Description
MannKind Corporation. 10% Owner ALFRED E MANN bought 31,250,000 shares on 6-27-2012 at $ 2.47
BUSINESS OVERVIEW
Business
Unless the context requires otherwise, the words “MannKind,” “we,” “company,” “us” and “our” refer to MannKind Corporation and its subsidiaries. Unless explicitly stated otherwise, AFREZZA refers to the combination of AFREZZA inhalation powder and the AFREZZA inhaler.
MannKind Corporation is a biopharmaceutical company focused on the discovery, development and commercialization of therapeutic products for diseases such as diabetes and cancer. Our lead product candidate, AFREZZA (insulin human [rDNA origin]) inhalation powder, is an ultra rapid-acting insulin that is in late-stage clinical investigation for the treatment of adults with type 1 or type 2 diabetes for the control of hyperglycemia. Diabetes is a significant health concern. According to the Centers for Disease Control and Prevention, in the United States in 2011, approximately 25.8 million people had diabetes and if current trends continue, one in three adults in the United States are expected to have diabetes by 2050. The International Diabetes Federation has estimated that approximately 366 million people have diabetes today; by 2030 this is expected to have risen to approximately 552 million.
PRODUCT PIPELINE
Our lead product candidate, AFREZZA, has a time-action profile unlike other insulin products. In our clinical trials to date, we have consistently observed that AFREZZA inhalation powder is rapidly absorbed into the bloodstream following inhalation, reaching peak levels within 12 to 14 minutes. In this manner, AFREZZA produces a profile of insulin levels in the bloodstream that closely approximates the early insulin secretion normally seen in healthy individuals immediately following the beginning of a meal, but which is absent in patients with diabetes.
The AFREZZA inhalation powder is centered on a class of pH-sensitive organic molecules that self-assemble into small particles under acidic conditions. We refer to these particles as Technosphere particles. Certain drugs, such as insulin, can be loaded onto these particles by combining an acidic solution of the drug with a suspension of Technosphere material, which is then dried to a powder. This powder is then filled into plastic cartridges and packaged. To administer AFREZZA inhalation powder, a patient loads a cartridge into our inhaler. By inhaling through this device, air is pulled through the cartridge, which aerosolizes the powder and pulls the particles into the air current and out through the mouthpiece. The individual particles within this aerosol are small and have aerodynamic properties that enable them to fly efficiently deep into the lungs. When the particles contact the moist lung surface with its neutral pH, the Technosphere particles dissolve immediately, releasing the insulin molecules to diffuse across a thin layer of cells into the bloodstream. We believe that the insulin absorption step is a passive process that occurs without any active assistance or enhancement and without disruption of either cell membranes or the tight junctions between cells.
To date, the AFREZZA clinical program has involved 61 different studies of AFREZZA and over 5,600 adult patients. In our clinical studies, we observed that AFREZZA produces the following clinical benefits:
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Consistent decreases in A1C levels, comparable to current insulin therapies. In a number of clinical studies involving patients with type 1 and type 2 diabetes, we have evaluated levels of glycosylated hemoglobin, or A1C, which is a measure of average blood glucose. A consistent finding was that AFREZZA produced decreases in A1C levels that were essentially comparable to the decreases observed in the control arm of these studies, including studies that compared AFREZZA to rapid-acting insulin analogs, to pre-mixed insulin analogs and to metformin in combination with a sulfonylurea.
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Superior post-meal glucose control. Because AFREZZA inhalation powder has a shorter duration of action we believe that its glucose-lowering effect better meets a patient’s needs following a meal than other available insulin therapies. Specifically, AFREZZA treatment produces lower blood glucose levels than comparators in the first hour following meal ingestion with comparable levels after two hours. Importantly, AFREZZA does not remain active for an extended period of time, thereby reducing the risk of hypoglycemia between meals.
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Improved fasting glucose control. In clinical trials of both type 1 and type 2 diabetes, AFREZZA has consistently provided lower fasting blood glucose levels than comparator insulin therapies. As we reported with external authors in a report of one of our earlier Phase 3 studies that was reported in The Lancet in 2010, this observation might be the result of greater suppression of endogenous glucose production with AFREZZA plus a basal insulin than with a conventional insulin regimen.
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Less hypoglycemia due to better synchronization with glucose absorption from meals. In clinical trials involving patients with type 2 diabetes, we observed that the incidence and frequency of hypoglycemia was significantly reduced. Similar results were observed in patients with type 1 diabetes. The overall hypoglycemic event rate was lower for AFREZZA at all times of the day, but in particular, there were fewer nocturnal hypoglycemic events, a condition much feared by patients with diabetes.
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Little or no weight gain. In our clinical trials, patients treated with AFREZZA experienced weight reduction or significantly less weight gain compared to other insulin therapies.
There are no assurances, however, that these or any other advantages of AFREZZA will be agreed to by the US Food and Drug Administration, or FDA, or otherwise included in final product labeling or advertising.
To date, our clinical trials have indicated that AFREZZA has a favorable safety profile. The most common adverse event associated with AFREZZA therapy was a transient, mild and non-productive cough, which occurred early in about 25-30% of subjects and diminished within the first few weeks after initiation of AFREZZA therapy. The occurrence of mild cough is well recognized with inhaled medications. In our studies, the incidence of cough leading to the discontinuation of AFREZZA was low.
After a two-year Phase 3 clinical trial of AFREZZA, we determined that the use of AFREZZA in patients with diabetes was non-inferior to usual diabetes care with respect to a decline in FEV1, a measure of lung function that assesses the volume of air that can be forcibly expired within one second. Similar results were obtained for other measures of lung function.
Our clinical trials for AFREZZA have not demonstrated an increased risk of pulmonary cancer. In addition, we conducted comprehensive nonclinical studies of AFREZZA and unloaded Technosphere particles, including a two-year rat carcinogenicity study and a six-month transgenic mouse study. These studies indicated that there was no increased risk of cancer, or any other pathological effects.
Regulatory Approval Status
In March 2009, we submitted a new drug application, or NDA, for AFREZZA, in which we sought approval of the product using MedTone, our first-generation inhaler. In March 2010, we received a Complete Response letter from the FDA that requested additional information and currently available clinical data to support the clinical utility of AFREZZA as well as information about the comparability of the commercial version of the MedTone inhaler to the earlier version of this device that was used in pivotal clinical trials. After meeting with the FDA in June 2010, we determined that the best way to address the agency’s inhaler-related questions was to submit information regarding the bioequivalence of the MedTone inhaler and our next-generation inhaler, known as Dreamboat, which by that time had become our preferred device from a clinical and commercial perspective, given that it is smaller, easier to use and lower in cost than the MedTone inhaler. In June 2010, we submitted to the FDA the available bioequivalency data for the two devices along with additional evidence of efficacy of AFREZZA as part of our response to the 2010 Complete Response letter.
In January 2011, we received a second Complete Response letter in which the FDA requested that we conduct two clinical studies with the Dreamboat inhaler (one in patients with type 1 diabetes and one in patients with type 2 diabetes), with at least one trial including a treatment group using the MedTone inhaler in order to obtain a head-to-head comparison of the pulmonary safety data for the two devices. Over the next eight months, we participated in a number of written and verbal exchanges with the FDA in order to clarify the agency’s requirements for approval of AFREZZA, culminating in an in-person meeting in August 2011 in which we confirmed with the FDA the designs of the two requested studies.
The study in patients with type 1 diabetes, known as study 171, is an open-label study in which all patients are first optimized on their basal insulin regimen before being randomized to one of three arms: a control arm, in which patients utilize an injected insulin analog at mealtimes, or one of two AFREZZA arms, one each for our MedTone device and our Dreamboat device. After the mealtime insulin is titrated, there will be a 12-week observation period on relatively stable doses of the mealtime insulin to assess A1c levels. The primary endpoint is to show non-inferiority of the change in A1c levels in the Dreamboat group compared to the injected insulin analog group. The inclusion of two AFREZZA arms will permit us to perform a head-to-head comparison of the pulmonary safety data for the two devices, which we anticipate will provide a bridge to the extensive safety data that we collected in our earlier clinical studies of the MedTone inhaler. The basic design of this study (comparing different mealtime insulins in combination with a basal insulin regimen) is similar in design to a previous Phase 3 study that we conducted in patients with type 1 diabetes using our MedTone inhaler.
The other requested study, known as study 175, is a placebo-controlled study in patients with type 2 diabetes who are inadequately controlled on metformin with or without a second or third oral medication. Patients are assigned to treatment with AFREZZA or placebo powder in a randomized fashion. There is a titration period followed by a 12-week observation period to assess A1c levels. The primary objective of this study is to show superiority of the AFREZZA group over the placebo group in lowering A1c levels. We have previously compared AFREZZA to placebo powder in successful Phase 2 studies involving patients with type 2 diabetes using the MedTone inhaler.
Both studies are currently enrolling subjects. If enrollment continues as expected, we anticipate completing both of these studies by or near the end of 2012. We then would expect to submit the results to the FDA as an amendment to our NDA during the first half of 2013. However, the data collected from these clinical trials may not reach statistical significance or otherwise be sufficient to support an amendment to our NDA, or FDA approval. Moreover, there can be no assurance that we will satisfy all of the FDA’s requirements with these two clinical studies or that the FDA will ultimately find our proposed approach to these clinical studies acceptable. The FDA could also request that we conduct additional clinical studies beyond the currently planned studies in order to provide sufficient data for approval of AFREZZA.
