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Discovery Laboratories, Inc. (NASDAQ:DSCO)

Q4 2013 Earnings Conference Call

March 13, 2014 10:00 ET

Executives

John Tattory - Chief Accounting Officer and Vice President, Finance

John Cooper - President and Chief Executive Officer

Dr. Tom Miller - Senior Vice President and Chief Operating Officer

Dr. Russell Clayton - Senior Vice President, Research and Development

Analysts

Joel Sendek - Stifel

Operator

Good morning, and welcome to Discovery Labs’ Q4 2013 Business Update Conference Call. All participants will be in listen-only mode. (Operator Instructions) Please note that this event is being recorded.

Now, I would like to turn the conference over to John Tattory. Mr. Tattory, please go ahead.

John Tattory - Chief Accounting Officer and Vice President, Finance

Thank you, Keith. Good morning, everyone and thank you for participating in today’s call. This morning’s conference call will provide our fourth quarter financial and business update.

Before we start, I will read the Safe Harbor statement. This conference call will contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to future events or the company’s future financial performance. Such statements are subject to certain risks and uncertainties, which could cause our actual results to differ materially from any future results expressed or implied by such statements, predominantly those inherent in the process of discovering, developing and commercializing drugs. The listener is cautioned not to rely on these forward-looking statements. Actual results could vary materially from those described as a result of a number of factors including those set forth in the current report on Form 8-K filed this morning, Discovery Labs’ Annual Report on Form 10-K to be filed with the SEC and any subsequent SEC filings as they may have been amended.

Joining me on today’s call are John Cooper, President and Chief Executive Officer; Dr. Tom Miller, Senior Vice President and Chief Operating Officer; and Dr. Russell Clayton, Senior Vice President, Research and Development.

I will now turn the call over to John Cooper.

John Cooper - President and Chief Executive Officer

Good morning, everyone. Thank you so much for taking this morning for our call. The call today obviously covers the fourth quarter of 2013, which for us was a real pivotal quarter. We accomplished some things that in many ways when we think about our mindset here set an inflection point into the company. That inflection point was driven by of course SURFAXIN getting cleared by the FDA and then our eventual launch in the latter half of the quarter, the introduction of AEROSURF into clinical trials and the fact that Discovery puts some money on its balance sheet so that we could properly finance and be very smart in the way we finance a franchise that we are building.

And maybe before we get into some specifics with respect to SURFAXIN’s launch and the AEROSURF program, we used to talk about that franchise and put things in perspective. We are working and developing our technologies into products in a market that has been complacent for 10 years, maybe 20 years as that all depends upon when you look at specific timelines, but you have a market that has a need, a desire for innovation, a medical community that is treating premature infants, a very fragile infants with processes and technologies that for the most part have been the same, people are trying to make improvements, but again technology is what’s necessary to make those improvements. What we believe we represent, what we believe we have is that technology. That technology is in the form of products or products in the pipeline that have been scientifically engineered to hopefully produce outcomes in the future that will change the practice of medicine, where we would marry our technology with medical practitioners who have a desire for our products and of course help families and babies in the future.

What do I mean by scientifically engineered? Let’s look at SURFAXIN first. A drug that has a key peptide that mimics what you and I have in our lungs, a drug that requires precise warming, a drug that has a dose administration and a volume that has been scientifically engineered to optimize distribution of SURFAXINs in the lung, the importance of proper patient management when managing our drug and applying our drug. It’s important with respect to how you position an infant, how you manage ventilatory settings. All of these are scientifically organized, scientifically designed for ideally improved out consumer future. SURFAXIN’s Phase 3 clinical trials were very voluminous in terms of patients’ enrollment. We have quite a bit of data that is now today in publications, peer reviewed publications where we believe the clinical and pharmacoeconomic attributes SURFAXIN show themselves there. And we are excited about it. That’s what we are taking into the market.

