nvus-10q_20180630.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

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

For the quarterly period ended June 30, 2018

OR

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

For the transition period from            to           

Commission File Number: 001-36620

 

NOVUS THERAPEUTICS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

Delaware

 

20-1000967

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

 

 

19900 MacArthur Blvd., Suite 550

Irvine, California

 

92612

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code:

(949) 238-8090

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes      No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).      Yes      No

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

 

Large accelerated filer

Accelerated filer

 

 

 

 

Non-accelerated filer

  (Do not check if a smaller reporting company)

Smaller reporting company

 

 

 

 

 

 

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

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

As of August 3, 2018, there were 9,422,143 shares of the Registrant’s common stock outstanding.

 

 

 


Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties. Any statements in this Quarterly Report on Form 10-Q about the company’s future expectations, plans and prospects, including statements about its strategy, future operations, development of its product candidates, the review of strategic alternatives and the outcome of such review and other statements containing the words “believes,” “anticipates,” “plans,” “expects,” “estimates,” “intends,” “predicts,” “projects,” “targets,” “could,” “may,” and similar expressions, constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, although not all forward-looking statements include such identifying words. Forward-looking statements include, but are not limited to statements regarding:

 

expectations regarding the timing for the commencement and completion of product development or
clinical trials;

 

the rate and degree of market acceptance and clinical utility of the company’s products;

 

the company’s commercialization, marketing and manufacturing capabilities and strategy;

 

the company’s intellectual property position and strategy;

 

the company’s ability to identify additional products or product candidates with significant commercial potential;

 

the company’s estimates regarding expenses, future revenue, capital requirements and needs for additional financing;

 

developments relating to the company’s competitors and industry; and

 

the impact of government laws and regulations.

Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors, including: the ability to develop commercially viable product formulations; the sufficiency of the company’s cash resources; the ability to obtain necessary regulatory and ethics approvals to commence additional clinical trials; whether data from early clinical trials will be indicative of the data that will be obtained from future clinical trials; whether the results of clinical trials will warrant submission for regulatory approval of any investigational product; whether any such submission will receive approval from the United States Food and Drug Administration or equivalent foreign regulatory agencies and, if we are able to obtain such approval for an investigational product, whether it will be successfully distributed and marketed. These risks and uncertainties, as well as other risks and uncertainties that could cause the company’s actual results to differ significantly from the forward-looking statements contained herein, are described in greater detail in Item 1A. of Part II, Risk Factors. Any forward-looking statements contained in this Quarterly Report on Form 10-Q speak only as of the date hereof and not of any future date, and the company expressly disclaims any intent to update any forward-looking statements, whether as a result of new information, future events or otherwise.

 

 

 

 

2


NOVUS THERAPEUTICS, INC.

FORM 10-Q

FOR THE QUARTER ENDED JUNE 30, 2018

Table of Contents

 

 

 

 

Page

 

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements (Unaudited)

 

4

 

 

 

 

 

Condensed Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017

 

4

 

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Six Months Ended June 30, 2018 and 2017

 

5

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017

 

6

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

7

 

 

 

 

Item 2.

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

 

21

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

25

 

 

 

 

Item 4.

Controls and Procedures

 

26

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

27

 

 

 

 

Item 1A.

Risk Factors

 

27

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

50

 

 

 

 

Item 3.

Defaults Upon Senior Securities

 

50

 

 

 

 

Item 4.

Mine Safety Disclosures

 

50

 

 

 

 

Item 5.

Other Information

 

50

 

 

 

 

Item 6.

Exhibits

 

50

 

 

 

 

Exhibit Index

 

51

 

 

 

 

Signatures

 

52

 

3


PART I - FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited).

NOVUS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

 

June 30,

2018

 

 

December 31,

2017

 

 

 

(Unaudited)

 

 

(Note 2)

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash

 

$

19,189

 

 

$

17,233

 

Restricted cash

 

 

 

 

 

70

 

Prepaid expenses and other current assets

 

 

1,889

 

 

 

1,697

 

Total current assets

 

 

21,078

 

 

 

19,000

 

Property and equipment, net

 

 

20

 

 

 

25

 

Goodwill

 

 

1,867

 

 

 

1,867

 

Total assets

 

$

22,965

 

 

$

20,892

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

706

 

 

$

418

 

Accrued severance

 

 

224

 

 

 

668

 

Accrued expenses and other liabilities

 

 

522

 

 

 

354

 

Total liabilities

 

 

1,452

 

 

 

1,440

 

Commitments and contingencies (Note 6)

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

Preferred stock, $0.001 par value, 5,000,000 shares authorized and none

   issued and outstanding at June 30, 2018 and December 31, 2017

 

 

 

 

 

 

Common stock, $0.001 par value, 200,000,000 shares authorized at June 30,

   2018 and December 31, 2017; 9,407,024 and 7,110,414 shares issued and outstanding

   at June 30, 2018 and December 31, 2017, respectively

 

 

9

 

 

 

7

 

Additional paid-in capital

 

 

55,005

 

 

 

46,951

 

Accumulated deficit

 

 

(33,501

)

 

 

(27,506

)

Total stockholders’ equity

 

 

21,513

 

 

 

19,452

 

Total liabilities and stockholders’ equity

 

$

22,965

 

 

$

20,892

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

4


NOVUS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except share and per share data)

(Unaudited)

 

 

 

Three Months Ended

June 30,

 

 

Six Months Ended

June 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

1,329

 

 

$

533

 

 

$

2,426

 

 

$

1,012

 

General and administrative

 

 

1,860

 

 

 

6,133

 

 

 

3,558

 

 

 

7,039

 

Total operating expenses

 

 

3,189

 

 

 

6,666

 

 

 

5,984

 

 

 

8,051

 

Loss from operations

 

 

(3,189

)

 

 

(6,666

)

 

 

(5,984

)

 

 

(8,051

)

Other income (expense), net

 

 

 

 

 

4

 

 

 

(11

)

 

 

15

 

Net loss and comprehensive loss

 

$

(3,189

)

 

$

(6,662

)

 

$

(5,995

)

 

$

(8,036

)

Net loss per share, basic and diluted

 

$

(0.34

)

 

$

(1.32

)

 

$

(0.70

)

 

$

(2.51

)

Weighted-average common shares outstanding, basic and

   diluted

 

 

9,407,024

 

 

 

4,154,842

 

 

 

8,582,723

 

 

 

2,270,907

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

5


NOVUS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Six Months Ended

June 30,

 

 

 

2018

 

 

2017

 

Operating activities

 

 

 

 

 

 

 

 

Net loss

 

$

(5,995

)

 

$

(8,036

)

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

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

5

 

 

 

16

 

Stock-based compensation

 

 

565

 

 

 

236

 

Loss on disposal of fixed assets

 

 

 

 

 

31

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Prepaid expenses and other assets

 

 

(192

)

 

 

(1,167

)

Accounts payable and accrued expenses

 

 

12

 

 

 

7

 

Net cash used in operating activities

 

 

(5,605

)

 

 

(8,913

)

Investing activities

 

 

 

 

 

 

 

 

Cash received from merger transaction

 

 

 

 

 

23,250

 

Proceeds from sale of equipment

 

 

 

 

 

8

 

Net cash provided by investing activities

 

 

 

 

 

23,258

 

Financing activities

 

 

 

 

 

 

 

 

Proceeds from issuance of common stock, net

 

 

7,491

 

 

 

4,000

 

Proceeds from exercise of warrants

 

 

 

 

 

3,119

 

Net cash provided by financing activities

 

 

7,491

 

 

 

7,119

 

Net increase in cash and restricted cash

 

 

1,886

 

 

 

21,464

 

Cash and restricted cash at beginning of period

 

 

17,303

 

 

 

1,117

 

Cash and restricted cash at end of period

 

$

19,189

 

 

$

22,581

 

Supplemental disclosure of cash flow information

 

 

 

 

 

 

 

 

Noncash activities:

 

 

 

 

 

 

 

 

Conversion of promissory notes and interest to common stock

 

$

 

 

$

3,447

 

Conversion of contingently issuable shares to common stock

 

$

 

 

$

291

 

Issuance of common stock in merger

 

$

 

 

$

23,375

 

Conversion of preferred stock to common stock

 

$

 

 

$

27

 

Fair value of assets acquired and liabilities assumed in the merger:

 

 

 

 

 

 

 

 

Fair value of assets acquired, excluding cash and restricted cash

 

$

 

 

$

3,072

 

Fair value of liabilities assumed

 

 

 

 

 

(2,947

)

Fair value of net assets acquired in the merger

 

$

 

 

$

125

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

6


NOVUS THERAPEUTICS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Description of Business

Novus Therapeutics, Inc. is a specialty pharmaceutical company focused on developing products for disorders of the ear, nose, and throat (“ENT”). Unless otherwise indicated, references to the terms the “combined company”, “Novus”, the “Company”, refer to Otic Pharma, Ltd. prior to the consummation of the Reverse Merger, and Novus Therapeutics, Inc., upon the consummation of the Reverse Merger described herein. The term “Tokai” refers to Tokai Pharmaceuticals, Inc., and its subsidiaries prior to the Reverse Merger.