Other Product Opportunities
AFREZZA utilizes our proprietary Technosphere formulation technology; however, this technology is not limited to insulin delivery. We believe it represents a versatile drug delivery platform that may allow pulmonary administration of certain drugs that currently require administration by injection. Beyond convenience, we believe the key advantage of drugs inhaled as Technosphere formulations is that they can be absorbed very rapidly into the arterial circulation, essentially mimicking intra-arterial administration. Currently, we are actively working with several parties to assess the feasibility of formulating different active ingredients on Technosphere particles. Additionally, our inhaler technology has been well received and has the potential to be utilized for the administration of dry powder formulations for various other applications.
In addition to our Technosphere platform, we have evaluated an investigational cancer immunotherapy product, MKC1106-MT, in a Phase 2 clinical trial. We have also conducted preclinical studies of a drug candidate, MKC204, that may have the potential to treat certain malignancies and inflammatory diseases. Due to resource constraints, we have halted most of our internal development activities in our non-AFREZZA programs.
OUR STRATEGY
The following are key elements of our strategy:
Complete the remaining clinical studies and gain FDA approval of AFREZZA . We have confirmed with the FDA the design of the two requested clinical studies to evaluate the efficacy and safety of AFREZZA and are actively recruiting patients into these studies. If enrollment continues at current levels, we expect to complete both of these studies by or near the end of 2012. We then would expect to submit the results to the FDA as an amendment to our NDA during the first half of 2013.
Seek a development and commercialization partner for AFREZZA. We intend to pursue potential collaboration opportunities with large pharmaceutical companies in the United States, Europe and elsewhere in order to provide the financial and operational resources to develop, commercialize, market and sell AFREZZA. We have not licensed or transferred any of our rights to this product or to our platform technology.
Capitalize on our proprietary Technosphere and inhaler technology for the delivery of active pharmaceutical ingredients. We are actively exploring opportunties to out-license our proprietary Technosphere formulation technology. We believe that Technosphere formulations of active pharmaceutical ingredients have the potential to demonstrate clinical advantages over existing therapeutic options in a variety of therapeutic areas. Additionally, our inhaler technology has been well received and has the potential to be utilized for the administration of dry powder formulations for various other applications.
SALES AND MARKETING
Our efforts to date have primarily been directed at developing pharmaceutical products for a number of different markets. We currently have no sales or distribution capabilities and have no experience as a company in marketing or selling pharmaceutical products. However, we have built a small marketing team and are engaged in the planning and market research activities that would normally be undertaken to support the late-stage development of a pharmaceutical product.
In order to commercially market any of our products, we need either to develop an internal sales team, continue to expand our marketing infrastructure or collaborate with third parties who have greater sales and marketing capabilities and have access to potentially large markets. Although we believe that establishing our own sales and marketing organizations in North America would have substantial advantages, we recognize that this may not be practical for some of our products and that collaborating with companies with established sales and marketing capabilities in a particular market or markets may be a more effective alternative for some products. To date, we have retained worldwide commercialization rights for all of our product candidates, including AFREZZA. We intend to pursue potential collaboration opportunities to assist us in the commercialization of AFREZZA in the United States and other major markets.
MANUFACTURING AND SUPPLY
We formulate and fill the AFREZZA inhalation powder into plastic cartridges and blister package the cartridges in our Danbury facility. We believe that our Danbury facility has enough capacity to satisfy the initial commercial demand for AFREZZA, if approved, although the facility includes expansion space that can allow production capacity to be increased based on anticipated needs during the initial years of commercialization. The quality management systems of our facility were certified to be in conformance with the ISO 13485 and ISO 9001 standards. In addition, our facility underwent a successful pre-approval inspection by the FDA during the fall of 2009. A portion of this pre-approval inspection was related to our ability to fill and package cartridges for the MedTone inhaler. We anticipate that our facility may need to undergo another successful pre-approval inspection related to our ability to fill and package cartridges for the next-generation inhaler before the FDA will approve the NDA for AFREZZA using the Dreamboat inhaler.
Currently, our insulin inventory is from two sources. In June 2011, we entered into a letter agreement with N.V. Organon, a subsidiary of Merck, to settle a dispute that arose between us and Organon in connection with the termination by us of the insulin supply agreement between us and Organon dated November 2007. Under the terms of the letter agreement, we agreed to pay Organon an aggregate of $16.0 million in two installments, after we received certain quantities of recombinant human insulin manufactured and supplied by Organon. The letter agreement is in full and final settlement of, and we and Organon agreed to release each other from, any and all actions and claims that we and Organon had or may have against each other in connection with the dispute regarding the supply agreement and related matters. As of July 31, 2011, we had received both shipments of recombinant human insulin and had paid the full amount of $16.0 million.
In June 2009, we acquired a quantity of bulk insulin from Pfizer Manufacturing Frankfurt GmbH, a subsidiary of Pfizer Inc., or Pfizer, as well as Pfizer’s rights under a license to manufacture insulin for pulmonary delivery. In addition, we acquired an option to purchase additional insulin inventory, in whole or in part, at a specified price, to the extent it remains available.
Once we have used our existing supply of insulin, we will need to secure additional insulin from market sources.
We are in the process of qualifying a manufacturer to supply us with our Dreamboat inhaler and the corresponding cartridges. We rely on our manufacturers to comply with relevant regulatory requirements, including compliance with Quality System Regulations, or QSRs.
Currently, we purchase the raw material from which we produce Technosphere particles from a major chemical manufacturer with facilities in Europe and North America. We also have the capability of manufacturing this chemical ourselves in our Danbury facility, which is treated as a back-up facility. Like us, our third-party manufacturers are subject to extensive governmental regulation.
INTELLECTUAL PROPERTY AND PROPRIETARY TECHNOLOGY
Our success will depend in large measure on our ability to obtain and enforce our intellectual property rights, effectively maintain our trade secrets and avoid infringing the proprietary rights of third parties. Our policy is to file patent applications on what we deem to be important technological developments that might relate to our product candidates or methods of using our product candidates and to seek intellectual property protection in the United States, Europe, Japan and selected other jurisdictions for all significant inventions. We have obtained, are seeking, and will continue to seek patent protection on the compositions of matter, methods and devices flowing from our research and development efforts. We have also in-licensed certain technology.
Our Technosphere drug delivery platform, including AFREZZA, enjoys patent protection relating to the particles, their manufacture, and their use for pulmonary delivery of drugs. We have additional patent coverage relating to the treatment of diabetes using AFREZZA. We have been granted patent coverage for our inhaler and cartridges in the form in which we expect our insulin product to be sold to the consumer, if and when approved by the FDA. We have additional pending patent applications, and expect to file further applications, relating to the drug delivery platform, methods of manufacture, the AFREZZA product and its use, and other Technosphere-based products, inhalers and inhaler cartridges. Overall, AFREZZA is protected by over 300 issued patents, and we also have over 300 pending applications in the United States and selected jurisdictions around the world related to our Technosphere platform. These include composition and method of treatment patents providing protection for AFREZZA that will remain in force into 2020. In addition, patents providing protection for our inhaler and cartridges will remain in force into 2023, and we have certain treatment claims that can be maintained in force variously into 2026 and 2029.
In addition, we own or have in-licensed intellectual property relating to several drug targets of interest in the treatment of cancer and other fields. Patents and patent applications in this area are drawn to drug screening methods, methods of treatment, and chemical structures of inhibitors of these targets. Our cancer immunotherapy program is built on proprietary methods for the selection, design and administration of epitopes, as well as the plasmids and peptides that are the active ingredients of our product candidates.
The fields of pulmonary drug delivery and cancer therapies are crowded and a substantial number of patents have been issued in these fields. In addition, because patent positions can be highly uncertain and frequently involve complex legal and factual questions, the breadth of claims obtained in any application or the enforceability of issued patents cannot be confidently predicted. Further, there can be substantial delays in commercializing pharmaceutical products, which can partially consume the statutory period of exclusivity through patents.
In addition, the coverage claimed in a patent application can be significantly reduced before a patent is issued, either in the United States or abroad. Statutory differences in patentable subject matter may limit the protection we can obtain on some of our inventions outside of the United States. For example, methods of treating humans are not patentable in many countries outside of the United States. These and other issues may limit the patent protection we are able to secure internationally. Consequently, we do not know whether any of our pending or future patent applications will result in the issuance of patents or, to the extent patents have been issued or will be issued, whether these patents will be subjected to further proceedings limiting their scope, will provide significant proprietary protection or competitive advantage, or will be circumvented or invalidated. Furthermore, patents already issued to us or our pending applications may become subject to disputes that could be resolved against us. In addition, patent applications in the United States filed before November 29, 2000 are currently maintained in secrecy until the patent issues, although in certain countries, including the United States, for applications filed on or after November 29, 2000, applications are generally published 18 months after the application’s priority date. In any event, because publication of discoveries in scientific or patent literature often trails behind actual discoveries, we cannot be certain that we were the first inventor of the subject matter covered by our pending patent applications or that we were the first to file patent applications on such inventions.
