to seek additional commercialization collaborations to commercialize ADASUVE in the United States and countries outside the Ferrer Territories.

In December 2012, the FDA approved our NDA for Staccato loxapine, as ADASUVE (loxapine) Inhalation Powder 10 mg for the acute treatment of agitation associated with schizophrenia or bipolar disorder in adults. In the United States, ADASUVE must be administered only in healthcare facilities enrolled in the ADASUVE REMS program that have immediate access on-site to equipment and personnel trained to manage acute bronchospasm, including advanced airway management (intubation and mechanical ventilation). In connection with our reacquisition of the ADASUVE commercial U.S. rights, the ADASUVE NDA and other related regulatory documents were transferred to us and we have primary responsibility for all regulatory activities and requirements.  In December 2015, a supplemental New Drug Application or sNDA was submitted to the FDA, seeking certain changes in the product labeling and REMS.  The review period for this sNDA is projected to be six months.

In February 2013, the EC granted marketing authorization for ADASUVE in the EU. ADASUVE, 4.5 mg and 9.1 mg inhalation powder loxapine, pre-dispensed, is authorized in the EU for the rapid control of mild-to-moderate agitation in adult patients with schizophrenia or bipolar disorder. The ADASUVE marketing authorization requires that patients receive regular treatment

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immediately after control of acute agitation symptoms, and that ADASUVE is administered only in a hospital setting under the supervision of a healthcare professional. The ADASUVE marketing authorization also states that a short- acting beta-agonist bronchodilator treatment should be available for treatment of possible severe respiratory side-effects, such as bronchospasm. The marketing authorization for ADASUVE is valid in all 28 EU Member States, plus Iceland, Liechtenstein and Norway. Beginning in August 2014, Ferrer began to receive individual country approvals in Latin America. As of May 6, 2016, Ferrer or its distributors currently markets ADASUVE in twenty-one countries of the Ferrer Territories. Ferrer has also received approval to market ADASUVE in ten additional Latin American countries. We expect Ferrer will launch in a number of European countries through 2016. In Latin America, we expect Ferrer will continue to work on product regulatory approvals and launch in already approved countries throughout 2016.

Until June 2015, we had primary responsibility for certain post-approval requirements outlined in the marketing authorisation for ADASUVE. Two of the five requirements have been completed and the data submitted to the European Medicines Agency, or the EMA. Work on the three additional requirements is ongoing. In June 2015, Ferrer assumed responsibility for these post-approval responsibilities.

Commercialization Strategy — Other Countries

We continue to seek additional strategic collaborators to commercialize ADASUVE in the United States and countries outside the Ferrer Territories.

Commercial Production Update

We are responsible for the global commercial manufacturing of ADASUVE in our facility in Mountain View, California for commercialization in the United States, the Ferrer Territories and in any potential future territories. This facility has been inspected by the U.S., EU and other country competent authorities and operates under applicable U.S., EU and other country regulations.

In 2015, Teva and Ferrer provided longer-term, ADASUVE orders, allowing us to manufacture ADASUVE in a consistent manner to take advantage of the efficiencies of continued batch production. Through the third quarter of 2015, we produced approximately 112,000 units of ADASUVE which completed the fulfillment of the Teva and Ferrer orders. We have completed the suspension of the ADASUVE commercial production operations and plan to resume commercial production in the future as additional commercial product is required by Ferrer or any future collaborators. We may also consider contracting with third party manufacturers for ADASUVE units if deemed more efficient, including third-party manufacturers with multi-product facilities. As a result of the suspension of ADASUVE commercial production, we reduced our headcount to approximately 27 employees.

ADASUVE is our only product approved for commercialization. In the United States, ADASUVE must be administered only in healthcare facilities enrolled in the ADASUVE REMS program that have immediate access on-site to equipment and personnel trained to manage acute bronchospasm, including advanced airway management (intubation and mechanical ventilation). If we or our future collaborators are not able to successfully commercialize ADASUVE in the U.S., or if Ferrer is not able to successfully commercialize ADASUVE in the Ferrer Territories, our ability to generate revenue will be jeopardized and, consequently, our business will be seriously harmed.