Reverse Merger

On December 21, 2016, Tokai, a Delaware corporation, Otic Pharma, Ltd., a private limited company organized under the laws of the State of Israel (“Otic”), and the stockholders of Otic (each a “Seller” and collectively, the “Sellers”), entered into a Share Purchase Agreement (the “Share Purchase Agreement”), pursuant to which, among other things, each Seller agreed to sell to Tokai, and Tokai agreed to purchase from each Seller, all of the common and preferred shares of Otic (“Otic Shares”) owned by such Seller in exchange for the issuance of a certain number of shares of common stock of Tokai, as determined pursuant to the terms of the Share Purchase Agreement (the “Reverse Merger”). The parties amended and restated the Share Purchase Agreement on March 2, 2017.

On May 9, 2017, Tokai, Otic, and the Sellers closed the transaction contemplated by the Share Purchase Agreement, and subsequently effected a reverse stock split at a ratio of one-for-nine (see Reverse Stock-Split below). On a post-split basis, Tokai issued to the Sellers an aggregate of 4,027,693 shares of Tokai’s common stock in exchange for 840,115 Otic Shares. Following the completion of the Reverse Merger, the business being conducted by Tokai became primarily the business conducted by Otic. In connection with the Reverse Merger, the name of the surviving corporation was changed to “Novus Therapeutics, Inc.”

Private Placement

On January 31, 2017, Novus entered into a stock purchase agreement (the “Stock Purchase Agreement”) with certain purchasers named therein (the “Purchasers”), pursuant to which the Purchasers agreed to purchase approximately $4.0 million of the Company’s common stock through the purchase of 400,400 shares of the Company’s common stock at a price of $9.99 per share (the “Private Placement”). The Private Placement closed on May 10, 2017. After giving effect to the issuance of the shares in the Private Placement, the stockholders of Otic owned approximately 64% of the Company’s common stock.

Note 2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and Article 10 of Regulation S-X requirements as set forth by the Securities and Exchange Commission (“SEC”) for interim financial information and reflect all adjustments and disclosures, which are, in the opinion of management, of a normal and recurring nature, and considered necessary for a fair presentation of the financial information contained herein. Pursuant to these rules and regulations, the unaudited condensed consolidated financial statements do not include all information and notes necessary for a complete presentation of results of operations and comprehensive loss, financial position, and cash flows in conformity with GAAP.

The accompanying unaudited condensed consolidated financial statements and notes should be read in conjunction with the audited financial statements and accompanying notes of Novus for the year ended December 31, 2017 included in the Annual Report on Form 10-K filed by the Company with the SEC on April 2, 2018. The results of operations and comprehensive loss for the three and six months ended June 30, 2018 are not necessarily indicative of results expected for the full fiscal year or any other future period.

There have been no significant and material changes in our critical accounting policies and significant judgments and estimates during the three and six months ended June 30, 2018, except as described below.

7


Principles of Consolidation

Novus, a Delaware corporation, owns 100% of the issued and outstanding common stock or other ownership interest in Otic. Otic owns 100% of the issued and outstanding common stock or other ownership interest in its U.S. subsidiary, Otic Pharma, Inc.

The functional currency of the Company’s foreign subsidiary is the U.S. Dollar; however, certain expenses, assets and liabilities are transacted at the local currency. These transactions are translated from the local currency into U.S. Dollars at exchange rates during or at the end of the reporting period.

All significant intercompany accounts and transactions among the entities have been eliminated from the condensed consolidated financial statements.

Liquidity and Financial Condition

The Company has experienced recurring net losses and negative cash flows from operating activities since its inception. The Company recorded a net loss of $3.2 million and $6.0 million for the three months and six months ended June 30, 2018, respectively. As of June 30, 2018, the Company had cash of $19.2 million, working capital of $19.6 million and an accumulated deficit of $33.5 million. Due to continuing research and development activities, the Company expects to continue to incur net losses into the foreseeable future. In order to continue these activities, the Company may need to raise additional funds through future public or private debt and equity financings or strategic collaboration and licensing arrangements. If the Company issues equity or convertible debt securities to raise additional funding, its existing stockholders may experience dilution, it may incur significant financing costs, and the new equity or convertible debt securities may have rights, preferences and privileges senior to those of its existing stockholders. If the Company issues debt securities to raise additional funding, it would incur additional debt service obligations, it could become subject to additional restrictions limiting its ability to operate its business, and it may be required to further encumber its assets. Sufficient additional funding may not be available or be available on acceptable terms. If so, the Company may need to delay, reduce the scope of, or put on hold research and development activities while the Company seeks strategic alternatives.

The Company’s ability to raise additional capital in the equity and debt markets is dependent on a number of factors, including, but not limited to, the market demand for the Company’s common stock, which itself is subject to a number of development and business risks and uncertainties, as well as the uncertainty that the Company would be able to raise such additional capital at a price or on terms that are favorable to the Company.

The Company has performed an analysis and concluded substantial doubt does not exist with respect to the Company being able to continue as a going concern and the Company has sufficient cash resources to continue for a period of at least twelve months from the date of issuance of the accompanying unaudited condensed consolidated financial statements.

Reverse Stock-Split

On May 11, 2017, Novus effected a reverse stock-split of its issued and outstanding common stock and options for common stock at a ratio of one-for-nine. The Company filed an Amended and Restated Certificate of Incorporation with the Secretary of State of the State of Delaware effecting the reverse stock-split. The accompanying condensed consolidated financial statements and notes give retroactive effect to the reverse stock-split for all periods presented.

Use of Estimates

The preparation of the Company’s financial statements in conformity with GAAP requires management to make informed estimates and assumptions that affect the reported amounts of assets, liabilities and expenses and the disclosure of contingent assets and liabilities in the Company’s unaudited condensed consolidated financial statements and accompanying notes. The most significant estimates in the Company’s financial statements relate to stock-based compensation, accruals for liabilities, carrying value of goodwill, and other matters that affect the condensed consolidated financial statements and related disclosures. Actual results could differ materially from those estimates under different assumptions or conditions and the differences may be material to the consolidated financial statements.

8


Cash and Cash Equivalents

Cash represents cash deposits held at financial institutions. The Company considers all liquid investments purchased with an original maturity of three months or less and that can be liquidated without prior notice or penalty to be cash equivalents. Cash equivalents are held for the purpose of meeting short-term liquidity requirements, rather than for investment purposes. The Company had no cash equivalents at June 30, 2018 and December 31, 2017.

Restricted Cash

Restricted cash represents cash required to be set aside as security for lease payments or to maintain a letter of credit for the benefit of the landlord for the Company’s offices. The Company had restricted cash of $0 and $70,000 at June 30, 2018 and December 31, 2017, respectively.

Concentration of Credit Risk and Other Risks and Uncertainties

As of June 30, 2018 and December 31, 2017, all of the Company’s long-lived assets were located in the United States.

Financial instruments that are subject to concentration of credit risk consist primarily of cash equivalents. The Company’s policy is to invest cash in institutional money market funds to limit the amount of credit exposure. At times, the Company maintains cash equivalents in short‑term money market funds and it has not experienced any losses on its cash equivalents.

The Company’s products will require approval from the U.S. Food and Drug Administration (“FDA”) and foreign regulatory agencies before commercial sales can commence. There can be no assurance that its products will receive any of these required approvals. The denial or delay of such approvals may impact the Company’s business in the future.

The Company is subject to risks common to companies in the pharmaceutical industry, including, but not limited to, new technological innovations, clinical development risk, establishment of appropriate commercial partnerships, protection of proprietary technology, compliance with government and environmental regulations, uncertainty of market acceptance of products, product liability, the volatility of its stock price and the need to obtain additional financing.

Business Combinations

Accounting for acquisitions requires extensive use of estimates and judgment to measure the fair value of the identifiable tangible and intangible assets acquired, including in-process research and development and liabilities assumed. Additionally, the Company must determine whether an acquired entity is considered a business or a set of net assets because the excess of the purchase price over the fair value of net assets acquired can only be recognized as goodwill in a business combination. The Company accounted for the merger with Tokai as a business combination under the acquisition method of accounting. Consideration paid to acquire Tokai was measured at fair value and included the exchange of Tokai’s common stock and preferred stock. The allocation of the purchase price resulted in recognition of intangible assets related to goodwill. The operating activity for Tokai, the acquiree for accounting purposes, was immediately integrated with Otic post-merger, therefore it is not practical to segregate results of operations related specifically to Tokai since the date of acquisition.