Although we own a number of domestic and foreign patents and patent applications relating to our Technosphere-based investigational products and our cancer products under development, we have identified certain third-party patents having claims relating to pulmonary insulin delivery that may trigger an allegation of infringement upon the commercial manufacture and sale of AFREZZA. We have also identified third-party patents disclosing methods and compositions of matter related to cancer vaccines that also may trigger an allegation of infringement upon the commercial manufacture and sale of our cancer immunotherapy. We believe that we are not infringing any valid claims of any patent owned by a third party. However, if a court were to determine that our inhaled insulin product or cancer immunotherapies were infringing any of these patent rights, we would have to establish with the court that these patents were invalid in order to avoid legal liability for infringement of these patents. Proving patent invalidity can be difficult because issued patents are presumed valid. Therefore, in the event that we are unable to prevail in an infringement or invalidity action we will either have to acquire the third-party patents outright or seek a royalty-bearing license. Royalty-bearing licenses effectively increase costs and therefore may materially affect product profitability. Furthermore, if the patent holder refuses to either assign or license us the infringed patents, it may be necessary to cease manufacturing the product entirely and/or design around the patents. In either event, our business would be harmed and our profitability could be materially adversely impacted. If third parties file patent applications, or are issued patents claiming technology also claimed by us in pending applications, we may be required to participate in interference proceedings in the United States Patent and Trademark Office, or USPTO, to determine priority of invention. We may be required to participate in interference proceedings involving our issued patents and pending applications.
CEO BACKGROUND
lfred E. Mann has been one of our directors since April 1999, our Chairman of the Board since December 2001 and our Chief Executive Officer since October 2003. He founded and formerly served as Chairman and Chief Executive Officer of MiniMed, Inc., a publicly traded company focused on diabetes therapy and microinfusion drug delivery that was acquired by Medtronic, Inc. in August 2001. Mr. Mann also founded and, from 1972 through 1992, served as Chief Executive Officer of Pacesetter Systems, Inc. and its successor, Siemens Pacesetter, Inc., a manufacturer of cardiac pacemakers, now the Cardiac Rhythm Management Division of St. Jude Medical Corporation. Mr. Mann founded and since 1993, has served as Chairman and until January 2008, as Co-Chief Executive Officer of Advanced Bionics Corporation, a medical device manufacturer focused on neurostimulation to restore hearing to the deaf and to treat chronic pain and other neural deficits, that was acquired by Boston Scientific Corporation in June 2004. In January 2008, the former stockholders of Advanced Bionics Corporation repurchased certain segments from Boston Scientific Corporation and formed Advanced Bionics LLC for cochlear implants and Infusion Systems LLC for infusion pumps. Mr. Mann was non-executive Chairman of both entities. Advanced Bionics LLC was acquired by Sonova Holdings on December 30, 2009. Infusion Systems LLC was acquired by the Alfred E. Mann Foundation in February 2010. Mr. Mann has also founded and is non-executive Chairman of Second Sight Medical Products, Inc., which is developing a visual prosthesis for the blind; Bioness Inc., which is developing rehabilitation neurostimulation systems; Quallion LLC, which produces batteries for medical products and for the military and aerospace industries; and Stellar Microelectronics Inc., a supplier of electronic assemblies to the medical, military and aerospace industries. Mr. Mann also founded and is the managing member of PerQFlo, LLC, which is developing drug delivery systems. Mr. Mann is the managing member of the Alfred E. Mann Foundation and is also non-executive Chairman of Alfred Mann Institutes at the University of Southern California, AMI Purdue and AMI Technion, and the Alfred Mann Foundation for Biomedical Engineering, which is establishing additional institutes at other research universities. Mr. Mann holds bachelor’s and master’s degrees in Physics from the University of California at Los Angeles, honorary doctorates from Johns Hopkins University, the University of Southern California, Western University and the Technion-Israel Institute of Technology and is a member of the National Academy of Engineering. The Board believes that Mr. Mann’s business experience, including his extensive experience as a founder, board member and executive officer of medical device companies, combined with his business acumen and judgment provide our Board with valuable scientific and operational expertise and leadership skills.
Hakan S. Edstrom has been our President and Chief Operating Officer since April 2001 and has served as one of our directors since December 2001. Mr. Edstrom was with Bausch & Lomb, Inc., a health care product company, from January 1998 to April 2001, advancing to the position of Senior Corporate Vice President and President of Bausch & Lomb, Inc. Americas Region. From 1981 to 1997, Mr. Edstrom was with Pharmacia Corporation, where he held various executive positions, including President and Chief Executive Officer of Pharmacia Ophthalmics Inc. Mr. Edstrom was educated in Sweden and holds a master’s degree in Business Administration from the Stockholm School of Economics. The Board believes that Mr. Edstrom’s business experience, including his extensive experience as an executive officer of health care product companies, combined with his business acumen and judgment provide our Board with valuable operational expertise and leadership skills.
Abraham (Barry) E. Cohen has been one of our directors since May 2007. Mr. Cohen served as Senior Vice President of Merck & Co. until his retirement in January 1992 and as President of the Merck Sharp & Dohme International Division from 1977 to 1988. Since his retirement, Mr. Cohen has been active as an international business consultant. He is presently a director of Chugai Pharmaceutical Co., Ltd. and Teva Pharmaceutical Industries Ltd. The Board believes that Mr. Cohen’s business experience, including his experience as an executive officer of Merck, and his service on other public company boards, combined with his business acumen and judgment provide our Board with valuable operational expertise and leadership skills.
Ronald Consiglio has been one of our directors since October 2003. Since 1999, Mr. Consiglio has been the managing director of Synergy Trading, a securities-trading partnership. From 1999 to 2001, Mr. Consiglio was Executive Vice President and Chief Financial Officer of Trading Edge, Inc., a national automated bond-trading firm. From January 1993 to 1998 Mr. Consiglio served as Chief Executive Officer of Angeles Mortgage Investment Trust, a publicly traded Real Estate Investment Trust. His prior experience includes serving as Senior Vice President and Chief Financial Officer of Cantor Fitzgerald & Co. and as a member of its board of directors. Mr. Consiglio is currently a member of the board of trustees for the Metropolitan West Funds. Mr. Consiglio is a certified public accountant and holds a bachelor’s degree in accounting from California State University at Northridge. The Board believes that Mr. Consiglio’s knowledge and understanding of accounting and finance, his experience as a board member and executive officer at financial services firms, combined with his business acumen and judgment provide our Board with valuable accounting, financial and operational expertise and leadership skills.
Michael Friedman, M.D. has been one of our directors since December 2003. Currently, Dr. Friedman is the President and Chief Executive Officer of the City of Hope National Medical Center. Previously, from September 2001 until April 2003, Dr. Friedman held the position of Senior Vice President of Research and Development, Medical and Public Policy, for Pharmacia Corporation and, from July 1999 until September 2001, was a senior vice president of Searle, a subsidiary of Monsanto Company. From 1995 until June 1999, Dr. Friedman served as Deputy Commissioner for Operations for the Food and Drug Administration, and was Acting Commissioner and Lead Deputy Commissioner from 1997 to 1998. Dr. Friedman received a bachelor of arts degree, magna cum laude, from Tulane University, New Orleans, Louisiana, and a doctorate in medicine from the University of Texas, Southwestern Medical School. The Board believes Dr. Friedman’s business experience, including his experience as an executive officer at biopharmaceutical companies and a leading clinical and research center specializing in cancer and diabetes, and his service at the Food and Drug Administration, combined with his business acumen and judgment provide our Board with valuable scientific and operational expertise and leadership skills.
Kent Kresa has been one of our directors since June 2004. Mr. Kresa is Chairman Emeritus of Northrop Grumman Corporation, a defense company and from September 1990 until October 2003, he was its Chairman. He also served as Chief Executive Officer of Northrop Grumman Corporation from January 1990 until March 2003 and as its President from 1987 until September 2001. Mr. Kresa is also Chairman of the Board of Trustees of the California Institute of Technology (“Caltech”) and has been a member of the Caltech Board of Trustees since 1994. Mr. Kresa serves on the boards of Fluor Corporation, and several non-profit organizations and universities. He is also on the Advisory Board of Trust Company of the West. As a graduate of Massachusetts Institute of Technology, he received a B.S. in 1959, an M.S. in 1961, and an E.A.A. in 1966, all in aeronautics and astronautics. The Board believes that Mr. Kresa’s business experience, including his experience as a director and executive officer of Northrop Grumman, and his service on other public company boards, combined with his business acumen and judgment provide our Board with valuable operational expertise and leadership skills.