Product Candidate Development

We have retained all rights to the Staccato system and to our product candidates other than ADASUVE, the exclusive commercial rights to which we have licensed to Ferrer in the Ferrer Territories. We intend to develop certain product candidates internally and to identify external resources or collaborators to develop and commercialize other product candidates.

AZ-002 (Staccato alprazolam) for Acute Repetitive Seizures

Epilepsy, a disorder of recurrent seizures, affects approximately 2.5 million Americans, making it the third most common neurological disorder in the United States. ARS refers to seizures that are serial, clustered, or crescendo, and ones that are distinct from the patient’s usual seizure pattern with an onset easily recognized by caregiver and physician. Typically there is recovery between seizures. Among the implications of ARS are concerns for patient safety. Prolonged or recurrent seizure activity persisting for 30 minutes or more may result in serious injury, health impacts or death that correlate directly with seizure duration. ARS, if left untreated, has been reported to evolve into a state of persistent seizure, or status epilepticus, which has a 3% mortality rate in children and 26% in adults.

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Benzodiazepines are considered to be medications of first choice for the treatment of acute seizures. Clinical advantages of benzodiazepines include relatively rapid onset of action, high efficacy and minimal toxicity. The rapidity by which a medication can be delivered to the systemic circulation and then to the brain plays a significant role in reducing the time needed to treat seizures and reducing the likelihood of damage to the central nervous system. Current standard of care for ARS is the rectal gel formulation of diazepam, which must be administered by a caregiver or healthcare professional. In our market research, patients surveyed have commented that they find that the rectal gel takes longer to work than they would like and that the route of administration is sub-optimal and cannot be used in public. Intravenous benzodiazepines are rapid acting, but must be administered by a healthcare professional in a medical facility.

The ability to treat quickly is clinically important to potentially prevent an epileptic event from evolving into status epilepticus or causing other serious complications. We believe a product that can be administered in the home setting to effectively treat ARS may result in avoiding a trip to the hospital for treatment or diminishing the need to use the rectal formulation of diazepam.

If approved, AZ-002 could reduce the use of IV or rectal benzodiazepines in treating patients who experience ARS. The potential benefits of AZ-002 may include a faster delivery to the blood stream, when compared to rectal delivery, and greater ease of use. AZ-002 could be administered after a first seizure in a cluster with the aim of preventing further seizures. The caregiver could provide dosing assistance between cluster seizures. We believe that alprazolam’s ability to inhibit anxiety, or anxiolytic action, may provide additional therapeutic benefits to ARS patients. We own full development and commercial rights to AZ-002. We have applied for orphan drug status with the FDA for AZ-002 and expect to apply for orphan drug status in the EU. There is no assurance that AZ-002 will receive such designation.

We initiated a Phase 2a proof-of-concept study for AZ-002 in January 2015. This AZ-002 Phase 2a study is an in-clinic, randomized, placebo-controlled, double-blind design, 5-way crossover evaluating patients with epilepsy using the Intermittent Photic Stimulation model, with the primary endpoint being reduction in mean Standardized Photosensitivity Range, or SPR.  The primary aim of this study is to assess the safety and the pharmacodynamic electroencephalographic effects of a single dose of AZ-002 at three dose strengths (0.5mg, 1.0mg and 2.0mg) as compared with a placebo (administered twice during the six-week protocol for each patient). This study has enrolled four patients to date (of the six initially planned) at three U.S. clinical centers. In December 2015, we announced results of the interim analysis of the study. The interim analysis showed that AZ-002 had dose-related effects on mean SPR (the primary endpoint of the study), no serious adverse effects and was well tolerated in the patients studied.  There were also dose-related changes in two visual-analogue scales for sedation and for alertness, which are established pharmacodynamic markers of benzodiazepine drug activity.  Importantly, in both measures the pharmacodynamic effect was demonstrated at the two-minute time point, which was the first assessment in the study, demonstrating the rapid onset of effect of alprazolam as delivered by the Staccato technology. Data from this clinical trial are expected to serve as the basis for dose determination in potential future efficacy and safety clinical studies. We expect to complete this study in the first half of 2016.