As a result of the Reverse Merger, historical common stock, stock options and additional paid-in capital, including share and per share amounts, have been retroactively adjusted to reflect the equity structure of the Company.

Reportable Segments

Operating segments under GAAP are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (“CODM”), or decision-making group, in deciding how to allocate resources and in assessing performance. The CODM is the Company’s Chief Executive Officer and the Company has determined that it operates in one business segment, which is developing products for disorders of the ear, nose, and throat.

9


Goodwill

Goodwill represents the difference between the consideration transferred and the fair value of the assets acquired and liabilities assumed under the acquisition method of accounting. Goodwill is not amortized but is evaluated for impairment during the last fiscal quarter of the year or if indicators of impairment exist that would, more likely than not, reduce the fair value from its carrying amount. The Company determined there were no impairment indicators as of June 30, 2018 and December 31, 2017.

Long-Lived Assets

Property and equipment are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the respective assets. Additions, major renewals and improvements are capitalized and repair and maintenance costs are charged to expense as incurred. Leasehold improvements are amortized over the remaining life of the initial lease term or the estimated useful lives of the assets, whichever is shorter.

The carrying value of long-lived assets, including intangible assets, is evaluated whenever events or changes in business circumstances or the Company’s planned use of long-lived assets indicate, based on undiscounted future operating cash flows, that their carrying amounts may not be fully recoverable or that their useful lives are no longer appropriate. When an indicator of impairment exists, undiscounted future operating cash flows of long-lived assets are compared to their respective carrying value. If the carrying value is greater than the undiscounted future operating cash flows of long-lived assets, the long-lived assets are written down to their respective fair values and an impairment loss is recorded. Fair value is determined primarily using the discounted cash flows expected to be generated from the use of assets. Significant management judgment is required in the forecast of future operating results that are used in the preparation of expected cash flows. No impairments of tangible assets have been identified during the periods presented.

Research and Development Expenses

Research and development expenses include personnel and facility-related expenses, outside contracted services including clinical trial costs, manufacturing and process development costs, research costs and other consulting services and non-cash stock-based compensation. Research and development costs are expensed as incurred. Amounts due under contracts with third parties may be either fixed fee or fee for service, and may include upfront payments, monthly payments and payments upon the completion of milestones or receipt of deliverables. Non-refundable advance payments under agreements are capitalized and expensed as the related goods are delivered or services are performed.

The Company’s contracts with third parties to perform various clinical trial activities in the on-going development of potential products. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payment flows to its vendors. Payments under the contracts depend on factors such as the achievement of certain events, successful enrollment of patients, and completion of portions of the clinical trial or similar conditions. The Company’s accrual for clinical trials is based on estimates of the services received and efforts expended pursuant to contracts with clinical trial centers and clinical research organizations. These contracts may be terminated by the Company upon written notice and the Company is generally only liable for actual effort expended by the organizations to the date of termination, although in certain instances the Company may be further responsible for termination fees and penalties. The Company estimates its research and development expenses and the related accrual as of each balance sheet date based on the facts and circumstances known to the Company at that time. There have been no material adjustments to the Company’s prior‑period accrued estimates for clinical trial activities through June 30, 2018.

10


Net Loss Per Share

Basic net loss per common share is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period, without consideration for potentially dilutive securities. Diluted net loss per share is computed by dividing the net loss attributable to common stockholders by the weighted-average number of common shares and potentially dilutive securities outstanding for the period determined using the treasury-stock and if-converted methods. For purposes of the diluted net loss per share calculation, preferred stock, convertible notes and accrued interest, stock options, warrants and restricted stock units are considered to be potentially dilutive securities and are excluded from the calculation of diluted net loss per share because their effect would be anti-dilutive. Therefore, basic and diluted net loss per share was the same for the periods presented due to the Company’s net loss position.

 

 

 

Three Months Ended

June 30,

 

 

Six Months Ended

June 30,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

 

 

(In thousands, except share and per share data)

 

Net loss available to stockholders of the company

 

$

(3,189

)

 

$

(6,662

)

 

$

(5,995

)

 

$

(8,036

)

Interest accumulated on preferred shares and on

   preferred shares contingently issuable for little

   or no cash

 

 

 

 

 

(98

)

 

 

 

 

 

(328

)

Net loss attributable to shareholders of preferred shares

   and to shareholders of preferred shares contingently

   issuable for little or no cash

 

 

 

 

 

1,279

 

 

 

 

 

 

2,666

 

Net loss used in the calculation of basic and diluted loss

   per share

 

$

(3,189

)

 

$

(5,481

)

 

$

(5,995

)

 

$

(5,698

)

Net loss per share, basic and diluted

 

$

(0.34

)

 

$

(1.32

)

 

$

(0.70

)

 

$

(2.51

)

Weighted-average number of common shares

 

 

9,407,024

 

 

 

4,154,842

 

 

 

8,582,723

 

 

 

2,270,907

 

 

The computation of diluted earnings per share excludes stock options, warrants, and restricted stock units that are anti-dilutive. For the three and six months ended June 30, 2018, common share equivalents of 996,983 shares and 949,204 shares were anti-dilutive, respectively. For the three and six months ended June 30, 2017, common share equivalents of 587,819 shares were anti-dilutive.

Stock-based Compensation

For stock options granted to employees, the Company recognizes compensation expense for all stock-based awards based on the grant-date estimated fair value.

The fair value of stock options is determined using the Black-Scholes option pricing model, using assumptions which are subjective and require significant judgment and estimation by management. The risk-free rate assumption was based on observed yields from governmental zero-coupon bonds with an equivalent term. The expected volatility assumption was based on historical volatilities of a group of comparable industry companies whose share prices are publicly available. The peer group was developed based on companies in the pharmaceutical industry. The expected term of stock options represents the weighted-average period that the stock options are expected to be outstanding. Because the Company does not have historical exercise behavior, it determined the expected life assumption using the simplified method, which is an average of the options ordinary vesting period and the contractual term. The expected dividend assumption was based on the Company’s history and expectation of dividend payouts. The Company has not paid and does not expect to pay dividends at any time in the foreseeable future. The Company recognizes forfeitures on an actual basis and as such did not estimate forfeitures to calculate stock-based compensation.

Stock-based compensation expense related to stock options granted to non-employees is recognized based on the fair value of the stock options, determined using the Black-Scholes option pricing model, as they are earned. The awards generally vest over the period the Company expects to receive services from the non-employee. Stock options granted to non-employees are subject to periodic revaluation over their vesting terms.

For the three and six months ended June 30, 2018, no excess tax benefits for tax deductions related to share-based awards were recognized in the accompanying condensed consolidated statements of operations and comprehensive loss as no stock options were exercised.

11


Income Taxes

The asset and liability approach is used to recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Tax law and rate changes are reflected in income in the period such changes are enacted. The Company includes interest and penalties related to income taxes, including unrecognized tax benefits, within income tax expense.

The Company’s income tax returns are based on calculations and assumptions that are subject to examination by the Internal Revenue Service and other tax authorities. In addition, the calculation of the Company’s tax liabilities involves dealing with uncertainties in the application of complex tax regulations. The Company recognizes liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. While the Company believes it has appropriate support for the positions taken on its tax returns, the Company regularly assesses the potential outcomes of examinations by tax authorities in determining the adequacy of its provision for income taxes. The Company continually assesses the likelihood and amount of potential revisions and adjusts the income tax provision, income taxes payable and deferred taxes in the period in which the facts that give rise to a revision become known. For additional information, see Note 7. Income Taxes in the notes to the condensed consolidated financial statements.

Recently Issued Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). Under this guidance, an entity is required to recognize right-of-use assets and corresponding lease liabilities on its balance sheet and disclose key information about leasing arrangements. This guidance offers specific accounting guidance for a lessee, a lessor, and sale and leaseback transactions. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. The Company will adopt the standard effective in the first quarter of 2019 and is currently assessing the impact of adopting this guidance on its condensed consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which modifies the measurement of expected credit losses of certain financial instruments. ASU No. 2016-13 will be effective for the Company beginning in its first quarter of 2020 and early adoption is permitted. The adoption of ASU No. 2016-13 is not expected to have a material impact on the Company’s condensed consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles – Goodwill and Other (Topic 350), which eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. The standard has tiered effective dates, starting in 2020 for calendar-year public business entities that meet the definition of an SEC filer. Early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. The Company is currently assessing the impact and timing of adopting this guidance on its condensed consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220), which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the passing of H.R. 1/Public Law No. 115-97, commonly known as the Tax Cuts and Jobs Act (the “Act”) and requires certain disclosures about stranded tax effects. The amendments in ASU No. 2018-02 are effective beginning in 2019, with early adoption permitted, and may be applied either in the period of adoption or retrospectively to each period in which the effect of the change in the U.S. federal corporate tax rate in the Act is recognized. The Company is currently assessing the impact and timing of adopting this guidance on its condensed consolidated financial statements.