AEROSURF takes all of those learnings especially around the drug and begins to continue innovation, continue to look at ways where you can take out SURFAXIN and apply it to a baby most importantly without the requirement for incubation. But again high science is involved there as well. You have got the science of the SURFAXIN itself. You have got the science of the delivery with vehicles, the delivery system from sophisticated nasal CPAP equipment where we are working with some of the best in the world who manufacture those ventilators to patient interface capabilities to the overall design and engineering of a capillary aerosol generator.

When people sometimes think about delivering a drug this is “nebulized”, you normally think of a hand held device. In our situation there is a lot of engineering and a lot of technology that goes into the capillary aerosol generating to deliver an aerosol to the baby. All of these things come together with a lot of disciplined and a lot of attention to detail most importantly we need to be very, very clear about how we are working with the medical community and how we are working very deliberately with the FDA as we take these products through their various channels to bring them out. Again why the word deliberate, why am I taking this through this, let’s put things in perspective. We believe we have a franchise. We believe we have a franchise if we do things right and if we apply things appropriately somewhere over the course of the next decade this technology has the potential to truly transform the management of respiratory distress syndrome. We take that very seriously.

And with that respect now let’s talk about SURFAXIN. In the last call one of the things that we mentioned is that we are bringing this product out very slowly, very deliberately in a very measured and controlled process hospital by hospital, training members of hospital staff person by person, very, very important the technology that I have just described earlier requires change. It requires that NICUs today and in the future adopt the change. People don’t adopt change that quickly. If you take a look at any marketing studies, marketing studies always show you how early adopters and then it takes time and then they influence adopters after that. We have recognized that, we understand that and so it’s really, really important that as we bring SURFAXIN out. Remember SURFAXIN is also a precursor to AEROSURF, should we be successful in clinical trials, so we take that very seriously and we are bringing SURFAXIN into hospitals slowly hospital by hospital, training again members of the staff person by person.

Now with that said the most important thing that we can do early on in this launch is gain hospital formulary acceptance that allows us to build the foundation. That foundation is very, very important and in business terms one could argue that that’s an installed base. I like to look at it from the purpose of we are building trust hospital by hospital. We are gaining trust not just for SURFAXIN but eventually again for AEROSURF. I will say though that with respect to our own internal planning and some of the guidance that we have provided in the past externally and to our self what we do see is that the process of working with the formulary or having a hospital adopt a product on formulary and then eventually through the ordering process is a considerable amount of time. It has taken considerably longer than we have anticipated, but nevertheless that is the system.

We are working in a world today also where we are learning that hospital systems are going through change as well, issues like the Affordable Care Act, issues like consolidation amongst hospitals change was taking place. So it’s not only taking place with the innovation and the evolution of our technology into the markets, but it’s also taking place with respect to the market itself. So I want to be very clear that we are recognizing and we are experiencing very early in the process. And again, it is early.

We are recognizing we are out in the market now for approximately four months, two months of which were associated with weather issues, two months of which of course were around holidays. Nevertheless, it’s early in the process and we are working through the hospital formulary change is taking its time. We also were – and had an impact in that time. The hospital formulary process usually doesn’t want to kick start until two things happen. Number one, product is available which for us started in November, but also we did not want to start that process until of course our price was available. And we did not want to introduce that price into the formulary process until we launched the product for obvious competitive reasons. So that’s been an experience to-date.

I will tell you another experience that we are seeing as well and that is there is a very high level of awareness of SURFAXIN amongst the neonatologists. We are seeing that we are managing with that, but we are also seeing again back to the hospital environment that the neonatologists is only one of a handful of stakeholders that have an impact in how a product is ultimately adopted into the hospital. The pharmacist, the hospital administrative system is taking a much more predominant role than we anticipated even when we did our work and continue to do our work, but even when we were doing our work last year in navigating through the hospital. So all of these things take time, it’s taking time to work through.