AZ-007 (Staccato zaleplon) for Insomnia

We are developing AZ-007 for the treatment of insomnia in patients who have difficulty falling asleep, including those patients with middle of the night awakening who have difficulty falling back asleep. Insomnia is the most prevalent sleep disorder, and we believe that it affects at least 15% to 20% of the United States population, with some estimates of up to 50% of Americans reporting difficulty getting a good night’s sleep at least a few nights a week. Insomnia can be due to a variety of causes, including depression, grief or stress, menopause, age, shifting work, or environmental disruption. Whatever the cause of insomnia, it can take its toll on both the afflicted and the non-afflicted. Sleep disturbances have a major negative impact on public health and economic productivity.

Although benzodiazepines have been the clinical standard in treatment for sleep disorders for decades, issues with drug misuse and dependency are common and concerning. Other current treatments for insomnia include non-benzodiazepine GABA-A receptor agonists, which include zolpidem, immediate release and controlled-release tablets, zaleplon, and eszopiclone, which have less abuse potential and fewer side effects than classical benzodiazepines and can be used for longer term treatment. Patients and physicians surveyed in market research suggest that current oral forms of these leading insomnia medications can take from 30-60 minutes to work, while promotions for insomnia medications cite 20-30 minutes. Compounds with a longer half-life keep patients asleep longer and if dosed in the middle of the night, can have residual side effects that can cause a “hangover” feeling the next day.

We believe the opportunity in insomnia is a product which achieves a balance in treating patients so they can fall asleep quickly, whether at bedtime or in the middle of the night, while enabling them to function well the next day without a groggy feeling that can impact driving, employment or leisure activities.

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We believe there is a potentially large clinical need for a product which has the potential to lead to rapid and predictable onset of sleep in patients with middle of the night insomnia, coupled with a predictable duration of sleep and rapid, clear awakening has the potential to be satisfied by AZ-007.

We have completed Phase 1 testing for AZ-007. In the Phase 1 study, AZ-007 delivered an IV-like pharmacokinetic profile with a median time to peak drug concentration of 1.6 minutes. Pharmacodynamics, measured as sedation assessed on a 100 mm visual- analog scale, showed onset of effect as early as 2 minutes after dosing. We do not anticipate further development of AZ-007 without obtaining additional capital resources, but if we are able to secure additional funding, we plan to initiate a Phase 2 clinical study for AZ-007. The primary goal of this study will be to: (i) determine AZ-007’s effects and impact on sleep, as measured with polysomnography, (ii) to determine AZ-007’s residual effects after dosing, as measured in a driving simulator environment, and (iii) to collect additional safety data on AZ-007.

Financing update

In September 2015, we issued the Ferrer Note to Ferrer. The terms of the Ferrer Note provided that (i) Ferrer would loan us up to $5.0 million in tranches, (ii) the initial tranche of $3.0 million was received by us on September 28, 2015, (iii) another tranche of $1.0 million was received by us on March 21, 2016, (iv) the third tranche of $1.0 million was received by us on April 15, 2016, (v) interest accrues on the outstanding principal at the rate of 6% per annum, compounded monthly, through May 31, 2016, (vi) all outstanding principal and accrued interest under the Ferrer Note became due and payable upon Ferrer’s demand on May 31, 2016, (vii) we could prepay the Ferrer Note at any time without premium or penalty, and (viii) we issue 125,000 shares of our common stock to Ferrer as partial consideration for the loan. The common stock was issued to Ferrer pursuant to a stock issuance agreement and was not registered at the time of issuance under the Securities Act of 1933, as amended. On May 9, 2016 in connection with our execution of the Merger Agreement, we amended and restated the Ferrer Note in order to, among other things (i) increase the maximum principal amount of the Ferrer Note to $6.3 million, (ii) extend the maturity date of the Ferrer Note to September 30, 2016 and (iii) provide for certain events of default under the Ferrer Note in connection with the Merger. As of May 11, 2016, the outstanding principal amount of the Ferrer Note was $6.3 million.