12


In June 2018, the FASB issued ASU No. 2018-07, Improvements to Nonemployee Share-Based Payment Accounting, which expands the scope of Topic 718 Compensation—Stock Compensation, to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU No. 2018-07 supersedes Subtopic 505-50 Equity—Equity-Based Payments to Non-Employees. The amendments in ASU No. 2018-07 are effective beginning in 2020, with early adoption permitted, but no earlier than a company’s adoption date of Topic 606 Revenue from Contracts with Customers. The Company is currently assessing the impact and timing of adopting this guidance on its condensed consolidated financial statements.

Recently Adopted Accounting Pronouncements

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which updates certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU No. 2016-01 was adopted by the Company in its first quarter of 2018 and did not have a material impact on its condensed consolidated financial statements as the Company does not currently hold any equity investments.

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfer of Assets Other than Inventory, which requires the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. ASU No. 2016-16 was adopted by the Company in its first quarter of 2018 and did not have a material impact on its condensed consolidated financial statements.  

In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business (Topic 805), which clarifies and provides a more robust framework to use in determining when a set of assets and activities is a business. ASU No. 2017-01 was adopted by the Company in its first quarter of 2018 and will be applied prospectively. The impact of this guidance will be determined by the terms of any future acquisitions.

In May 2017, the FASB issued ASU No. 2017-09, Scope of Modification Accounting, which amends the scope of modification accounting for share-based payment arrangements, provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under Accounting Standards Codification (“ASC”) Topic 718 Compensation – Stock Compensation. ASU No. 2017-09 was adopted by the Company in its first quarter of 2018 and did not have a material impact on its condensed consolidated financial statements as it is not the Company’s practice to change either the terms or conditions of share-based payment awards once they are granted.

In March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118, which amended various SEC paragraphs pursuant to the issuance of SEC Staff Accounting Bulletin No. 118 (“SAB 118”). SAB 118 was issued by the SEC in December 2017 to provide immediate guidance for accounting implications of U.S. tax reform under the Act, which became effective for the Company on January 1, 2018. The Company has evaluated the potential impacts of SAB 118 and has applied this guidance to its condensed consolidated financial statements and related disclosures beginning the first quarter of 2018. For additional information on SAB 118 and the impacts of the Act on the Company’s condensed consolidated financial statements and related disclosures, see Note 7. Income Taxes in the notes to the condensed consolidated financial statements.

No other new accounting pronouncement issued or effective during the fiscal period had or is expected to have a material impact on the Company’s condensed consolidated financial statements or disclosures.

 

Note 3. Reverse Merger

The Company completed the Reverse Merger with Tokai as discussed in Note 1. Based on the terms of the Reverse Merger, the Company concluded that the transaction is a business combination pursuant to ASC Topic 805 Business Combinations, Otic was deemed the acquiring company for accounting purposes, and the transaction has been accounted for as a reverse acquisition under the acquisition method of accounting for business combinations in accordance with GAAP. Under the acquisition method of accounting, the total purchase price is allocated to the acquired tangible and intangible assets and assumed liabilities of Tokai based on their estimated fair values as of the Reverse Merger closing date. The excess of the purchase price over the fair value of assets acquired and liabilities assumed was allocated to goodwill.

13


On May 9, 2017, Tokai issued 4,027,693 shares of its common stock to the stockholders of Otic and the holders of warrants and options of Otic upon the exercise of such options and warrants in exchange for 840,115 Otic Shares. All warrants were exercised as of the merger date and after consummation of the Reverse Merger, Otic stockholders owned a majority of the fully diluted common stock of Novus Therapeutics, Inc.

Purchase Consideration

The purchase price for Tokai on May 9, 2017, the closing date of the Reverse Merger, was as follows (in thousands):

 

Fair value of Tokai common stock outstanding (1)

 

$

14,486

 

Premium paid (2)

 

 

8,889

 

Purchase price

 

$

23,375

 

 

(1)

Comprised of 2,515,739 shares of common stock outstanding at the date of the Reverse Merger based on the closing price of $5.76 per share on May 9, 2017, as adjusted for the one-for-nine reverse stock-split on May 11, 2017.

(2)

Premium paid over fair value of common stock based on net tangible asset multiple of 1.08x book value of Tokai equity of $21.5 million as of May 9, 2017.

Allocation of Purchase Consideration

The allocation of the estimated purchase price to the acquired assets and liabilities assumed of Tokai, based on their estimated fair values as of May 9, 2017, the close of the transaction, is as follows (in thousands):

 

Cash, cash equivalents, and restricted cash

 

$

23,250

 

Prepaids and other current assets

 

 

1,132

 

Property and equipment

 

 

73

 

Goodwill

 

 

1,867

 

Accounts payable, accrued expenses and other liabilities

 

 

(2,947

)

Net assets acquired

 

$

23,375

 

 

The Company engaged a third-party valuation firm to assist management in its analysis of the fair value of Tokai. All estimates, key assumptions, and forecasts were either provided by or reviewed by management. While the Company chose to utilize a third-party valuation firm, the fair value analysis and related valuations represent the conclusions of management and not the conclusions or statements of any third party. The excess of the total purchase price over the fair value of assets acquired and liabilities assumed was allocated to goodwill.

The Company believes that the historical values of Tokai’s current assets and current liabilities approximate fair value based on the short-term nature of such items.

Goodwill, which relates principally to intangible assets that do not qualify for separate recognition under GAAP, was calculated as the difference between the fair value of the consideration expected to be transferred and the values assigned to the identifiable tangible and intangible assets acquired and liabilities assumed. Goodwill is not expected to be deductible for tax purposes.

Pro Forma Results in Connection with Reverse Merger

The operating activity for Tokai, the acquiree for accounting purposes, was immediately integrated with Otic post‑merger, therefore it is not practical to segregate results of operations related specifically to Tokai since the date of acquisition.

14


The unaudited financial information in the following table summarizes the combined results of operations of the Company and Tokai, on a pro forma basis, as if the Reverse Merger had occurred at the beginning of the periods presented
(in thousands):

 

 

 

Three Months Ended

June 30, 2017

 

 

Six Months Ended

June 30, 2017

 

Operating expenses

 

 

 

 

 

 

 

 

Research and development

 

$

686

 

 

$

1,471

 

General and administrative

 

 

2,592

 

 

 

5,474

 

Total operating expenses

 

 

3,278

 

 

 

6,945

 

Loss from operations

 

 

(3,278

)

 

 

(6,945

)

Other income, net

 

 

18

 

 

 

55

 

Net loss and other comprehensive loss

 

$

(3,260

)

 

$

(6,890

)

Net loss per share, basic and diluted

 

$

(0.47

)

 

$

(0.99

)

Weighted-average shares outstanding, basic and diluted

 

 

6,943,831

 

 

 

6,943,831

 

 

The above unaudited pro forma information was determined based on historical GAAP results of Otic and Tokai. The unaudited pro forma combined results are not necessarily indicative of what the Company’s combined results of operations would have been if the acquisition was completed at the beginning of the periods presented. The unaudited pro forma combined net loss includes pro forma adjustments primarily relating to the following non-recurring items directly attributable to the business combination:

 

Elimination of transaction costs of $5.4 million and $7.0 million incurred during the three and six months ended June 30, 2017, respectively. These amounts have been eliminated on a pro forma basis as they are not expected to have a continuing effect on the operating results of the combined company.

 

An increase in the weighted-average shares outstanding for the period after giving effect to the issuance of Tokai common stock in connection with the Reverse Merger and Private Placement.