Now, where are we? We are at a point where early in the launch very importantly, we have been successful in having SURFAXIN be adopted on five hospital formularies. That to us is an important number. It’s the beginning for lack of a better way of saying, it’s the beginning of a trend, it’s the beginning of a trend by which we will measure ourselves, because in order to obviously create revenues and to create our business, it’s important to get on formulary. Of those five hospitals, the number are very large key influence centers and also a number are small volume regional pediatric critical care centers, but that’s our start, that’s our start. And where we are right now as well is we see some real solid momentum in P&T committee meetings being established for us between now and the next three months. We are very encouraged by what we are seeing there. And a number of these P&T committees – in essence, we have a very full schedule through that period and a number of these meetings are with a very influential centers of excellence or centers of influence. People again the neonatal community, who we know, who understand SURFAXIN, who understand our technology of where we are going and we are organized in our schedule to have meetings with these institutions. So from that perspective, we are excited.

The other piece of information that we have claimed through this very early experience is that and actually an experience that we are positive about is in our original thinking we were thinking that the majority of the hospitals that are sole source and that’s the super majority of all hospitals. They have sole sourced an animal derived product and we can understand that with the various animal derived products, normally it choose one and that’s what you have on hospital. What we are seeing is a real willingness from the hospitals that we have worked with so far to bring SURFAXIN on formulary as a second or as an alternative to the animal derived, gain an experience with our product that to us makes a lot of sense of course. We don’t necessarily have to knock one product off formulary. We can be on formulary with the other, we can gain experience, we could work with the hospitals. Of course our goal which we believe in the long-term will happen will be for the ultimate conversion from an animal-derived source to them a full source of SURFAXIN and then long-term in the future, AEROSURF, when AEROSURF and Curosurf become available, but we’re seeing that process.

So for us a very important metric that we think about in the short term in the next 18 months is to really, really understand and see trends and progress in SURFAXIN being our formularies and hospitals through the United States, very important. It sets the tone for what the future can hold. And from a long-term perspective we have every reason today to believe that the long-term prospects for SURFAXIN remain as viable as we always have, but we do see this process in the beginning being slow. And it’s early but that is where we are and I think any good company, any good group of individuals understands the market and then adapts accordingly to make sure you’re successful in that market and that’s what our intentions are.

Now from a revenue recognition perspective, given what we’ve learned and given that there was previous guidance on the table, what we really have to do right now is no longer apply that guidance from the past. And most importantly since we’re so early in the process and we’re learning we want to see some time goby, we want to gain more experiences over the course of the next couple of months we’re going to learn more and we want those experience, those experiences to guide us and then we can in turn then can guide you with respect to revenue potential in the short term for the product. So I appreciate your patience on that, but we will be not providing any guidance in the short term and we will wait for further experiences on the revenue side to provide that guidance at a later point in time.

So with that said we again – I’m going to come back to the same. We’re focused on the long-term potential of our technology in the NICU. And what we see so far and even the short term successes that we’ve had is we’re building relationships with key institutions in the United States. SURFAXIN is that first step, formulary decisions are important and what’s again important to us is by getting on formulary it begins a process that represents a potential long-term annuity value both medically and economically. I’d like to stick to the medical side first because again what we see is a business that and a technology that can change medical practice, change the ability of helping babies in the future and that’s so critical.

And with AEROSURF now in the clinic and having AEROSURF visible to the neonatal community all of these learnings that we’ve experienced so far really helps us and it helps us position not only what we’re doing, not only where we are with SURFAXIN but ultimately where we are and where we’re going with AEROSURF. AEROSURF is without the question a very, very exciting product. Without the question a – I’ll use the term blockbuster, it’s an overused term, but it is a very valuable medical and economically valuable product.

The ability to deliver an aerosolized surfactant to a baby without having to incubate that baby is exciting. And we’re excited to be where we are with this opportunity. It’s been a long time to get to where we are today. So let’s go through that and then we’ll cover this more in Q&A. We have a very important Phase 2 program. As the Phase 2 program is broken into two parts. We call it 2a and 2b. 2a is all about safety, tolerability, and evaluating three doses of increasing amounts of aerosolized KL4 surfactant in the babies we’re hoping to truly help.