In May 2013, we entered into a Convertible Promissory Note and Agreement to Lend, between us and Teva, or the Teva Note, pursuant to which we had the ability, upon written notice to Teva, to draw upon the Teva Note to fund agreed operating budgets related to ADASUVE. As of December 31, 2014, the aggregate drawdowns totaled $25.0 million.  In February 2016, we entered into an amendment to the Teva Note, or the Amended Teva Note. The Amended Teva Note provided that (i) we issue  2,172,886 shares of our common stock to Teva pursuant to a stock issuance agreement as consideration for a reduction in the outstanding balance of the Amended Teva Note by $5.0 million and forgiveness of all accrued and unpaid interest under the Amended Teva Note, (ii) we are obligated to repay the remaining $20.0 million outstanding balance of the Amended Teva Note in four annual consecutive payments of $5.0 million beginning in the first calendar year following the calendar year in which the aggregate annual net sales of ADASUVE and any other Staccato enabled products first reach $50.0 million in the United States, and (iii) we may prepay the outstanding balance of the Amended Teva Note.

In the fourth quarter of 2015, we did not make the quarterly interest payment due on December 15, 2015 for the non-recourse notes issued by Atlas in connection with our royalty securitization financing, or the Notes.  As a result, we received a notice of event of default from the trustee. The aggregate interest payments that were in default were approximately $4.2 million, which includes the interest due and payable since September 15, 2015. In January 2016, we entered into a forbearance agreement with the holders of the Notes whereby such holders would generally forbear from delivering an acceleration notice and exercising other remedies under the Notes for thirty day renewing periods through June 15, 2016. As a result of our default and the short forbearance time period, the principal balance of $45.0 million and the amortization of the debt discounts of $1.0 million related to the 2014 Warrants were reclassified from non-current liabilities to current liabilities since the fourth quarter of 2015. Additionally, the deferred interest charges associated with the royalty securitization financing that were being amortized over five years were reclassified from non-current assets to other current assets as of March 31, 2016 consistent with the related debt. In connection with the execution of the Merger Agreement, we entered into a Forbearance and Waiver Agreement, or the Second Forbearance Agreement with Atlas U.S. Royalty, LLC, a Delaware limited liability company and our wholly-owned subsidiary, or Atlas, Purchaser and the holders of the 2014 Warrants and the Notes. Pursuant to the terms of the Second Forbearance Agreement, the holders of the Notes agreed (i) to forbear on exercising all rights and remedies under that certain Indenture by and between Atlas and U.S. Bank National Association, as the trustee, or the Indenture, and the other documentation relating to the Notes and Atlas through the earlier of November 9, 2016 (subject to extension under certain circumstances) and the termination of the Merger Agreement and (ii) to ratify certain amendments to the Teva Agreement. Pursuant to the terms of the Second Forbearance Agreement, the holders of the Notes also agreed to the cancellation of the Notes and the discharge of the Indenture in connection with the consummation of the Offer and to take any and all actions necessary to effect the foregoing.  In addition, the holders of the 2014 Warrants agreed to the treatment of the 2014 Warrants in

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connection with the Offer as described in the Merger Agreement effective as of the Merger.  Each of the holders of the Notes, the holders of the 2014 Warrants, Atlas and us also agreed to certain releases of claims effective upon the consummation of the Offer or, in the case of claims with respect to Purchaser and its affiliates, upon the execution of the Second Forbearance Agreement.

In connection with the execution of the Merger Agreement, the holders of the Notes each entered into a participation agreement with Atlas pursuant to which Atlas agreed to grant to the holders of the Notes contractual rights to receive payments from Atlas upon the receipt of certain payments and achievement of certain milestones in respect of the commercialization of ADASUVE within the Unites States.

Results of Operations

Comparison of Three Months Ended March 31, 2016 and 2015

Revenue

Revenues for the three months ended March 31, 2016 and 2015 were:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2016

 

 

2015

 

Product revenue

 

$

 

 

$

87

 

Amortization of deferred revenue

 

 

712

 

 

 

613

 

Royalty revenue

 

 

8

 

 

 

5

 

Total revenue

 

$

720

 

 

$

705

 

 

Product Revenue We began shipping commercial units and recognizing revenue on ADASUVE product shipments to Ferrer in the second quarter of 2013 and to Teva in the fourth quarter of 2013. We suspended our commercial production of ADASUVE in the third quarter of 2015. We have fulfilled all of the orders we received from Teva and Ferrer for commercial units of ADASUVE for the near and medium term and we are uncertain of when we will resume production. Accordingly, no additional revenue related to product shipments is expected to be earned beginning in the first quarter of 2016. If we contract with a third party to assume production responsibilities for ADASUVE, we may not recognize any future ADASUVE product revenue.