David H. MacCallum has been one of our directors since June 2004. Currently, Mr. MacCallum is the Managing Partner of Outer Islands Capital, a hedge fund specializing in health care investments. From June 1999 until November 2001, he was Global Head of Health Care investment banking for Salomon Smith Barney, part of Citigroup, a financial institution. Prior to joining Salomon Smith Barney, he was Executive Vice President and Head of the Health Care group at ING Barings Furman Selz LLC, an investment banking firm and subsidiary of ING Group, a Dutch financial institution, from April 1998 to June 1999. Prior to that, Mr. MacCallum formed the Life Sciences group at UBS Securities, an investment banking firm, where he was Managing Director and Global Head of Life Sciences from May 1994 to April 1998. Before joining UBS Securities, he built the health care practice at Hambrecht & Quist, an investment banking firm, where he was Head of Health Care and Co-Head of Investment Banking. Mr. MacCallum received an A. B. degree from Brown University and an M.B.A. degree from New York University. He is a Chartered Financial Analyst. The Board believes that Mr. MacCallum’s knowledge and understanding of accounting and finance, his business experience in the investment banking industry, combined with his business acumen and judgment provide our Board with valuable accounting, financial and operational expertise and leadership skills.
Henry L. Nordhoff has been one of our directors since March 2005. Mr. Nordhoff has served as Chairman of the Board of Gen-Probe Incorporated, a clinical diagnostic and blood screening company, since September 2002 and served as Chief Executive Officer and President of Gen-Probe from July 1994 until May 2009. Prior to joining Gen-Probe, he was President and Chief Executive Officer of TargeTech, Inc., a gene therapy company that was merged into Immune Response Corporation. Prior to that, Mr. Nordhoff was at Pfizer, Inc. in senior positions in Brussels, Seoul, Tokyo and New York. He received a B.A. in international relations and political economy from Johns Hopkins University and an M.B.A. from Columbia University. The Board believes that Mr. Nordhoff’s business experience, including his experience as a director and executive officer at pharmaceutical and biotech companies, combined with his business acumen and judgment provide our Board with valuable operational expertise and leadership skills.
James S. Shannon, M.D., MRCP (UK) has been one of our directors since February 2010. Dr. Shannon is trained in Medicine and Cardiology. He received his undergraduate and postgraduate degrees at Queen’s University of Belfast and is a Member of the Royal College of Physicians (UK). He has more than 20 years experience at senior levels of the pharmaceutical industry and until his retirement in 2008 was Global Head of Drug Development for Novartis Pharma AG based in Basel, Switzerland. He entered the pharmaceutical industry in 1987 joining Sterling Winthrop working initially in Europe and subsequently in the USA, where he held positions of increasing responsibility in the management of Research and Development ultimately serving as Senior Vice-President, Clinical Development. Following the acquisition of Sterling in 1994 he joined Sandoz in Basel as Head of Drug Regulatory Affairs. Dr. Shannon held a number of significant positions in Novartis including Head of the Integration Office for R&D overseeing the creation of the Novartis R&D groups from those of Ciba and Sandoz and also Head of the Cardiovascular Strategic Team where he oversaw the design and implementation of the clinical trial program for Diovan. Subsequently he was appointed Global Head of Project Management before being appointed Global Head of Clinical Development and Medical Affairs in 1999, a position that he held until 2005 when he was appointed to Head Pharma Development. During these years Novartis was recognized as the leading company in terms of FDA approvals for New Molecular Entities and one of the leading companies with regard to the adoption of novel technology in Development. In addition to our Board, Dr. Shannon currently serves on the boards of Biotie Therapies, Circassia Holdings Ltd., Endocyte Inc. and Xanodyne Pharmaceuticals, Inc. The Board believes that Dr. Shannon’s business experience and his extensive experience in drug development, combined with his business acumen and judgment provide our Board with valuable scientific and operational expertise and leadership skills.
MANAGEMENT DISCUSSION FROM LATEST 10K
OVERVIEW
We are a biopharmaceutical company focused on the discovery and development of therapeutic products for diseases such as diabetes and cancer. Our lead product candidate, AFREZZA, is an ultra rapid-acting insulin therapy that is in late-stage clinical investigation for the treatment of adults with type 1 or type 2 diabetes for the control of hyperglycemia.
We are a development stage enterprise and have incurred significant losses since our inception in 1991. As of December 31, 2011, we have incurred a cumulative net loss of $1.9 billion and a stockholders’ deficit of $313.7 million. To date, we have not generated any product revenues and have funded our operations primarily through the sale of equity securities and convertible debt securities and borrowings under a loan arrangement provided by our principal stockholder. As discussed below in “Liquidity and Capital Resources,” if we are unable to obtain additional funding in the future, there will continue to be substantial doubt about our ability to continue as a going concern.
We do not expect to record sales of any product prior to regulatory approval and commercialization of AFREZZA. We currently do not have the required approvals to market any of our product candidates, and we may not receive such approvals. We may not be able to achieve positive cash flow from operations even if we succeed in commercializing any of our product candidates. We expect to make substantial expenditures and to incur additional operating losses for at least the next several years as we:
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continue the clinical development of AFREZZA and new inhalation systems for the treatment of diabetes;
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seek regulatory approval to sell AFREZZA in the United States and other markets;
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seek development and commercialization collaborations for AFREZZA; and
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develop additional applications of our proprietary Technosphere formulation technology for the pulmonary delivery of other drugs.
Our business is subject to significant risks, including but not limited to the risks inherent in our ongoing clinical trials and the regulatory approval process, our potential inability to enter into sales and marketing collaborations or to commercialize AFREZZA in a timely manner, the results of our research and development efforts, competition from other products and technologies and uncertainties associated with obtaining and enforcing patent rights.
RESEARCH AND DEVELOPMENT EXPENSES
Our research and development expenses consist mainly of costs associated with the clinical trials of our product candidates that have not yet received regulatory approval for marketing and for which no alternative future use has been identified. This includes the salaries, benefits and stock-based compensation of research and development personnel, raw materials, such as insulin purchases, laboratory supplies and materials, facility costs, costs for consultants and related contract research, licensing fees, and depreciation of laboratory equipment. We track research and development costs by the type of cost incurred. We partially offset research and development expenses with the recognition of estimated amounts receivable from the State of Connecticut pursuant to a program under which we can exchange qualified research and development income tax credits for cash. Included in research and development expenses for the year ended December 31, 2011 were purchases of insulin totaling $8.4 million.
Our research and development staff conducts our internal research and development activities, which include research, product development, clinical development, manufacturing and related activities. This staff is located in our facilities in Valencia, California; Paramus, New Jersey; and Danbury, Connecticut. We expense research and development costs as we incur them.
Clinical development timelines, likelihood of success and total costs vary widely. We are focused primarily on advancing AFREZZA through regulatory filings.
At this time, due to the risks inherent in the clinical trial process and given the early stage of development of our product candidates other than AFREZZA, we are unable to estimate with any certainty the costs that we will incur in the continued development of our product candidates for commercialization. The costs required to complete the development of AFREZZA will be largely dependent on the cost and efficiency of our clinical trial operations and discussions with the FDA regarding its requirements.
During the first quarter of 2011, we implemented a restructuring to streamline operations, reduce operating expenses, extend our cash runway and focus our resources on securing FDA approval of the NDA for AFREZZA. In connection with the restructuring, we recorded charges to research and development expenses of approximately $4.7 million for employee severance and other related termination benefits. The restructuring resulted in research and development operating cost savings of approximately $9.5 million in 2011. These savings were partially offset by increased costs associated with the additional trials required by the FDA.
GENERAL AND ADMINISTRATIVE EXPENSES
Our general and administrative expenses consist primarily of salaries, benefits and stock-based compensation for administrative, finance, business development, human resources, legal and information systems support personnel. In addition, general and administrative expenses include professional service fees and business insurance costs.
In connection with the restructuring, we recorded charges to general and administrative expenses of approximately $1.6 million for employee severance and other related termination benefits. The restructuring resulted in general and administrative operating cost savings of approximately $2.8 million in 2011. These savings were offset primarily by increased professional fees.
CRITICAL ACCOUNTING POLICIES
We have based our discussion and analysis of our financial condition and results of operations on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making estimates of expenses such as stock option expenses and judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. The significant accounting policies that are critical to the judgments and estimates used in the preparation of our financial statements are described in more detail below.
Impairment of long-lived assets
Assessing long-lived assets for impairment requires us to make assumptions and judgments regarding the carrying value of these assets. We evaluate long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset may not be recoverable. The assets are considered to be impaired if we determine that the carrying value may not be recoverable based upon our assessment of the following events or changes in circumstances:
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significant changes in our strategic business objectives and utilization of the assets;
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a determination that the carrying value of such assets cannot be recovered through undiscounted cash flows;
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loss of legal ownership or title to the assets;
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a significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator; or
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the impact of significant negative industry or economic trends.
If we believe our assets to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. Any write-downs would be treated as permanent reductions in the carrying amount of the asset and an operating loss would be recognized. In addition, we base the useful lives and related amortization or depreciation expense on our estimate of the useful lives of the assets. If a change were to occur in any of the above-mentioned factors or estimates, our reported results could materially change.
To date, we have had recurring operating losses, and the recoverability of our long-lived assets is contingent upon executing our business plan. If we are unable to execute our business plan, we may be required to write down the value of our long-lived assets in future periods.