Phase 2b is determining the optimal dose for a Phase 3 study and of course defining the expected efficacy margins that one could then see and we are prepared for, for a Phase 3 program. The Phase 2 program, in total, remains on track. The Phase 2 program, in total, I think will bring some clinical data points throughout ‘14 and ‘15 whereby at the end of ‘15 in the second half I should say of ‘15, we will be in a position to hopefully see the benefits through this Phase 2 arrangement.

The mindset that we take into the development program is without a question work closely with the FDA and without a question same theme as SURFAXIN deliberate, controlled, measured way too much value here. We try to rush way too much value to cut corners. We look at all of our opportunities with respect to technologies with again working with our capillary aerosol generator looking at the technologies to enhance and improve the aerosol flow to a baby, so that we can increase the odds of a baby receiving SURFAXIN in its lungs and then ultimately helping that baby. And last but not least, again remember it’s the SURFAXIN it’s the same SURFAXIN that is developed for, for SURFAXIN, in this case lyophilized, reconstituted and then converted into an aerosol. When that conversion takes place, we know what retains the same characteristics in surfactant properties that it’s supposed to have. So very, very exciting.

The 2a study that we are currently conducting remains on track with results expected to be available in the third quarter of this year not that far from now. It is again a 2a study. We are conducting this trial in preterm infants of between 29 and 32 weeks gestational age. We are conducting this trial in four centers, all of them centers of influence, with a very good track record and established track record in participating and in running multicenter clinical trials in preterm infants. When we look at the arms, we have patients either receiving aerosolized KL4 surfactant via nasal CPAP and it’s core supplying our aerosolization technologies versus the comparator and the comparator with nasal CPAP alone. Again, we expect the results in the third quarter of this year. We believe that seeing a positive signal and again I suppose we do and in terms of safety and tolerability is a very important milestone. Yes, it’s not efficacy, but that’s what the study is right now, its safety and tolerability. Can for the first time in a registration trial, can we deliver surfactant to a very sophisticated scientifically designed system? See SURFAXIN, get that SURFAXIN to the baby and have that baby receive it safely and tolerate the doses.

Now, in addition to that, we know both us, the community all wants to get an understanding of is the baby getting surfactant in the lungs? Is the baby – are we seeing differences between baseline? Now, remember small, small, small study do the science properly, step at a time, evolve to the next stage, so we can move this program forward. That’s the main thing. But remember, we are always managing the baby properly in this trial. So every infant will be evaluated for overall respiratory status, the degree of supplemental oxygen required, the duration of CPAP required and whether the infant requires rescue with endotracheal intubation. So, these babies will be managed for standard-of-care hopefully. When we apply AEROSURF, we are seeing something in terms of positive trends there as well. So again, very excited and we look forward to providing further news, which is not that far away in the third quarter of this year.

So with that said, I’d like to turn the call over to John Tattory, our VP of Finance who will go through the financial highlights for the last quarter.

John Tattory - Chief Accounting Officer and Vice President, Finance

Thanks John. I will briefly cover off on some of the key financial items included in the earnings release we issued earlier this morning. In the fourth quarter we shipped approximately $140,000 of SURFAXIN to our specialty distributor. We currently use the sell-through method for revenue recognition, which means sales to our specialty distributor are deferred until the distributor sells product through to the hospital and all other revenue recognition criteria are met. In accordance with this policy all SURFAXIN sales for the fourth quarter have been deferred.

We reported an operating loss of $10.3 million versus $12.4 million in the fourth quarter of 2012. Primary components of the 2013 operating loss are costs associated with the initiation of our AEROSURF Phase 2a clinical study and costs associated with the SURFAXIN launch and commercialization. For the fourth quarter of 2013 net cash outflows before financing activities were $10.4 million. We ended 2013 with $86 million in cash and cash equivalents. We also had $30 million in long-term debt to Deerfield, repayment of the Deerfield debt where we made in three equal annual installments beginning in 2017.