Amortization of Deferred Revenues The upfront payments received from a Collaboration, License and Supply Agreement we executed with Ferrer in October 2011, or the Ferrer Agreement, are recognized as revenue over the period in which we complete our obligations under the Ferrer Agreement. The amount amortized can vary based on changes of the expected timing to complete our obligation and the receipt of any further upfront payments. Due to the amendment of the Ferrer Agreement, we accelerated the amortization period of the upfront payments for revenue recognition starting in June 2015 to December 2015 resulting in an increase in amortization of deferred revenue as compared to 2014. This reflects the potential period in which the technology transfer would occur for manufacturing capabilities. Prior to the amendment of the Ferrer Agreement, the estimated amortization periods ended March 2017.

Milestone Revenue There were no milestone revenues earned during the three months ended March 31, 2016 and 2015.

Royalty Revenue Royalty revenue was earned under the Teva Agreement for sales of ADASUVE in the U.S. Teva commercially launched ADASUVE in March 2014. We have reacquired the ADASUVE U.S. commercial rights and will not receive any future royalties under the Teva Agreement after the first quarter of 2016.

Cost of Goods Sold

Costs of goods sold include the direct costs incurred to manufacture products sold combined with allocated manufacturing overhead, which consists of indirect costs, including labor and facility overhead. The carrying cost of inventory is reduced so as to not be in excess of market value as determined by the contractual transfer prices to Ferrer and Teva. These amounts are expensed to cost of goods sold. Cost of goods sold consists mainly of excess manufacturing costs during the period in addition to the cost of the units shipped.

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During the three months ended March 31, 2015, we recorded additional cost of goods sold related to $1.2 million of inventory with fixed expiration dates and $1.0 million of prepayments made to the supplier of our lower housing assembly all of which are in excess of our expected production needs prior to the planned suspension of production operations.

We contracted with Autoliv, through a third-party supplier, to build an additional manufacturing cell at a cost of approximately $2.4 million, or the New Cell. The New Cell was expected to be installed at Autoliv with the cell currently being utilized by Autoliv, or the Original Cell, to be installed at a second source supplier. Due to the Original Cell no longer being utilized and the uncertainty of the timing of engaging a second source supplier, we wrote down the Original Cell to $0, which resulted in an impairment of $1.4 million that was recognized as cost of goods sold in the three months ended March 31, 2015. The New Cell will be utilized if and when commercial production resumes.

In February 2016, we entered into the Teva Amendment, whereby we reacquired the ADASUVE commercial U.S. rights. As part of this exchange, all remaining ADASUVE inventory held by Teva was transferred to us along with a right to resell such inventory for up to one year. The Teva Amendment is intended to allow us to continue to provide ADASUVE product to patients and health care providers either on our own or through another unaffiliated partner, at which time all Teva license rights to ADASUVE would terminate. We accounted for the sub-license rights and the receipt of inventory under ASC 845, Nonmonetary Transaction. We concluded that the cost of the inventory transferred to us shall be based on the fair value of the inventory received as its fair value is more clearly evident than the fair value of the future milestone and royalty obligations relinquished. The fair value of the inventory was determined to be $0.9 million with an offsetting gain on exchange that is reflected as a non-operating line item within our consolidated statements of loss and comprehensive loss. However, given our continued operating losses, the uncertainty of when we will resume commercial production, the limited ability to sell the inventory, the twelve-month expiration of this inventory, and our ability to continue as a going concern, we subsequently fully impaired the inventory received by recording a $0.9 million, or $0.05 per share, impairment charge that was included in our cost of goods sold within our consolidated statements of loss and comprehensive loss.