Clinical trial expenses
Our clinical trial accrual process seeks to account for expenses resulting from our obligations under contract with vendors, consultants, and clinical site agreements in connection with conducting clinical trials. The financial terms of these contracts are subject to negotiations which vary from contract to contract and may result in payment flows that do not match the periods over which materials or services are provided to us under such contracts. Our objective is to reflect the appropriate trial expenses in our financial statements by matching period expenses with period services and efforts expended. We account for these expenses according to the progress of the trial as measured by patient progression and the timing of various aspects of the trial. We determine accrual estimates through discussions with internal clinical personnel and outside service providers as to the progress or state of completion of trials, or the services completed. Service provider status is then compared to the contractual obligated fee to be paid for such services. During the course of a clinical trial, we adjust our rate of clinical expense recognition if actual results differ from our estimates. In the event that we do not identify certain costs that have begun to be incurred or we underestimate or overestimate the level of services performed or the costs of such services, our reported expenses for a period would be too low or too high. The date on which certain services commence, the level of services performed on or before a given date and the cost of the services are often judgmental. We make these judgments based upon the facts and circumstances known to us in accordance with generally accepted accounting principles.
Stock-based compensation
We account for stock-based compensation in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 718 (“ASC 718”) Compensation- Stock Compensation , previously FASB Statement No. 123R, Accounting for Stock-Based Compensation . ASC 718 requires all share-based payments to employees, including grants of stock options, restricted stock units, performance-based awards and the compensatory elements of employee stock purchase plans, to be recognized in the income statement based upon the fair value of the awards at the grant date. We use the Black-Scholes option valuation model to estimate the grant date fair value of employee stock options and the compensatory elements of employee stock purchase plans. Restricted stock units are valued based on the market price on the grant date. We evaluate stock awards with performance conditions as to the probability that the performance conditions will be met and estimate the date at which the performance conditions will be met in order to properly recognize stock-based compensation expense over the requisite service period.
Accounting for income taxes
We must make management judgments when determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. At December 31, 2011, we have established a valuation allowance of $689.4 million against all of our net deferred tax asset balance, due to uncertainties related to our deferred tax assets as a result of our history of operating losses. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to change the valuation allowance, which could materially impact our financial position and results of operations.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations primarily through the sale of equity securities and convertible debt securities and borrowings under our loan arrangement with our principal stockholder.
In October 2007, we entered into a loan arrangement with our principal stockholder allowing us to borrow up to a total of $350.0 million. In February 2009, as a result of our principal stockholder being licensed as a finance lender under the California Finance Lenders Law, the promissory note underlying the loan arrangement was revised to reflect the lender as The Mann Group LLC, an entity controlled by our principal stockholder. Interest will accrue on each outstanding advance at a fixed rate equal to the one-year LIBOR rate as reported by the Wall Street Journal on the date of such advance plus 3% per annum and is payable quarterly in arrears. In August 2010, we amended and restated the existing promissory note evidencing the loan arrangement with The Mann Group to extend the maturity date from December 31, 2011 to December 31, 2012. In January, 2012, we amended the note with The Mann Group to extend the maturity date of the $350.0 million loan arrangement from December 31, 2012 to March 31, 2013. We can continue to borrow under the amended terms of the note until June 30, 2012. Under the amended and restated promissory note, The Mann Group can require us to prepay up to $200.0 million in advances that have been outstanding for at least 12 months. If The Mann Group exercises this right, we will have 90 days after The Mann Group provides written notice (or the number of days to maturity of the note if less than 90 days) to prepay such advances. In August 2010, we entered into a letter agreement confirming a previous commitment by The Mann Group to not require us to prepay amounts outstanding under the amended and restated promissory note if the prepayment would require us to use our working capital resources, including the proceeds from the sale of our 5.75% Senior Convertible Notes due 2015. In the event of a default, all unpaid principal and interest either becomes immediately due and payable or may be accelerated at the lender’s option, and the interest rate will increase to the one-year LIBOR rate calculated on the date of the initial advance or in effect on the date of default, whichever is greater, plus 5% per annum. All borrowings under the loan arrangement are unsecured. The loan arrangement contains no financial covenants. As of December 31, 2011, the amount borrowed and outstanding under the arrangement was $277.2 million and we had $45.0 million of available borrowings under the arrangement.
In August 2010, we completed a Rule 144A offering of $100.0 million aggregate principal amount of 5.75% Senior Convertible Notes due 2015. The net proceeds to us from the sale of the notes were approximately $95.8 million, after deducting the discount to the initial purchasers of $3.3 million and the offering expenses paid by us.
In connection with the offering of the notes, in August 2010, we entered into a share lending agreement with Bank of America, pursuant to which we lent 9,000,000 shares of our common stock to Bank of America, which is obligated to return the borrowed shares (or, in certain circumstances, the cash value thereof) to us on or about the 45 th business day following the date as of which the entire principal amount of the notes ceases to be outstanding, subject to extension or acceleration in certain circumstances or early termination at Bank of America’s option.
Also in August 2010, we entered into an underwriting agreement with Merrill Lynch and Bank of America, pursuant to which the borrowed shares were offered and sold to the public at a fixed price of $5.55 per share. We did not receive any proceeds from the sale of the borrowed shares to the public, but received a lending fee of $90,000 pursuant to the share lending agreement for the use by Bank of America of the borrowed shares. Bank of America received all of the net proceeds from the sale of the borrowed shares to the public.
On February 8, 2012, we sold $86.3 million worth of units in an underwritten public offering, with each unit consisting of one share of common stock and a warrant to purchase 0.6 of a share of common stock, and reflects the full exercise of an over-allotment option granted to the underwriters. Net proceeds from this offering were approximately $80.6 million, excluding any warrant exercises. Concurrent with this public offering, The Mann Group LLC agreed to purchase $77.2 million worth of restricted shares of common stock which will be paid by cancellation of principal indebtedness under the amended loan arrangement, subject to stockholder approval to increase the number of our authorized shares.
During the year ended December 31, 2011, we used $123.9 million of cash for our operations and had a net loss of $160.8 million for the year ended December 31, 2011, of which $27.1 million consisted of non-cash charges such as depreciation and amortization, and stock-based compensation. By comparison, during the year ended December 31, 2010, we used $148.7 million of cash for our operations and had a net loss of $170.6 million, of which $30.9 million consisted of non-cash charges such as depreciation and amortization, and stock-based compensation. Cash used for our operations for the year ended December 31, 2011 decreased by $24.8 million compared to cash used for our operations for the year ended December 31, 2010 due primarily to reduced salary-related costs and the positive impact of cost cutting measures on operating costs as a result of our February 2011 restructuring. Additionally, the change in accounts payable and accrued expenses and other current liabilities increased over the prior year due to an increase in current liabilities primarily related to clinical trial activities. We expect our negative operating cash flow to continue at least until we obtain regulatory approval and achieve commercialization of AFREZZA.
We used $2.9 million of cash for investing activities during the year ended December 31, 2011, compared to $11.7 million of cash used for the year ended December 31, 2010. For the year ended December 31, 2011 and 2010, $6.9 million and $9.5 million, respectively, were used to purchase machinery and equipment to expand our manufacturing operations and our quality systems that support clinical trials for AFREZZA. Cash used in investing activities for the year ended December 31, 2011 decreased $8.8 million compared to the same period in prior year due to the purchase of $4.2 million of marketable securities during the year ended December 31, 2010 compared to none in the current year. We received an increase of $1.8 million in proceeds received from sales and maturities of marketable securities compared to the same period in the prior year. We received cash of $3.8 million for the year ended December 31, 2011 related to the early termination of certificates of deposit that were previously held as collateral for foreign exchange hedging instruments compared to $2.0 million received in the same period in prior year as a certificate of deposit matured. Cash used to purchase machinery and equipment decreased $2.8 million compared to the same period in the prior year.
Our financing activities generated $63.4 million of cash for the year ended December 31, 2011, compared to $196.4 million for the same period in 2010. For the year ended December 31, 2011, cash from financing activities was primarily from $53.0 million of related party borrowings and $10.9 million related to the sale of common stock to Seaside during the first quarter of 2011 as well as the vesting of restricted stock units, exercise of stock options, and shares purchased through the employee stock purchase plan. For the year ended December 31, 2010, cash from financing activities was primarily from the issuance of $95.8 million of 5.75% Senior Convertible Notes due 2015 in August 2010, $87.0 million of related party borrowings, $14.1 million related to the sale of common stock to Seaside during the fourth quarter of 2010 and $2.9 million related to the sale of common stock as well as the vesting of restricted stock units, exercise of stock options, and shares purchased through the employee stock purchase plan. Cash from financing activities for the year ended December 31, 2011 decreased by $133.0 million compared to cash from financing for the same period in the prior year due to proceeds from the issuance of the 5.75% Senior Convertible Notes due 2015 in August 2010 as well as decreased related party borrowings, and decreased sales of common stock primarily to Seaside.
As of December 31, 2011, we had $3.2 million in cash, cash equivalents and marketable securities (including $0.4 million of certificate of deposit held as collateral for commercial credit card program). On February 8, 2012, we sold $86.3 million worth of units in an underwritten public offering, with each unit consisting of one share of common stock and a warrant to purchase 0.6 of a share of common stock, and reflects the full exercise of an over-allotment option granted to the underwriters. Net proceeds from this offering were approximately $80.6 million, excluding any warrant exercises.
