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The long-awaited ascendance of Discovery Laboratories (NASDAQ:DSCO) from a speculative biotechnology company to a fully functioning drug company may have gotten a little longer. The FDA has requested clarification and provided recommendations regarding the product specification for Surfaxin, Discovery Laboratories' most notable drug that obtained FDA approval last spring. Despite the negative news though, I see this as just another roadbump from the company, rather than a fatal blow.

In the third quarter of 2012, during a routine review of analytical testing and quality control of Surfaxin, Discovery Labs determined that one of its analytical chemistry methods used to assess Surfaxin's drug product conformance to specifications, required improvement and that an update to product specifications was necessary. The company related these findings to the FDA, improved and validated the analytic chemistry method, and submitted updated product specifications to the FDA.

The FDA recently requested clarifications from Discovery Labs on certain aspects including:

* Recommendations regarding how the product specifications should be documented and notated
* A specific recommendation for the upper limit of a single product specification that Discovery Labs can readily accept
* A request for two existing and readily available documents related to the improved analytical chemistry method
* Request for supporting data using the recently improved and revalidated analytical chemistry method that is being generated from recent SURFAXIN batches.

The biggest risk this FDA delay could present to Discovery Labs is draining the company of its funds. Discovery Labs had a total of $27 million cash on hand at the end of the fourth quarter of 2012. The company struck a deal with Deerfield that generated an additional $10 million and guaranteed $20 million after commercial sales of Surfaxin began. The deal with Deerfield helped Discovery Labs gain some breathing room with its diminishing finances; however, the company needs to get its act together and follow through with the commercialization of Surfaxin this year.

Discovery Labs has plans to provide a response to the FDA's inquiries within two months. The company still expects to introduce Surfaxin in the fourth quarter of 2013 as well. Nonetheless, it will be interesting to see how this all plays out for this speculative biotechnology company, and whether this news will crush the stock price or have little effect. My guess is the share price sinks and stays down until the result of the FDA revision is resolved.

Company Drug Valuation

Afectair and Surfaxin are the two products that were approved by the FDA last year. Afectair is a drug delivery product that simplifies the delivery of any inhaled therapies. It has begun production in the U.S. and European Union earlier last month. Surfaxin too, is expected to hit the market later this year. Surfaxin is a synthetic form of surfactant, and a recent study showed that synthetic forms of surfactants can be much more cost effective than animal-derived surfactants. In fact, a study performed by Discovery Laboratories recently showed that Surfaxin resulted in a potential hospital cost savings of $160,000 to $242,000 per 100 infants. The company also estimate that approximately 130,000 infants are born with RDS annually in the United States alone and of the 130,000 about 90,000 require surfactant replacement therapy.

Revenue & EPS Outlook

There is always great risk involved when approaching a low-cap investment such as Discovery Laboratories. Its financing hasn't been stellar, and its EPS has been inconsistent and negative. Through these past four years though, Discovery Laboratories has been in a developmental stage for most of its major pharmaceutical products. With two products recently approved, it would be wise to keep an eye on the company's EPS and net income. If Discovery Laboratories can straighten out its finances, then maybe it would become an appealing long-term speculative option.

Income Statement Annual

2011
12/31/11
2010
12/31/10
2009
12/31/09
2008
12/31/08
NET SALES OR REVENUES582004,600
Depreciation, Depletion And Amortization1,2341,5491,9922,215
Depreciation700--1,4001,600
Amortization of Intangibles534--592615
GROSS INCOME(652)(1,549)(1,992)2,385
Selling, General & Admin Expenses23,46023,97926,60540,779
Research and Development Expense17,23017,13618,87726,566
OPERATING INCOME(24,112)(25,528)(28,597)(38,394)
Extraordinary Credit - Pretax3,5606,4223690
Extraordinary Charge - Pretax(400)0(600)0
Non-Operating Interest Income131348802
Other Income/Expenses - Net(6)2755100
Interest Expense On Debt203571,0961,614
PRETAX INCOME(20,965)(19,175)(29,871)(39,106)
NET INCOME BEFORE EXTRA ITEMS/PREFERRED DIVIDENDS(20,965)(19,175)(29,871)(39,106)
NET INCOME USED TO CALCULATE BASIC EARNINGS PER SHARE(20,965)(19,175)(29,871)(39,106)
Shares used in computing earnings per share - Fully Diluted22,66011,6027,6806,541
Earning per Common Share - Basic(0.93)(1.65)(3.89)(5.98)
Earning per Common Share - Fully Diluted(0.93)(1.65)(3.89)(5.98)

= Negative Values
In U.S. dollars
Values are displayed in thousands except for earnings per share

Discovery Labs once again disappointed investors with this news but we will not know the end result of this situation until Discovery Labs comes forth with more information. I cannot recommend this stock at the time because it is not worth the risk. Investing in a traditional biotechnology company such as Merck (NYSE:MRK), Pfizer (NYSE:PFE), Johnson & Johnson (NYSE:JNJ), or Abbott Laboratories (NYSE:ABT) is a better choice for your portfolio, and will provide you with a solid yield. Monitor this company for the next two months though and, if Surfaxin clears this FDA revision, I would say make your decision about perhaps purchasing shares then and there.

Source: Discovery Laboratories Stumbles