Research and Development Expenses

Research and development expenditures made to advance ADASUVE and our product candidates, and, prior to commercial production of ADASUVE, develop our manufacturing capabilities during the three months ended March 31, 2016 and 2015 consisted of the following (in thousands):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2016

 

 

2015

 

Total research and development

 

$

2,438

 

 

$

3,824

 

 

The decrease of $1.4 million in research and development expenses during the three months ended March 31, 2016 as compared to the same period in 2015 was primarily due to the effects of the restructuring strategy inclusive of our reduction in employee headcount. With the suspension of commercial ADASUVE production operations in the third quarter of 2015, the decrease was partially offset by a larger percentage of fixed overhead costs being allocated to research and development expenses beginning in the fourth quarter of 2015.

We expect that research and development expenses will decrease during the fiscal year 2016 compared to 2015. We anticipate continuing to incur expenses related to our AZ-002 Phase 2a clinical trial, and, if financing is secured, expenses related to the clinical development of AZ-007.

General and Administrative Expenses

General and administrative expenses during the three months ended March 31, 2016 and 2015 consisted of the following (in thousands):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2016

 

 

2015

 

General and Administrative

 

$

2,392

 

 

$

3,737

 

 

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The decrease of $1.4 million in general and administrative expenses during the three months ended March 31, 2016 as compared to the same period in 2015 was primarily due to our reduction in employee headcount, decreased accounting fees due to the change in auditors, and lower consulting expenses.

We expect our general and administrative expenses in 2016 to continue to decrease as compared to 2015. We may further reduce our headcount if we do not secure additional funding.

Change in the Fair Value of Contingent Consideration Liability

In connection with our acquisition of all of the outstanding equity of Symphony Allegro, Inc., or Allegro, in the third quarter of 2009, we are obligated to pay the former stockholders of Allegro certain percentages of cash receipts that may be generated from future collaboration transactions for ADASUVE, AZ-104 and/or AZ-002. We measure the fair value of this contingent consideration liability on a recurring basis. Any changes in the fair value of this contingent consideration liability are recognized in earnings in the period of the change. Certain events, including, but not limited to, clinical trial results, regulatory approval or nonapproval of our submissions, the timing and terms of a strategic partnership, and the commercial success of ADASUVE, AZ-104, and/or AZ-002, could have a material impact on the fair value of the contingent consideration liability, and as a result, our results of operations.

During the three months ended March 31, 2016, we updated the discounted cash flow model to reflect adjusted U.S. ADASUVE milestones and royalties with any future U.S. collaborator and adjusted sales milestones for the ADASUVE Ferrer. These changes resulted in our recognizing a non-operating, non-cash gain of $0.2 million, or $0.009 per share during the three months ended March 31, 2016.

During the three months ended March 31, 2015 we updated the contingent liability fair value model primarily to reflect the projected uptake of ADASUVE in the U.S. market. As part of this process, we received updated projections from our collaboration partners in the first quarter of 2015 that indicated sales of ADASUVE would be lower in 2015 and 2016 than had been anticipated in the various projections and scenarios used to estimate the contingent consideration liability in previous periods. As a result of these lower projected sales and the decision to suspend our commercial production operations, we reevaluated the rate at which we believe sales will increase, the amount of peak sales, the period of time it will take to reach peak sales, the number of years at which peak sales would be achieved, and the related impact on the amount and timing of related royalties and milestones to be received. This evaluation resulted in a decrease to projected sales and the related milestones and royalties under the high, medium and low sales scenarios and a heavier weighting to the lower sales scenario. The change in projected product uptake, and the projected related sales milestone payments, resulted in our recognizing a non-operating, non-cash gain of $14.8 million. A payment of approximately $0.9 million was made during the same period to the former Allegro stockholders.