Note 4. Prepaid Expenses and Other Assets

Prepaid expenses and other assets consisted of the following at June 30, 2018 and December 31, 2017 (in thousands):

 

 

 

 

June 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Prepaid insurance

 

$

1,565

 

 

$

1,518

 

Prepaid other

 

 

309

 

 

 

161

 

Other current assets

 

 

15

 

 

 

18

 

Total prepaid expenses and other current assets

 

$

1,889

 

 

$

1,697

 

 

Note 5. Accrued Expenses and Other Liabilities

Accrued expenses and other liabilities consisted of the following as of June 30, 2018 and December 31, 2017 (in thousands):

 

 

 

June 30,

 

 

December 31,

 

 

 

2018

 

 

2017

 

Accrued clinical

 

$

64

 

 

$

85

 

Accrued compensation and related expenses

 

 

100

 

 

 

 

Accrued professional services

 

 

171

 

 

 

158

 

Accrued vacation

 

 

135

 

 

 

111

 

Accrued other

 

 

52

 

 

 

 

Total accrued expenses and other liabilities

 

$

522

 

 

$

354

 

 

15


Note 6. Commitments and Contingencies

Operating Leases

The Company leases office space under various operating leases. Total rental expense for all operating leases in the accompanying condensed consolidated statements of operations and comprehensive loss was $42,000 and $141,000 for the three months ended June 30, 2018 and 2017, respectively, and $84,000 and $182,000 for the six months ended June 30, 2018 and 2017, respectively.

In February 2015, Tokai entered into a sublease for 15,981 square feet of office space in Boston, Massachusetts. The term of the sublease commenced on April 1, 2015 and expired on December 31, 2016 and was subsequently extended through July 31, 2018. In November 2017, the Company terminated the lease early and paid an additional $455,000 in advance rent in conjunction with the lease termination.

In September 2015, Otic entered into a three-year operating lease for 5,197 square feet of office space in Irvine, California. The lease had an expiration date of August 31, 2018; however, the Company extended the term of the lease through September 30, 2021 by amending the office lease in April 2018.

Future payments under noncancelable extended operating leases having initial or remaining terms of one year or more are as follows for the remaining fiscal year and thereafter (in thousands):

 

2018 (remainder of)

 

$

88

 

2019

 

 

187

 

2020

 

 

195

 

2021

 

 

152

 

Total minimum lease payments

 

$

622

 

Restricted Cash and Letter of Credit

The Company was required to maintain a letter of credit totaling $70,000 for the benefit of the landlord of Tokai’s Boston office. The landlord could draw against the letter of credit in the event of default by the Company. The Company held $70,000 in restricted cash as part of current assets on the condensed consolidated balance sheet as of December 31, 2017. Although the Boston office lease was terminated in November 2017, the process to release the restricted cash was not completed as of December 31, 2017. On March 12, 2018, the restricted cash was released and transferred into general funds.

Grants and Licenses

Israeli Innovation Authority Grant

From 2012 through 2015, the Company received grants in the amount of approximately $537,000 from the Israeli Innovation Authority (previously the Office of Chief Scientist) of the Israeli Ministry of Economy and Industry designated for investments in research and development. The grants are linked to the U.S. Dollar and bear annual interest of LIBOR. The grants are to be repaid out of royalties from sales of the products developed by the Company from their investments in research and development. Because the Company has not yet earned revenues related to these investments and cannot estimate potential royalties, no liabilities related to these grants have been recorded as of each period presented. Repayment of the grant is contingent upon the successful completion of the Company’s R&D programs and generating sales. The Company has no obligation to repay these grants, if the R&D program fails, is unsuccessful or aborted or if no sales are generated. The Company had not yet generated sales as of June 30, 2018; therefore, no liability was recorded for the repayment in the accompanying condensed consolidated financial statements.

Otodyne License Agreement

In November 2015, the Company entered into an exclusive license agreement with Scientific Development and Research, Inc. and Otodyne, Inc. (collectively, the “Licensors”) granting it exclusive worldwide rights to develop and commercialize OP-02, a potential first-in-class treatment option for patients at risk for or with otitis media (middle ear inflammation with or without infection), which is often caused by Eustachian tube dysfunction. Under the terms of the agreement, the Company is obligated to use commercially reasonable efforts to seek approval for and commercialize at least one product for otitis media in the U.S. and key European markets (France, Germany, Italy, Spain, and the United Kingdom). The Company is responsible for prosecuting, maintaining, and enforcing all intellectual property and will be the sole owner

16


of improvements. Under the agreement with the Licensors, the Company paid license fees totaling $750,000 and issued 9,780 common shares to the Licensors, which was expensed to research and development during the year ended December 31, 2015.

In December 2015, the Licensors completed transfer of all technology, including the active Investigational New Drug application (“IND”) to the Company. The Company is obligated to pay up to $42.1 million in development and regulatory milestones if OP-02 is approved for three indications in the U.S., two in Europe, and two in Japan. The Company is also obligated to pay up to $36.0 million in sales based milestones, beginning with sales exceeding $1.0 billion in a calendar year. The Company is also obligated to pay a tiered royalty for a period up to eight years, on a country-by-country basis. The royalty ranges from a low-single to mid-single percentage of net sales. There were no milestones achieved during the six months ended June 30, 2018 or the year ended December 31, 2017.

Terminated License Agreements

In October 2013, the Company (through Tokai) entered into a master license agreement with the University of Maryland, Baltimore (“UMB”), pursuant to which, UMB granted the Company an exclusive, worldwide license, with the right to sublicense, and, under certain patents and patent applications to make, have made, use, sell, offer to sell and import certain anti-androgen steroids, including galeterone, for the prevention, diagnosis, treatment or control of any human or animal disease.

In January 2015, the Company (through Tokai) entered into an exclusive license agreement with The Johns Hopkins University (“Johns Hopkins”) pursuant to which Johns Hopkins granted the Company an exclusive, worldwide license under certain patents and patent applications, and a non-exclusive license under certain know-how, in each case with the right to sublicense, and to make, have made, use, sell, offer to sell and import certain assays to identify androgen receptor variants for use as a companion diagnostic with galeterone.

On October 5, 2017, the Company submitted notice of termination to UMB and John Hopkins. The Company no longer has any obligations to UMB as of December 4, 2017, and to John Hopkins as of January 3, 2018.

Legal Matters

The Company is involved in various lawsuits and claims arising in the ordinary course of business, including actions with respect to intellectual property, employment, and contractual matters. In connection with these matters, the Company assesses, on a regular basis, the probability and range of possible loss based on the developments in these matters. A liability is recorded in the financial statements if it is believed to be probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Because litigation is inherently unpredictable and unfavorable results could occur, assessing contingencies is highly subjective and requires judgments about future events. The Company regularly reviews outstanding legal matters to determine the adequacy of the liabilities accrued and related disclosures. The amount of ultimate loss may differ from these estimates. Each matter presents its own unique circumstances, and prior litigation does not necessarily provide a reliable basis on which to predict the outcome, or range of outcomes, in any individual proceeding. Because of the uncertainties related to the occurrence, amount, and range of loss on any pending litigation or claim, the Company does not consider a liability probable and is currently unable to predict their ultimate outcome, and, with respect to any pending litigation or claim where no liability has been accrued, to make a meaningful estimate of the reasonably possible loss or range of loss that could result from an unfavorable outcome. In the event that opposing litigants in outstanding litigation proceedings or claims ultimately succeed at trial and any subsequent appeals on their claims, any potential loss or charges in excess of any established accruals, individually or in the aggregate, could have a material adverse effect on the Company’s business, financial condition, results of operations, and/or cash flows in the period in which the unfavorable outcome occurs or becomes probable, and potentially in future periods.

Legal Proceedings

Doshi Action

On August 1, 2016, a purported stockholder of Tokai filed a putative class action lawsuit in the U.S. District Court for the Southern District of New York against Tokai, Jodie P. Morrison, and Lee H. Kalowski, entitled Doshi v. Tokai Pharmaceuticals, Inc., et al., No. 1:16-cv-06106 (“Doshi Action”). The plaintiff sought to represent a class of purchasers of Tokai securities between June 24, 2015, and July 25, 2016, and alleges that, in violation of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 promulgated thereunder, defendants made false and misleading statements and omissions about Tokai’s clinical trials for its drug candidate, galeterone. The lawsuit sought, among other things, unspecified

17


compensatory damages, interest, costs, and attorneys’ fees. On October 3, 2016, the case was transferred to the U.S. District Court for the District of Massachusetts. On September 28, 2017, this action was consolidated with Garbowski, et al. v. Tokai Pharmaceuticals, Inc., et al., No. 1:16-cv-11963 (see below). On April 26, 2018, the Court found that the Doshi Action could not proceed as a putative class action because it lacked a lead plaintiff. On May 1, 2018, the plaintiff dismissed the Doshi Action without prejudice.