We believe our existing cash resources, including the $45.0 million remaining available under our loan arrangement with The Mann Group, will be sufficient to fund our anticipated cash requirements into the fourth quarter of 2012. Accordingly, we will need to raise additional capital, either through the sale of equity or debt securities, the entry into a strategic business collaboration with a pharmaceutical or biotechnology company, the establishment of other funding facilities, licensing arrangements, asset sales or other means, or an increase in the borrowings available under the loan arrangement with our related party, in order to continue the development and commercialization of AFREZZA and other product candidates and to support our other ongoing activities. This raises substantial doubt about our ability to continue as a going concern.
We intend to use our capital resources to continue the development and commercialization of AFREZZA, if approved. In addition, portions of our capital resources will be devoted to expanding our other product development programs. We are expending a portion of our capital to scale up our manufacturing capabilities in our Danbury facilities. We also intend to use our capital resources for general corporate purposes.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
OVERVIEW
We are a biopharmaceutical company focused on the discovery, development and commercialization of therapeutic products for diseases such as diabetes and cancer. Our lead product candidate, AFREZZA (insulin human [rDNA origin]) inhalation powder, is an ultra rapid-acting insulin that is in late-stage clinical investigation for the treatment of adults with type 1 or type 2 diabetes for the control of hyperglycemia.
In January 2011, we received a second Complete Response letter in which the FDA requested that we conduct two clinical studies with the Dreamboat inhaler (one in patients with type 1 diabetes and one in patients with type 2 diabetes), with at least one trial including a treatment group using the MedTone inhaler in order to obtain a head-to-head comparison of the pulmonary safety data for the two devices. Over the next eight months, we participated in a number of written and verbal exchanges with the FDA in order to clarify the agency’s requirements for approval of AFREZZA, culminating in an in-person meeting in August 2011 in which we confirmed with the FDA the designs of the two requested studies.
The study in patients with type 1 diabetes, known as study 171, is an open-label study in which all patients are first optimized on their basal insulin regimen before being randomized to one of three arms: a control arm, in which patients utilize an injected insulin analog at mealtimes, or one of two AFREZZA arms, one each for our MedTone device and our Dreamboat device. After the mealtime insulin is titrated, there will be a 12-week observation period on relatively stable doses of the mealtime insulin to assess A1c levels. The primary endpoint is to show non-inferiority of the change in A1c levels in the Dreamboat group compared to the injected insulin analog group. The inclusion of two AFREZZA arms will permit us to perform a head-to-head comparison of the pulmonary safety data for the two devices, which we anticipate will provide a bridge to the extensive safety data that we collected in our earlier clinical studies of the MedTone inhaler. The basic design of this study (comparing different mealtime insulins in combination with a basal insulin regimen) is similar in design to a previous Phase 3 study that we conducted in patients with type 1 diabetes using our MedTone inhaler.
The other requested study, known as study 175, is a placebo-controlled study in patients with type 2 diabetes who are inadequately controlled on metformin with or without a second or third oral medication. Patients are assigned to treatment with AFREZZA or placebo powder in a randomized fashion. There is a titration period followed by a 12-week observation period to assess A1c levels. The primary objective of this study is to show superiority of the AFREZZA group over the placebo group in lowering A1c levels. We have previously compared AFREZZA to placebo powder in successful Phase 2 studies involving patients with type 2 diabetes using the MedTone inhaler.
Both studies are currently enrolling subjects. If enrollment continues as expected, we anticipate completing both of these studies in early 2013. We then would expect to submit the results to the FDA as an amendment to our NDA during the second half of 2013. However, the data collected from these clinical trials may not reach statistical significance or otherwise be sufficient to support an amendment to our NDA, or FDA approval. Moreover, there can be no assurance that we will satisfy all of the FDA’s requirements with these two clinical studies or that the FDA will ultimately find our proposed approach to these clinical studies acceptable. The FDA could also request that we conduct additional clinical studies beyond the currently planned studies in order to provide sufficient data for approval of AFREZZA.
We are a development stage enterprise and have incurred significant losses since our inception in 1991. As of March 31, 2012, we have incurred a cumulative net loss of $2.0 billion and an accumulated stockholders’ deficit of $277.4 million. To date, we have not generated any product revenues and have funded our operations primarily through the sale of equity securities, convertible debt securities and borrowings under our related party loan. As discussed below in “Liquidity and Capital Resources,” this raises substantial doubt about our ability to continue as a going concern.
We have held extensive discussions with a number of pharmaceutical companies concerning a potential strategic business collaboration for AFREZZA. To date we have not reached an agreement on a collaboration with any of these companies. There can be no assurance that any such collaboration will be available to us on a timely basis or on acceptable terms, if at all.
We do not expect to record sales of any product prior to regulatory approval and commercialization of AFREZZA. We currently do not have the required approvals to market any of our product candidates, and we may not receive such approvals. We may not be profitable even if we succeed in commercializing any of our product candidates. We expect to make substantial expenditures and to incur additional operating losses for at least the next several years as we:
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continue the clinical development of AFREZZA and new inhalation systems for the treatment of diabetes;
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seek regulatory approval to sell AFREZZA in the United States and other markets;
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seek development and commercialization collaborations for AFREZZA; and
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develop additional applications of our proprietary Technosphere platform technology for the pulmonary delivery of other drugs.
Our business is subject to significant risks, including but not limited to the risks inherent in our ongoing clinical trials and the regulatory approval process, our potential inability to enter into sales and marketing collaborations or to commercialize our lead product candidate in a timely manner, the results of our research and development efforts, competition from other products and technologies and uncertainties associated with obtaining and enforcing patent rights.
RESEARCH AND DEVELOPMENT EXPENSES
Our research and development expenses consist mainly of costs associated with the clinical trials of our product candidates that have not yet received regulatory approval for marketing and for which no alternative future use has been identified. This includes the salaries, benefits and stock-based compensation of research and development personnel, raw materials, such as insulin purchases, laboratory supplies and materials, facility costs, costs for consultants and related contract research, licensing fees, and depreciation of laboratory equipment. We track research and development costs by the type of cost incurred. We partially offset research and development expenses with the recognition of estimated amounts receivable from the State of Connecticut pursuant to a program under which we can exchange qualified research and development income tax credits for cash.
Our research and development staff conducts our internal research and development activities, which include research, product development, clinical development, manufacturing and related activities. This staff is located in our facilities in Valencia, California; Paramus, New Jersey; and Danbury, Connecticut. We expense research and development costs as we incur them.
Clinical development timelines, likelihood of success and total costs vary widely. We are focused primarily on advancing AFREZZA through regulatory filings. Based on the results of preclinical studies, we plan to develop additional applications of our Technosphere technology. Additionally, we anticipate that we will continue to determine which research and development projects to pursue, and how much funding to direct to each project, on an ongoing basis, in response to the scientific and clinical success of each product candidate. We cannot be certain when any revenues from the commercialization of our products will commence.
At this time, due to the risks inherent in the clinical trial process and given the early stage of development of our product candidates other than AFREZZA, we are unable to estimate with any certainty the costs that we will incur in the continued development of our product candidates for commercialization. The costs required to complete the development of AFREZZA will be largely dependent on the cost and efficiency of our clinical trial operations and discussions with the FDA regarding its requirements.
GENERAL AND ADMINISTRATIVE EXPENSES
Our general and administrative expenses consist primarily of salaries, benefits and stock-based compensation for administrative, finance, business development, human resources, legal and information systems support personnel. In addition, general and administrative expenses include professional service fees and business insurance costs.
CRITICAL ACCOUNTING POLICIES
There have been no material changes to our critical accounting policies as described in Item 7 of our Annual Report.
RESULTS OF OPERATIONS
Three months ended March 31, 2012 and 2011
Revenues
We did not recognize any revenue for the three months ended March 31, 2012. We recognized revenue of $50,000 under a license agreement for the three months ended March 31, 2011. We do not anticipate sales of any product prior to regulatory approval and commercialization of AFREZZA.
Other Income and Expense
Other income for the three months ended March 31, 2012 and for the same period in the prior year was $1.4 million, respectively. During the quarter ended March 31, 2012, we recorded a $2.0 million benefit on a forward purchase contract in other income offset by our common stock investment determined to be permanently impaired at a realized loss of $117,000. In addition, we recognized expense of $284,000 related to the fair value adjustment of the warrant liability. During the three months ended March 31, 2011, we recorded a realized gain of $1.3 million on the termination of foreign exchange hedging contracts.
Interest Expense
Interest expense for the three months ended March 31, 2012 increased by $733,000 as compared to the same period in the prior year primarily due to the additional interest expense associated with additional drawdowns on our note payable to our principal stockholder.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations primarily through the sale of equity securities, convertible debt securities and borrowings under our related party note.
In October 2007, we entered into a loan arrangement with our principal stockholder allowing us to borrow up to a total of $350.0 million. In February 2009, as a result of our principal stockholder being licensed as a finance lender under the California Finance Lenders Law, the promissory note underlying the loan arrangement was revised to reflect the lender as The Mann Group LLC, an entity controlled by our principal stockholder. Interest will accrue on each outstanding advance at a fixed rate equal to the one-year LIBOR rate as reported by the Wall Street Journal on the date of such advance plus 3% per annum and is payable quarterly in arrears.