Gains from Restructuring of Financing Obligations and Inventory from Teva

During the three months ended March 31, 2016, we recorded a non-operating and non-cash gain of $3.5 million. In February 2016, we amended the license and supply agreement with Teva, or Teva Amendment, whereby we reacquired the ADASUVE commercial U.S. rights through an exclusive, royalty-free sub-license arrangement in exchange for the termination of all future milestone and royalty obligations that Teva had under the original agreement. As part of this exchange, all remaining ADASUVE inventory held by Teva was transferred to us along with a right to resell such inventory for up to one year. The Teva Amendment is intended to allow us to continue to provide ADASUVE product to patients and health care providers either on our own or through another unaffiliated partner, at which time all Teva license rights to ADASUVE would terminate. We accounted for the sub-license rights and the receipt of inventory under ASC 845, Nonmonetary Transaction. We concluded that the cost of the inventory transferred to us shall be based on the fair value of the inventory received as its fair value is more clearly evident than the fair value of the future milestone and royalty obligations relinquished. The fair value of the inventory was determined to be $0.9 million with an offsetting gain on exchange that is reflected as a non-operating line item within our consolidated statements of loss and comprehensive loss. However, given our continued operating losses, the uncertainty of when we will resume commercial production, the limited ability to sell the inventory, the twelve-month expiration of this inventory, and our ability to continue as a going concern, we subsequently fully impaired the inventory received by recording a $0.9 million impairment charge that was included in our cost of goods sold within our consolidated statements of loss and comprehensive loss. Our inventory was fully reserved as of March 31, 2016.

Additionally in February 2016, we entered into an amendment to the Teva Note, or the Amended Teva Note, which provided for (i) the issuance of 2,172,886 shares of our common stock to Teva pursuant to a stock issuance agreement as consideration for a reduction in the outstanding balance of the Amended Teva Note by $5.0 million and the forgiveness of all accrued and unpaid interest under the Amended Teva Note; (ii) the contingent repayment of the remaining $20.0 million outstanding balance of the Amended Teva Note in four annual consecutive payments of $5.0 million beginning on January 31 of the calendar year following the calendar

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year in which aggregate annual net sales of ADASUVE and any other Staccato enabled products first reach $50.0 million in the United States; (iii) the elimination of the conversion feature, and (iv) the prepayment of the outstanding balance of the Amended Teva Note at any time without penalty. We assessed the note restructuring under ASC 470, Debt, and concluded that the transaction constituted a troubled debt restructuring as we are experiencing financial difficulty and the amended note contained a concession through a reduction in the effective interest rate from 5.2 percent to zero percent. At the date of restructuring, the carrying amount of the Teva Note was $23.1 million. As the restructuring involved a partial settlement by granting an equity interest and a modification of the terms of the remaining Teva Note, we first reduced the carrying amount by $0.6 million, representing the fair value of the 2,172,886 shares of our common stock granted based on the $0.28 per share price as of the restructuring date, net of $33,000 in direct issuance costs. The remaining carrying amount of $22.5 million was then written down to $20.0 million, representing the total future undiscounted cash payments of the Amended Teva Note and consisting entirely of the contingent repayments, resulting in a restructuring gain of $2.5 million, or $0.12 per share, that is reflected on our consolidated statements of loss and comprehensive loss. The remaining outstanding note of $20.0 million is classified as a non-current liability as of March 31, 2016.

Interest and Other Income/(Expense), Net

Interest and other income/(expense) was immaterial for the three months ended March 31, 2016 and 2015, respectively. The amounts generally represent income earned on our cash, cash equivalents, marketable securities and restricted cash. We expect interest income to remain nominal throughout 2016.

Interest Expense

Interest expense was $2.0 million and $2.2 million for the three months ended March 31, 2016 and 2015, respectively. The amounts represent interest on our borrowings from Teva, Ferrer, the March 2014 royalty securitization financing, and the amortization of the debt discounts on the 2014 Warrants. We expect interest expense to decrease in 2016 as a result of the Amended Teva Note due to the change of the effective interest rate from 5.2 percent to zero percent.

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through private placements and public offerings of equity securities, debt financings, revenues primarily from licensing agreements and government grants, and payments from Allegro. We have received additional funding from interest earned on investments, as described below, and funds received upon exercises of stock options and exercises of purchase rights under our previous employee stock purchase plan and our 2015 Employee Stock Purchase Plan, or the 2015 ESPP. As of March 31, 2016, we had $4.5 million in cash and cash equivalents and we had no marketable securities. Our cash and cash equivalents balances are held in money market accounts, investment grade commercial paper and government-backed securities. Cash in excess of immediate requirements is invested with regard to liquidity, capital preservation and yield.