Legal Proceedings Related to Tokai IPO

On September 22, 2014, Tokai completed the initial public offering of its common stock (the “IPO”). Subsequent to the IPO, several lawsuits were filed against Tokai, Jodie P. Morrison, Lee H. Kalowski, Seth L. Harrison, Timothy J. Barberich, David A. Kessler, Joseph A. Yanchik, III, and the underwriters of the IPO. The lawsuits allege that, in violation of the Securities Act of 1933 (“Securities Act”), Tokai’s registration statement for the IPO made false and misleading statements and omissions about Tokai’s clinical trials for galeterone. Each lawsuit sought, among other things, unspecified compensatory damages, interest, costs, and attorneys’ fees. Further details on each lawsuit are set forth below. The Company intends to vigorously defend against these claims. Given the uncertainty of litigation, the preliminary stage of these cases, and the legal standards that must be met for, among other things, success on the merits, the Company is unable to predict the ultimate outcome of these actions, and therefore it cannot estimate the reasonably possible loss or range of loss that may result from these actions.

 

Jackie888 Action. On August 19, 2016, a purported stockholder of Tokai filed a putative class action lawsuit in the Superior Court of the State of California, County of San Francisco, entitled Jackie888, Inc. v. Tokai Pharmaceuticals, Inc., et al., No. CGC-16-553796. The plaintiff sought to represent a class of purchasers of Tokai common stock in or traceable to Tokai’s IPO. On October 19, 2016, the defendants moved to dismiss or stay the action on grounds of forum non conveniens, and certain individual defendants moved to quash the plaintiff’s summons for lack of personal jurisdiction. On February 27, 2017, the Superior Court entered an order granting defendants’ motion to stay the lawsuit. On May 24, 2018, the plaintiff dismissed its complaint in the Superior Court of the State of California and refiled its complaint in the Business Litigation Session of the Superior Court Department of the Suffolk County Trial Court, Massachusetts (“Massachusetts State Court”). On June 28, 2018, plaintiff Wu moved to consolidate the Jackie888 Action with the Wu Action (discussed below). On June 29, 2018, plaintiffs Jackie888 and Wu filed a consolidated complaint. On July 6, 2018, the Jackie888 Action was consolidated with the Wu Action. Pursuant to the schedule for defendants’ motions to dismiss, defendants will move to dismiss the consolidated complaint by or on August 15, 2018, plaintiffs will oppose by or on, September 30, 2018, and defendants will file any replies in support of their motions on October 19, 2018. The court set a hearing for November 15, 2018 on defendants’ motions to dismiss.

 

Garbowski Action. On September 29, 2016, two purported stockholders of Tokai filed a putative class action lawsuit in the U.S. District Court for the District of Massachusetts, entitled Garbowski, et al. v. Tokai Pharmaceuticals, Inc., et al., No. 1:16-cv-11963 (“Garbowski Action”). In addition to the Securities Act claims, this lawsuit also alleges that the defendants made false and misleading statements and omissions about Tokai’s clinical trials for galeterone, in violation of the Exchange Act and Rule 10b-5 promulgated thereunder. The plaintiffs sought to represent a class of purchasers of Tokai common stock in or traceable to Tokai’s IPO as well as a class of purchasers of Tokai common stock between September 17, 2014, and July 25, 2016. On September 28, 2017, this action was consolidated with the Doshi Action. On April 26, 2018, the Court found that the Garbowski Action could not proceed as a putative class action because it lacked a lead plaintiff. On May 9, 2018, the plaintiffs dismissed the Garbowski Action without prejudice.

 

Wu Action. On December 5, 2016, a putative securities class action was filed in the Massachusetts State Court, entitled Wu v. Tokai Pharmaceuticals, Inc., et al., 16-3725 BLS (“Wu Action”). The plaintiff seeks to represent a class of purchasers of Tokai common stock in or traceable to Tokai’s IPO. On December 19, 2016, defendants removed the Wu Action to the U.S. District Court for the District of Massachusetts, where it was captioned Wu v. Tokai Pharmaceuticals, Inc., et al., 16-cv-12550, and assigned to the same judge presiding over the Doshi and Garbowski Actions. On December 22, 2016, defendants filed a motion to consolidate the Wu Action with the Doshi and Garbowski Actions. On January 6, 2017, plaintiff filed a motion to remand the Wu Action to Massachusetts State Court. On September 28, 2017, the court stayed the case pending a decision by the United States Supreme Court in Cyan, Inc. v. Beaver County Employees Retirement Fund, S. Ct. Case No. 15-1439. On March 20, 2018, the United States Supreme Court ruled in Cyan that state courts have subject matter jurisdiction over covered class actions alleging only Securities Act claims and that such actions are not removable to federal court. On March 22, 2018, plaintiff moved for leave to submit the Cyan decision in support of plaintiff’s remand motion. On March 27, 2018 the Wu Action was remanded to the Massachusetts State Court. On May 3, 2018, plaintiff filed an amended class action complaint. Following the refiling of the Jackie888 Action in

18


 

Massachusetts State Court (discussed above), on June 28, 2018, plaintiff Wu moved to consolidate the Jackie888 Action with the Wu Action. On June 29, 2018, plaintiffs Jackie888 and Wu filed a consolidated complaint. On July 6, 2018, the Jackie888 Action was consolidated with the Wu Action. Pursuant to the schedule for defendants’ motions to dismiss, defendants will move to dismiss the consolidated complaint by or on August 15, 2018, plaintiffs will oppose by or on, September 30, 2018, and defendants will file any replies in support of their motions on October 19, 2018. The court set a hearing for November 15, 2018 on defendants’ motions to dismiss.

 

Angelos Action. On July 25, 2017, a purported stockholder of Tokai filed a lawsuit in the U.S. District Court for the District of Massachusetts, entitled Peter B. Angelos v. Tokai Pharmaceuticals, Inc., et al., No. 1:17-cv-11365-MLW. The case was assigned to the same judge who was then presiding over the Garbowski and Doshi Actions.

Indemnification

In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties and provide for general indemnification. The Company’s exposure under these agreements is unknown because it involves future claims that may be made against the Company but have not yet been made. To date, the Company has not paid any claims or been required to defend any action related to its indemnification obligations. However, the Company may record charges in the future because of these indemnification obligations. No amounts associated with such indemnifications have been recorded to date.

Contingencies

From time to time, the Company may have certain contingent liabilities that arise in the ordinary course of business activities. The Company accrues a liability for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. There have been no contingent liabilities requiring accrual at June 30, 2018.

Note 7. Income Taxes

The Company is subject to income taxes under the Israeli and U.S. tax laws. The Company was subject to an Israeli corporate tax rate of 24% in the year 2017 and will be subject to an Israeli corporate tax rate of 23% in the year 2018 and thereafter. The Company was subject to a blended U.S. tax rate (federal as well as state corporate tax) of 35% in 2017 and will be subject to a blended U.S. tax rate of 21% in 2018.

On December 22, 2017, H.R. 1/Public Law No. 115-97, commonly known as the Tax Cuts and Jobs Act (the “Act”), was signed into law. The effects of this new federal legislation are recognized upon enactment, which is the date a bill is signed into law. The Act included numerous changes in existing tax law, including a permanent reduction in the federal corporate income tax rate from 35% to 21%, converting to a territorial tax system, and creating various income inclusion and expense limitation provisions. The rate reduction was effective beginning January 1, 2018. As a result of the Act, the Company has revalued its net deferred tax assets as of December 31, 2017 to reflect the rate reduction.

The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Act. SAB 118 provides a measurement period that should not extend beyond one year from the Act enactment date for companies to complete the accounting under ASC Topic 740 Income Taxes. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Act.

Due to insufficient guidance on certain aspects of the Act, such as officer’s compensation, as well as uncertainty around the GAAP treatment associated with many other parts of the Act, such as the implementation of certain international provisions, the Company cannot be certain that all deferred tax assets and liabilities have been established for the future effects of the legislation. Therefore, the final accounting for these provisions is subject to change as further information becomes available and further analysis is complete. Additionally, given the uncertainty and complexity of these new international tax regimes, the Company is continuing to evaluate how these provisions will be accounted for under U.S. generally accepted accounting principles; therefore, the Company has not yet adopted an accounting policy for treating the effects of these provisions as either a component of income tax expense in the period the tax arises, or through adjusting its

19


deferred tax assets and liabilities to account for the estimated future impact of the special international tax regimes. There were no changes to provisional amounts during the second quarter remeasurement period.

Note 8. Stockholders’ Equity

Warrants

During 2017, the following transactions represent the exercise of all outstanding warrants for the Company’s preferred stock, for total proceeds of approximately $3.1 million:

 

In March 2017, OrbiMed Israel Partners Limited Partnership, a related party, exercised a warrant to purchase 978,561 shares of Preferred B shares of the Company at $0.41 per share for an aggregate amount of approximately $400,000.