As a reminder, the first two repayments, the 2017 and 2018 payments are subject to deferral if we achieve certain financial milestones. In addition, we maintained an after market or ATM program. As of December 31, 2013 it was $23 million available under that facility. And as a side note, the amount currently available remains at $23 million. Regarding the $86 million in cash for planning purposes, we believe that the $86 million will take us well into the second half of 2015 at which time based on our current plans we will be in a process of completing the AEROSURF Phase 2 clinical program. For the first quarter of 2014 we are forecasting operating cash burn before financing activities of approximately $11 million.

With that, I will turn the call back to the operator for Q&A.

Question-and-Answer Session

Operator

Yes, thank you. We will now begin the question-and-answer session. (Operator Instructions) And the first question comes from Joel Sendek with Stifel.

Joel Sendek - Stifel

Hi, thanks. Thanks for going through all the details. So I guess a couple of questions I had since you are deferring the revenue presumably that means you didn’t have any sell-through in the fourth quarter, I am wondering since you have five hospitals on formulary now that presumably you have some sell-through and you didn’t report that happened in the first quarter of 2014, can you give us any clarity on that?

John Tattory

Joel, it’s John Tattory. We did actually have sell-through in the fourth quarter, but given the early – how early we are in this launch period we have determined that it’s more appropriate to defer that revenue on the initial sales into the hospitals. Once we see a reorder we will begin recognizing revenue immediately upon that reorder.

Joel Sendek - Stifel

Okay and to drill down on that and so for the $140,000 approximately how much was channel sale as opposed to sell-through if you can just give rough percentages?

John Tattory

Joel, I guess we are not going to get into that detail right now. We will cover that also on the Q1 call when we cover the entire quarter.

Joel Sendek - Stifel

Okay.

John Cooper

What I can say Joel to your point that it’s not sitting in the distributor’s warehouse.

Joel Sendek - Stifel

Okay, perfect.

John Cooper

And so when you normally think of channel, my interpretation of that is it’s shipped to the distributor, it’s not in the distributor, it’s with the hospital.

Joel Sendek - Stifel

Oh I see, I mean, okay, okay. And (indiscernible) as you are on, are they as of today or is that as of December 31 and are they exclusives?

Dr. Tom Miller

Hey Joel, it’s Tom Miller. So as of today that’s where we netted out there is a band of – the way we kind of approach this with respect to product utilization is there are incentives, financial incentives in place and that relates to pricing to support ultimate transition to exclusivity. But as John took you through early on although we are added to formulary, the process is very deliberate, right start with a core team trained work through in a very methodical way, introduction to a handful of babies. So we don’t anticipate much exclusivity in the institution in the immediate short-term. The idea is to get through this initial trialing period even though the product is on formulary and through that good experience, use that positive clinical experience and financial incentives to ultimately support exclusivity.

Joel Sendek - Stifel

I understood. Okay, thanks guys.

Dr. Tom Miller

Sure.

John Cooper

Thank you, Joel.

Operator

Thank you. (Operator Instructions) Alright, as there are no more questions at the present time, I would like to turn the call back over to management for any closing remarks.

John Cooper - President and Chief Executive Officer

Thank you very much everybody. Thank you so much for spending time with us this morning. Again, we feel we are at a very important time. I use the term inflection point. It’s the beginning in our minds of a long-term transition. We are proud to be in a position, where we have an approved product and we can take that approved product and generic to generate an aerosol, a very exciting program in AEROSURF for the neonatal community and we are – we are just thankful to be there. So thank you everybody for your time. Thank you for your patience. Thank you for your investments. And feel free to call with any of your questions to our direct lines. Thank you.

Operator

Thank you. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect. Have a nice day.

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