Cash Flows from Operating Activities. Net cash used in operating activities was $($4.3) million and $(12.7) million during the three months ended March 31, 2016 and 2015, respectively.

The net cash used in the three months ended March 31, 2016 primarily reflects the net loss of $3.4 million, the non-cash gains of $2.5 million and $0.9 million related to the restructuring of the Amended Teva Note and the fair value of the inventory that we received from Teva which was subsequently fully impaired, respectively, the change in our working capital of $0.5 million, amortization of debt discount and deferred interests of $0.6 million, depreciation and amortization of $0.6 million.

The net cash used in the three months ended March 31, 2015 primarily reflects the net loss of $0.4 million offset by the $14.8 million non-operating, non-cash gain related to the decrease in the contingent consideration liability, non-cash fixed asset impairment charge of $1.4 million, inventory write-off of $1.2 million, share-based compensation expense of $0.4 million and depreciation and amortization of $0.9 million. Cash flows from operating activities were also impacted by the decrease in accrued clinical and other accrued liabilities, primarily due to the payout of the amounts earned under our 2014 Cash Bonus Plan.

Cash Flows from Investing Activities. There were no investing activities during the three months ended March 31, 2016. Net cash provided by investing activities during the three months ended March 31, 2015 was $8.1 million which represented maturities, net of purchases, of available-for-sale securities.

Cash Flows from Financing Activities. Net cash provided by financing activities was $1.0 million and $0.5 million during the three months ended March 31, 2016 and 2015, respectively. Cash flows from financing activities have generally consisted of proceeds from the issuance of our common stock and net cash flows from our financing agreements. During the three months ended March 31,

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2016, we received the second tranche of $1.0 million from the Ferrer Note which brought the outstanding balance of the Ferrer Note to $4.0 million as of March 31, 2016. In the three months ended March 31, 2015, our restricted cash balance decreased by $1.4 million and we made payments of $0.9 million to the former stockholders of Symphony Allegro.

We believe that with current cash and cash equivalent balances, the additional $2.3 million drawn in April and May 2016 under the Ferrer Note and our current expected cash usage, we have sufficient capital resources to meet our anticipated cash needs, at our expected cost levels until the end of June 2016. Changing circumstances may cause us to consume capital significantly faster or slower than we currently anticipate or to alter our operations. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available financial resources sooner than we currently expect. The key assumptions underlying these estimates include:

 

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expenditures related to the ADASUVE post-approval commitments to both the FDA and EC during this period being within budgeted levels;

 

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expenditures related to ADASUVE commercial manufacturing during this period being within budgeted levels;

 

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no unbudgeted growth in the number of our employees during this period; and

 

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no material shortfall in our budgeted revenues.

Even if circumstances do not cause us to consume capital significantly faster or slower than we currently anticipate, we may be forced to significantly reduce our operations if our business prospects do not improve. If we are unable to source additional capital, we may be forced to shut down operations altogether.

Our forecast of the period of time that our financial resources will be adequate to support operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed in “Risk Factors.” In light of the numerous risks and uncertainties associated with the commercialization of ADASUVE, the commercial manufacturing of ADASUVE, the development of our product candidates and the extent to which we enter into additional strategic collaborations with third parties to participate in development and commercialization of our product candidates, we are unable to estimate the amounts of increased capital outlays and operating expenditures associated with our current and anticipated clinical trials. Our future funding requirements will depend on many factors, including:

 

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the cost and timing of the development of our commercialization abilities;

 

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the commercial success of ADASUVE or any other product candidates that are approved for marketing;

 

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the cost, timing and outcomes of regulatory approvals or non-approvals;

 

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the scope, rate of progress, results and costs of our preclinical studies, clinical trials and other research and development activities;

 

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the terms and timing of any additional distribution, strategic collaboration or licensing agreements that we may establish;

 

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the number and characteristics of product candidates that we pursue;

 

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the cost of producing ADASUVE in commercial quantities;

 

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the cost to initiate commercial production of ADASUVE after our production capabilities were suspended during the third quarter of 2015;

 

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the cost of establishing clinical supplies of our product candidates;

 

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the cost of preparing, filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and