 

In May 2017, OrbiMed Israel Partners Limited Partnership, a related party, exercised warrants to purchase 6,458,628 shares of Preferred B shares of the Company at a price of $0.41 per share for an aggregate amount of approximately $2.6 million. Additionally, 51,477 shares of common stock were issued in a cashless exercise of warrants.

 

In May 2017, Peregrine Management II Ltd., a related party, exercised warrants to purchase 192,454 shares of Preferred B shares at $0.41 per share for an aggregate amount of approximately $79,000. Additionally, 10,299 shares of common stock were issued in a cashless exercise of warrants.

 

In May 2017, Pontifax, in a cashless exercise of its warrants, purchased 90,804 shares of the Company’s common stock.

 

In the first half of 2017, individual stockholders, in a cashless exercise, purchased 311,850 of the Company’s preferred stock.

As of June 30, 2018 and December 31, 2017, no warrants were issued and outstanding.

Equity Distribution Agreement

On August 21, 2017, the Company entered into an equity distribution agreement (the “Equity Distribution Agreement”) with Piper Jaffray & Co. (“Piper Jaffray”), as sales agent, pursuant to which the Company may offer and sell, from time to time, through Piper Jaffray, shares of the Company’s common stock. In connection with the Equity Distribution Agreement on August 21, 2017, the Company filed a prospectus supplement (the “2017 Prospectus) under which the Company was permitted to offer and sell up to $8.5 million in shares of its common stock. From October 2, 2017 through March 9, 2018, the Company sold 2,463,966 shares of its common stock through Piper Jaffray under the Equity Distribution Agreement and 2017 Prospectus for gross proceeds of approximately $8.5 million. During the six months ended June 30, 2018, the Company received approximately $7.5 million in proceeds, net of $232,000 in offering costs.

No further sales will be made under the 2017 Prospectus.  

Note 9. Subsequent Events

On July 23, 2018, the Company filed a new prospectus supplement under which the Company may offer and sell, from time to time, through Piper Jaffray, up to an additional $9.8 million in shares of its common stock.

20


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The unaudited interim financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read together with our audited financial statements and accompanying notes for the year ended December 31, 2017 included in the Annual Report on Form 10-K filed by the Company with the SEC on April 2, 2018. In addition to historical information, this discussion and analysis contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Please see Part II, Item 1A. Risk Factors for a discussion of certain risk factors applicable to our business, financial condition, and results of operations. Operating results are not necessarily indicative of results that may occur for the full fiscal year or any other future period. The term “Otic Pharma” refers to Novus Therapeutics, Inc., prior to the consummation of the Reverse Merger. Unless otherwise indicated, references to the terms the “combined company”, “Novus”, the “Company”, “we”, “our” and “us” refer to Otic Pharma, prior to the consummation of the Reverse Merger and Novus Therapeutics, Inc., upon the consummation of the Reverse Merger described herein. The term “Tokai” refers to Tokai Pharmaceuticals, Inc. prior to the Reverse Merger.

ABOUT NOVUS THERAPEUTICS

Novus Therapeutics, Inc. (“Novus”) is a specialty pharmaceutical company focused on developing products for disorders of the ear, nose, and throat (“ENT”). Novus has two technologies, each that has the potential to be developed for multiple ENT indications. The company’s lead product (OP-02) is a surfactant-based, combination drug product being developed as a potential first-in-class treatment option for patients at risk for, or with, otitis media (“OM” or middle ear inflammation with or without infection). Globally, OM affects more than 700 million adults and children every year. OM is a common disorder seen in pediatric practice, and in the United States is the most frequent reason children are prescribed antibiotics and undergo surgery. Novus also has a foam-based drug delivery technology (OP-01), which may be developed in the future to deliver drugs into the ear, nasal, and sinus cavities.

OP-02 Surfactant Program

OP‑02 is being developed as a potential first-in-class treatment option for OM, which is often caused by Eustachian tube dysfunction (“ETD”). OP‑02 is a drug-device combination product comprised of a novel formulation of a surfactant (dipalmitoylphosphatidylcholine (“DPPC”)) and a spreading agent (cholesteryl palmitate (“CP”)) suspended in propellant. The product is administered intranasally via a metered- dose inhaler and is intended to be used to restore the normal physiologic activity of the Eustachian tube (“ET”), which is a small tube that connects from the chamber of the middle ear to the back of the nasopharynx. Together DPPC and CP are designed to effectively absorb to the air-liquid interface of the mucosa and reduce the interfacial surface tension of the ET, which reduces passive pressure required for the ET to open. In other words, OP‑02 is intended to promote ‘de-sticking’ of the ET so that ventilation and drainage of the middle ear may occur.

Novus expects to initiate a phase 1 clinical program of OP‑02 in 2018. The phase 1 program will include a single study to evaluate repeated intranasal doses of OP‑02 in healthy subjects plus additional phase 1 studies to explore safety and efficacy in patients with OM. Upon completion of the phase 1 program, Novus intends to initiate phase 2 and 3 studies of OP‑02, with an initial focus on a development program that, if successful, will lead to registration of OP‑02 in North America and key European markets as a product to treat OM and prevent OM in children. Additional development activities to support registration in other countries and/or for other OM/ETD disorders, or in other patient populations, may occur in the future.

OP-01 Foam Platform

OP‑01 is a foam-based product intended to be used as a delivery vehicle for drugs to be administered into the ears, as well as the nasal and sinus cavities. Specifically, OP‑01 was initially developed as an improved treatment option for acute otitis externa (“AOE”), a common medical condition of the outer ear canal that affects tens of millions of adults and children each year (frequently called “swimmer’s ear”). Novus completed four clinical trials of OP‑01 in 353 adult and pediatric subjects, including a successful phase 2b study with a steroid-free, antibiotic-only formulation of OP‑01 that performed similarly to standard of care, but with a favorable dosing regimen.

In 2016, Novus began development of a second-generation formulation of OP‑01 designed to rapidly relieve ear pain (an unmet need in AOE) and eradicate infection with less than seven days of treatment. In 2017, Novus paused the OP‑01 development program to focus resources on OP‑02.

21


RECENT DEVELOPMENTS

Reverse Merger

On December 21, 2016, Novus, formerly known as Tokai Pharmaceuticals, Inc. (“Tokai”), a Delaware corporation, Otic Pharma, Ltd., a private limited company organized under the laws of the State of Israel (“Otic”), and the stockholders of Otic (each a “Seller” and collectively, the “Sellers”), entered into a Share Purchase Agreement (the “Share Purchase Agreement”), pursuant to which, among other things, each Seller agreed to sell to Tokai, and Tokai agreed to purchase from each Seller, all of the common and preferred shares of Otic (“Otic Shares”) owned by such Seller in exchange for the issuance of a certain number of shares of common stock of Tokai, as determined pursuant to the terms of the Share Purchase Agreement (the “Reverse Merger”). The parties amended and restated the Share Purchase Agreement on March 2, 2017.

On May 9, 2017, Tokai, Otic, and the Sellers closed the transaction contemplated by the Share Purchase Agreement and subsequently effected a reverse stock-split at a ratio of one-for-nine (see Reverse Stock-Split below). On a post‑split basis, Tokai issued to the Sellers an aggregate of 4,027,693 shares of Tokai’s common stock in exchange for 840,115 Otic Shares. Following the completion of the Reverse Merger, the business being conducted by Tokai became primarily the business conducted by Otic. Subsequent to the Reverse Merger, the name of the surviving corporation was changed to “Novus Therapeutics, Inc.”

Private Placement

On January 31, 2017, Novus entered into a stock purchase agreement (the “Stock Purchase Agreement”) with certain purchasers named therein (the “Purchasers”), pursuant to which the Purchasers agreed to purchase approximately $4.0 million of the Company’s common stock through the purchase of 400,400 shares of the Company’s common stock at a price of $9.99 per share (the “Private Placement”). The Private Placement closed on May 10, 2017. After giving effect to the issuance of the shares in the Private Placement, the stockholders of Otic owned approximately 64% of the Company’s common stock.

Reverse Stock-Split

On May 11, 2017, Novus effected a reverse stock-split of its issued and outstanding common stock and options for common stock at a ratio of one-for-nine. The Company filed an Amended and Restated Certificate of Incorporation with the Secretary of State of the State of Delaware effecting the reverse stock-split. The accompanying condensed consolidated financial statements and notes give retroactive effect to the reverse stock-split for all periods presented.