In August 2010, we amended and restated the existing promissory note evidencing the loan arrangement with The Mann Group to extend the maturity date from December 31, 2011 to December 31, 2012. In January 2012, we amended the note with The Mann Group to extend the maturity date from December 31, 2012 to March 31, 2013 and to extend the date through which we can continue to borrow under the amended terms of the note until June 30, 2012. In addition, interest is payable on the first day of the calendar quarter following the calendar quarter in which an advance is made, or such other time as we mutually agree. On May 9, 2012, we amended the note with The Mann Group to extend the maturity date March 31, 2013 to July 1, 2013. Under the amended and restated promissory note, The Mann Group can require us to prepay up to $200.0 million in advances that have been outstanding for at least 12 months. If The Mann Group exercises this right, we will have 90 days after The Mann Group provides written notice (or the number of days to maturity of the note if less than 90 days) to prepay such advances. In August 2010, we and The Mann Group entered into a letter agreement confirming a previous commitment by The Mann Group to not require us to prepay amounts outstanding under the amended and restated promissory note if the prepayment would require us to use our working capital resources. In the event of a default, all unpaid principal and interest either becomes immediately due and payable or may be accelerated at the lender’s option, and the interest rate will increase to the one-year LIBOR rate calculated on the date of the initial advance or in effect on the date of default, whichever is greater, plus 5% per annum. All borrowings under the loan arrangement are unsecured. The loan arrangement contains no financial covenants. As of March 31, 2012, the amount borrowed and outstanding under the arrangement was $283.5 million and we had $38.8 million of available borrowings under the arrangement.
In August 2010, we completed a Rule 144A offering of $100.0 million aggregate principal amount of 5.75% Senior Convertible Notes due 2015. The net proceeds to us from the sale of the notes were approximately $95.8 million, after deducting the discount to the initial purchasers of $3.3 million and the offering expenses paid by us.
In connection with the offering of the notes, in August 2010, we entered into a share lending agreement with Bank of America, pursuant to which we lent 9,000,000 shares of our common stock to Bank of America, which is obligated to return the borrowed shares (or, in certain circumstances, the cash value thereof) to us on or about the 45 th business day following the date as of which the entire principal amount of the notes ceases to be outstanding, subject to extension or acceleration in certain circumstances or early termination at Bank of America’s option.
Also in August 2010, we entered into an underwriting agreement with Merrill Lynch and Bank of America, pursuant to which the borrowed shares were offered and sold to the public at a fixed price of $5.55 per share. We did not receive any proceeds from the sale of the borrowed shares to the public, but received a lending fee of $90,000 pursuant to the share lending agreement for the use by Bank of America of the borrowed shares. Bank of America received all of the net proceeds from the sale of the borrowed shares to the public.
On February 8, 2012, we sold $86.3 million worth of units in an underwritten public offering, with each unit consisting of one share of common stock and a warrant to purchase 0.6 of a share of common stock, and reflects the full exercise of an over-allotment option granted to the underwriters. Net proceeds from this offering were approximately $80.6 million, excluding any warrant exercises. Concurrent with this public offering, The Mann Group LLC agreed to purchase $77.2 million worth of restricted shares of common stock which will be paid, at the discretion of the Company, by cash or by cancellation of principal indebtedness under the amended loan arrangement, subject to stockholder approval to increase the number of our authorized shares.
During the three months ended March 31, 2012, we used $32.5 million of cash for our operations and had a net loss $38.2 million, of which $6.6 million consisted of non-cash charges such as depreciation and amortization, and stock-based compensation. By comparison, during the three months ended March 31, 2011, we used $30.7 million of cash for our operations and had a net loss of $41.5 million, of which $6.8 million consisted of non-cash charges such as depreciation and amortization, and stock-based compensation. Cash used for our operations for the three months ended March 31, 2012 increased by $1.8 million compared to cash used for our operations for the three months ended March 31, 2011 due primarily to an increase in clinical trial related expenses. We expect our negative operating cash flow to continue at least until we obtain regulatory approval and achieve commercialization of AFREZZA.
We used $291,000 of cash for investing activities during the three months ended March 31, 2012, compared to $1.8 million of cash provided by investing activities for the three months ended March 31, 2011. For the three months ended March 31, 2012 and 2011, $323,000 and $2.0 million, respectively, were used to purchase machinery and equipment to expand our manufacturing operations and our quality systems that support clinical trials for AFREZZA. Cash used in investing activities for the three months ended March 31, 2012 decreased $2.1 million compared to the same period in prior year due to $3.8 million in proceeds received from sales and maturities of marketable securities during the three months ended March 31, 2011. We received cash of $3.8 million for the three months ended March 31, 2011 related to the early termination of certificates of deposit that were previously held as collateral for foreign exchange hedging instruments.
Our financing activities generated $86.5 million of cash for the three months ended March 31, 2012, compared to $9.7 million for the same period in 2011. For the three months ended March 31, 2012, cash from financing activities was primarily from $80.6 million related to the February 2012 issuance of common stock and warrants through the sale of 35,937,500 units, with each unit consisting of one share of common stock and a warrant to purchase 0.6 of a share of common stock as well as the exercise of stock options. Additionally we generated cash of $6.3 million from related party borrowings. For the three months ended March 31, 2011, cash from financing activities was primarily from $9.7 million related to the sale of common stock to Seaside as well as the exercise of stock options.
As of March 31, 2012, we had $56.7 million in cash, cash equivalents and marketable securities (including $350,000 of certificate of deposit held as collateral for commercial credit card program). We believe our existing cash resources, including the $38.8 million remaining available under our loan arrangement with The Mann Group, will be sufficient to fund our anticipated cash requirements into the fourth quarter of 2012. Accordingly, we will need to raise additional capital, either through the sale of equity or debt securities, the entry into a strategic business collaboration with a pharmaceutical or biotechnology company, the establishment of other funding facilities, licensing arrangements, asset sales or other means, or an increase in the borrowings available under the loan arrangement with our related party, in order to continue the development and commercialization of AFREZZA and other product candidates and to support our other ongoing activities. This raises substantial doubt about our ability to continue as a going concern.
We intend to use our capital resources to continue the development and commercialization of AFREZZA, if approved. In addition, portions of our capital resources will be devoted to expanding our other product development programs. We are expending a portion of our capital to scale up our manufacturing capabilities in our Danbury facilities. We also intend to use our capital resources for general corporate purposes.
We have held extensive discussions with a number of pharmaceutical companies concerning a potential strategic business collaboration for AFREZZA. We cannot predict when, if ever, we could conclude an agreement with a partner. There can be no assurance that any such collaboration will be available to us on a timely basis or on acceptable terms, if at all.
If we enter into a strategic business collaboration with a pharmaceutical or biotechnology company, we would expect, as part of the transaction, to receive additional capital. In addition, we expect to pursue the sale of equity and/or debt securities, or the establishment of other funding facilities. Issuances of debt or additional equity could impact the rights of our existing stockholders, dilute the ownership percentages of our existing stockholders and may impose restrictions on our operations. These restrictions could include limitations on additional borrowing, specific restrictions on the use of our assets as well as prohibitions on our ability to create liens, pay dividends, redeem our stock or make investments. We also may seek to raise additional capital by pursuing opportunities for the licensing, sale or divestiture of certain intellectual property and other assets, including our Technosphere technology platform. There can be no assurance, however, that any strategic collaboration, sale of securities or sale or license of assets will be available to us on a timely basis or on acceptable terms, if at all. If we are unable to raise additional capital, we may be required to enter into agreements with third parties to develop or commercialize products or technologies that we otherwise would have sought to develop independently, and any such agreements may not be on terms as commercially favorable to us.
However, we cannot provide assurances that our plans will not change or that changed circumstances will not result in the depletion of our capital resources more rapidly than we currently anticipate. If planned operating results are not achieved or we are not successful in raising additional capital through equity or debt financing or entering a business collaboration, we may be required to reduce expenses through the delay, reduction or curtailment of our projects, including AFREZZA development activities, or further reduction of costs for facilities and administration, and there will continue to be substantial doubt about our ability to continue as a going concern.
CONF CALL
Matthew J. Pfeffer
Good afternoon, and welcome, and thank you for participating in today's call. I'll summarize our financial results for the first quarter of 2012 as reported earlier today. Then Hakan will discuss our current operations, and Al will conclude with an overview before we open up the call to your questions.
Before we proceed further, please note that comments made during this call will include forward-looking statements within the meaning of federal securities laws. It is possible that the actual results could differ from these stated expectations. For factors which could cause actual results to differ from expectations, please refer to the reports filed by the company with the Securities and Exchange Commission under the Securities and Exchange Act (sic) [Securities Exchange Act] of 1934.
This conference call contains time-sensitive information that is accurate only as of the date of this live broadcast, May 9, 2012. We undertake no obligation to revise or update any statements to reflect events or circumstances after the date of this call.
For the first quarter of 2012, total operating expenses were $33.9 million compared to $30.6 million for the fourth quarter of 2011 and $38.1 million for the first quarter of 2011. R&D expenses were $24.2 million the first quarter of 2012 compared to $20.2 million for the fourth quarter of 2011 and $26.3 million for the first quarter of 2011. The decrease in R&D expenses for the first quarter of 2012 compared to the same quarter in 2011 was primarily due to the decreased salary-related costs, as a result of the February 2011 reduction in force. So over the increase in R&D expenses this quarter from last quarter was primarily due to an increase in clinical trial-related activities as Trials 171 and 175 were initiated in the third and fourth quarters of 2011, respectively.
General and administrative expenses were $9.8 million for the first quarter of 2012 compared to $10.3 million for the fourth quarter of 2011 and $11.8 million for the first quarter of the previous year. General and administrative expenses remained relatively stable quarter-over-quarter. The decrease in salary-related costs, a result of the February 2011 RIF, accounted for the reduction from the prior year.
The net loss applicable to common stockholders for the first quarter of 2012 was $38.2 million or $0.27 per share compared with a net loss of applicable to common stockholders of $41.5 million or $0.34 per share for first quarter of 2011.
Our cash, cash equivalents and marketable securities at the end of the first quarter of 2012 totaled $56.7 million, which compares to $3.2 million at the end of 2011. Financial resources, including the remaining credit facility from Al, amounted to $95.5 million as of March 31, 2012.
Our cash burn increased from $20.1 million spend in the fourth quarter of 2011 to $33.1 million in the first quarter of 2012, reflecting the acceleration of our spending in 2012 as we enroll the planned clinical trials and approached commercialization. With our cash in hand and amount remaining available under the credit facility from Al, we believe we will be able to fund our operations into the fourth quarter of 2012. We continue to pursue additional funding opportunities to extend our cash runway, but I cannot comment further until we have something definitive to announce.
With that, I would like to now turn the call over to Hakan. Hakan?
Hakan S. Edstrom
Thank you, Matt. Good afternoon. The focus of the organization during the first quarter certainly have been on the clinical trial programs, and all of our clinical trials are progressing satisfactorily. Our 2 trials, the 171 and 175, are well underway. We've opened all the planned sites in the U.S., Russia and Ukraine, and they are actively bringing in patients to the studies.
As early in the month, we had screened approximately 75% of the planned patients in both trials. We have experienced higher-than-expected screen failure rates, that is patients that are evaluated but participation in the studies do not meet the protocol requirements for inclusion.
To address this shortfall of patients, we have initiated more sites in the U.S. using our own monitoring staff. We've also contracted with a CRO to start up a number of additional sites. And in addition, to help our sites identify potential patients, we are working with a vendor who will identify and refer additional patients to our study sites. We expect these measures to help expedite the screening and enrollment process.
As you will remember, we previously stated that we had hoped to complete enrollment in both the 171 and 175 clinical trials by the end of this quarter. While we have not yet given up on this timeline, it is foreseeable that the studies will not be fully enrolled until next quarter with last patient, last visit taking place sometime early in 2013.
And now -- let's now turn over to our oncology portfolio. As you probably notice by our press release on April 30, we have successfully reported one of our promising oncology compounds with Salt Lake City-based Tolero. We are very happy with this collaboration since it will allow the program to get its focus it deserves while allowing MannKind the opportunity to participate in the success of the program or even step back into development and commercialization role at a specified point in time.
And in closing, in my section, I'm sad to announce the resignation of Dr. James Shannon from our Board of Directors. As was recently announced, James had accepted the position of Global Chief Medical Officer for GSK with placements in London. James has been a prominent member of our board and provided a very valuable service to our company and our programs. In his new role at GSK, he was asked to resign his board positions given his anticipated workload. We thank James for his significant contributions to MannKind and wish him much success at GSK.
And with that, let me now hand the call over to Al.
Alfred E. Mann
Thank you, Hakan, and good afternoon. As Hakan described, MannKind's primary focus has been on completing the MKC-171 and MKC-175 Affinity trials to enable us to reach our objective of approval. Recruitment is well underway, and our clinical team is working hard to bring even more sites online so that we can get the last patient first visit as soon as possible.
I truly believe that AFREZZA will fill a very important need throughout the entire spectrum of diabetes. The extensive clinical program, to date, has shown AFREZZA to yield superior clinical benefits in so many measures, though not yet superiority in HbA1c.
Occasionally, I get asked to explain why in our trials AFREZZA has only been non-inferior to standard prandial insulin therapy in terms of lowering HbA1c. The key to this is that out of fear of hypoglycemia, the physicians who have participated in our clinical trial are used to managing fasting glucose levels very high. They do so because the late postprandial persistence of current prandial insulin products create hyperinsulinemia that can cause a significant drop in glucose levels.
Even though AFREZZA does not have the late postprandial persistence, basal insulins have not been separately titrated for the AFREZZA cohorts in our trials, so that fasting levels are excessively high in those patients as well. Since the HbA1c is really an average glucose level over 2 to 3 months, these high fasting glucose levels tend to mask the more physiological prandial benefits of AFREZZA.
With our current study MKC-171, we are targeting this issue head on by requiring the fasting glucose level to be lower to under 110 milligram per deciliter, unless there is hypoglycemia. In earlier trials, even with AFREZZA cohorts, clinicians have generally not increased basal insulins to adjust fasting glucose to goal.
In the Affinity trial, the FDA has authorized us to engage an independent monitor who will review e-diary records and will contact the clinicians responsible for patients that are not complying with the protocol. This should not only assure reaching a non-inferiority requirements for approval, but hopefully, it may even enable us to show superiority of AFREZZA in HbA1c.
I expect in this trial that compliant-AFREZZA patients will reach HbA1cs below the age American Diabetes Association's target of 7% and even the Endocrinology Society's goal of 6.5% and without increased risk of hypos. Indeed, my belief is that many patients are likely to reach A1Cs below 6%.
While you may not be fully convinced of my argument, the problem is not unique to our trials with AFREZZA. In its approval of Eli Lilly's insulin lispro in the 1990s, the FDA stated that they saw no clinical benefits of that rapid-acting analogue over regular insulins. The justification of approval was simply that lispro did not need to be injected so long before starting to eat. Today, I doubt that anyone would disagree that the kinetics and the dynamics of rapid-acting analogues, such as lispro and aspart, are superior to regular insulins and that they bring important clinical advantages.
But even these rapid analogues are not adequately physiologic. Indeed, in the closed-concerned surveys of clinicians at the annual ADA meetings, one of the questions asked in 2009 was whether the rapid analogues are fast enough. Only 4% thought they are. 94% expressed the need for a still-faster prandial insulin.
AFREZZA is such a faster insulin, and without the late postprandial persistence, that is the primary cause of hypoglycemia and weight gain seen with insulin therapy today. Yet, we still do see some hypos in our trial, though much less severe and with lower frequency than for the comparative cohorts.
But why should we see any at all? We see this in basal/bolus therapies, especially for type 1 patients. An examination with the timing of these events point to the insulin -- the basal insulins as the likely primary cause of the hypos in those trials. Glargine, or Lantus, has for years been the best basal insulin, but is by no means efficiently physiologic. Degludec, a new basal insulin, enables better basal control, and there are other long-acting insulins in development.
Yet even though the average connects and dynamics of these new basal insulins are better, an increasing number of KOLs are recognizing that a basal patch pump would be the ideal companion to AFREZZA in type 1 and late type 2. And while that maybe obvious for clinical results, the keys to market success of such basal/bolus therapy with AFREZZA and a basal pump will be simplicity and especially competitive economics. These therapies not only be -- must not only be safe and effective, but must be available without much of a premium in cost.
And while competitive pricing may seem a daunting challenge for these advanced products, that objective is within reach for both AFREZZA and a basal patch pump. Indeed, in the process of better control, we'll significantly lower the overall cost of diabetes.
In summary, I believe that in the near term for early-stage type 2 diabetes, patients will -- with the optimum therapy will prove to be AFREZZA or AFREZZA plus metformin. The data from our study MKC-175 should help support this prediction. In type 1 and late type 2, I expect AFREZZA plus an improved basal insulin, and especially a simple basal patch pump, will prove to be the ideal therapy and without the side effects of most of the alternative antiglycemic drugs that are widely used today.
We are well along the enrollment of both MKC-171 and MKC-175, and we are confident of successfully meeting the trial endpoints. This completion, we believe, we have clarified path to approval of AFREZZA. Our challenge is now to assure adequate financing to carry MannKind through the approval of AFREZZA and prepare for its launch. These are now my areas of primary focus.
Last year in response to a question about my willingness to continue to invest in MannKind, I gave an answer that was based on the liquidity of my portfolio. That remark was misconstrued by some as an unwillingness on my part to put more money into MannKind. Nothing could be further from the truth. I'm selling off some of my other ventures. One such sale was closed just last month. However, I don't want MannKind financing strategy to rest solely at my exits from other ventures.
As Matt described, MannKind did place an equity offering in February that netted us about $80 million as a bridge while we work to put in place additional financing that should fund our capital needs through this critical period. We are continuing to pursue and evaluate some potentially non-dilutive and minimally dilutive financings in order to preserve shareholder value. It is wise that I not comment further on these opportunities until we can make a definitive report.
With that, I thank you for joining us today, and we invite your questions. Operator?
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