Equity Distribution Agreement

On August 21, 2017, the Company entered into an equity distribution agreement (the “Equity Distribution Agreement”) with Piper Jaffray & Co. (“Piper Jaffray”), as sales agent, pursuant to which the Company may offer and sell, from time to time, through Piper Jaffray, shares of the Company’s common stock. In connection with the Equity Distribution Agreement, on August 21, 2017, the Company filed a prospectus supplement (the “2017 Prospectus”) under which the Company was permitted to offer and sell up to $8.5 million in shares of its common stock. From October 2, 2017 through March 9, 2018, the Company sold 2,463,966 shares of its common stock through Piper Jaffray under the Equity Distribution Agreement and 2017 Prospectus for gross proceeds of approximately $8.5 million. On July 23, 2018, the Company filed a new prospectus supplement, under which the Company may offer and sell, from time to time, through Piper Jaffray, up to an additional $9.8 million in shares of its common stock.  

CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES

Our management’s discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, and expenses and the disclosure of contingent assets and liabilities as of the date of the financial statements. On an ongoing basis, we evaluate our estimates and judgments. We base our estimates on historical experience, known trends and events, and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions. There have been no significant and material changes in our critical accounting policies and significant judgments and estimates during the six months ended June 30, 2018, as compared to those disclosed in the Annual Report on Form 10-K for the year ended December 31, 2017 filed by the Company with the SEC on April 2, 2018.

22


RESULTS OF OPERATIONS

Comparison of the Three Months Ended June 30, 2018 and 2017

The following table provides comparative unaudited results of operations for the three months ended June 30, 2018 and 2017 (in thousands):

 

 

 

Three Months Ended

June 30,

 

 

 

 

 

 

 

 

 

 

 

2018

 

 

2017

 

 

$ Variance

 

 

% Variance

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and Development

 

$

1,329

 

 

$

533

 

 

 

796

 

 

 

149

%

General and Administrative

 

 

1,860

 

 

 

6,133

 

 

 

(4,273

)

 

 

(70

)%

Total operating expenses

 

 

3,189

 

 

 

6,666

 

 

 

(3,477

)

 

 

(52

)%

Loss from operations

 

 

(3,189

)

 

 

(6,666

)

 

 

3,477

 

 

 

(52

)%

Other income (expense), net

 

 

 

 

 

4

 

 

 

(4

)

 

 

(100

)%

Net loss

 

$

(3,189

)

 

$

(6,662

)

 

 

3,473

 

 

 

(52

)%

 

Research and Development Expenses

The increase in research and development expenses of $796,000 for the three months ended June 30, 2018 compared to the three months ended June 30, 2017, was primarily due to the increase in formulation development costs for OP-02 of $603,000 and an increase in personnel related costs of $194,000 related to the hiring of additional employees in clinical operations and regulatory operations. We expect research and development expenses to increase in subsequent periods as we advance our OP‑02 programs.

General and Administrative Expenses

The decrease in general and administrative expenses of $4.3 million for the three months ended June 30, 2018 compared to the three months ended June 30, 2017 was primarily due to $4.4 million in non-recurring merger-related expenses incurred in 2017 and a decrease in rent expense of $89,000, partially offset by increases in stock-based compensation expenses of $277,000 and Tokai litigation costs of $115,000.

Other Income (Expense), Net

The change in other income (expense), net was due to the Company having interest income of $4,000 for the three months ended June 30, 2017. The Company had no other income or expenses during the same three-month period in 2018.

Comparison of the Six Months Ended June 30, 2018 and 2017

The following table provides comparative unaudited results of operations for the six months ended June 30, 2018 and 2017 (in thousands):

 

 

 

Six Months Ended

June 30,

 

 

 

 

 

 

 

 

 

 

 

2018

 

 

2017

 

 

$ Variance

 

 

% Variance

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Research and Development

 

$

2,426

 

 

$

1,012

 

 

 

1,414

 

 

 

140

%

General and Administrative

 

 

3,558

 

 

 

7,039

 

 

 

(3,481

)

 

 

(49

)%

Total operating expenses

 

 

5,984

 

 

 

8,051

 

 

 

(2,067

)

 

 

(26

)%

Loss from operations

 

 

(5,984

)

 

 

(8,051

)

 

 

2,067

 

 

 

(26

)%

Other income (expense), net

 

 

(11

)

 

 

15

 

 

 

(26

)

 

 

(173

)%

Net loss

 

$

(5,995

)

 

$

(8,036

)

 

 

2,041

 

 

 

(25

)%

 

Research and Development Expenses

The increase in research and development expenses of $1.4 million for the six months ended June 30, 2018 compared to the six months ended June 30, 2017, was primarily due to the increase in formulation development costs for OP-02,

23


including consulting expenses, of $1.2 million, and an increase in personnel related costs of $257,000 related to the hiring of additional employees in clinical operations and regulatory operations.

General and Administrative Expenses

The decrease in general and administrative expenses of $3.5 million for the six months ended June 30, 2018 compared to the six months ended June 30, 2017 was primarily due to $4.5 million in non-recurring merger-related expenses incurred in 2017 and a decrease in rent expense of $88,000, partially offset by an increase of $855,000 in insurance, professional fees, board of directors expense, and other administrative costs associated with operating a public company as well as increases in stock-based compensation expenses of $311,000 and Tokai litigation costs of $150,000.

Other Income (Expense), Net

The change in other income (expense), net was primarily related to $9,000 in VAT taxes paid in Israel and $2,000 in realized losses on foreign currency translation for the six months ended June 30, 2018.  During the same period in 2017, the Company had interest income of $15,000.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2018, we had cash of $19.2 million, consisting of readily available cash in bank accounts. While we believe our cash is not subject to excessive risk, we maintain significant amounts of cash at one or more financial institutions that are in excess of federally insured limits. To date, our operations have been financed primarily by net proceeds from the sale of preferred and common stock, the issuance of convertible promissory notes, and cash received in the Reverse Merger with Tokai. We believe our cash will be sufficient to fund our operations for at least the next 12 months from the date of issuance of these financial statements.

On May 9, 2017, we completed our Reverse Merger with Tokai, which provided $23.3 million in cash and cash equivalents. Immediately following the Reverse Merger, we raised $4.0 million in aggregate gross proceeds from a private placement of our common stock.

On August 21, 2017, the Company entered into the Equity Distribution Agreement with Piper Jaffray and filed the 2017 Prospectus pursuant to which it sold 2,463,966 shares of its common stock for gross proceeds of approximately $8.5 million between October 2017 and March 2018. No further sales will be made under the 2017 Prospectus. On July 23, 2018, the Company filed a new prospectus supplement, under which the Company may offer and sell, from time to time, through Piper Jaffray, up to an additional $9.8 million in shares of its common stock.

Our primary uses of capital are, and we expect will continue to be, funding research efforts and the development of our product candidates, compensation and related expenses, hiring additional staff (including clinical, scientific, operational, financial, and management personnel) and costs associated with operating as a public company. We expect to incur substantial expenditures in the foreseeable future for the development and potential commercialization of our product candidates.

We plan to continue to fund losses from operations and capital funding needs through cash on hand and future equity or debt financings, as well as potential additional collaborations or strategic partnerships with other companies. The sale of additional equity or convertible debt could result in additional dilution to our stockholders. The incurrence of indebtedness would result in debt service obligations and could result in operating and financing covenants that would restrict our operations. We can provide no assurance that financing will be available in the amounts we need or on terms acceptable to us, if at all. If we are not able to secure adequate additional funding we may be forced to delay, make reductions in spending, extend payment terms with suppliers, liquidate assets where possible, or suspend or curtail planned programs. Any of these actions could materially harm our business.

24


Cash Flows

The following table provides a summary of our net cash flow activity (in thousands):

 

 

 

Six Months Ended

June 30,

 

 

 

2018

 

 

2017

 

Net cash used in operating activities

 

$

(5,605

)

 

$

(8,913

)

Net cash provided by investing activities

 

 

 

 

 

23,258

 

Net cash provided by financing activities

 

 

7,491

 

 

 

7,119

 

Net increase in cash and restricted cash

 

$

1,886

 

 

$

21,464

 

 

Comparison of the Six Months Ended June 30, 2018 and 2017

Net cash used in operating activities for the six months ended June 30, 2018 consisted primarily of our net loss of $6.0 million, partially offset by non-cash items consisting primarily of stock-based compensation and depreciation totaling $601,000. Additionally, cash used in operating expenses for the six months ended June 30, 2018 reflected a net decrease in cash from changes in operating assets and liabilities of $180,000, primarily due to an increase in our prepaid expenses and a decrease in accrued severance expenses, partially offset by increases in our accounts payable and other accrued expenses.

Net cash used in operating activities for the six months ended June 30, 2017 consisted primarily of our net loss of $8.0 million, partially offset by non-cash items consisting of stock-based compensation, loss on disposal of fixed assets and depreciation totaling $283,000. Additionally, cash used in operating expenses for the six months ended June 30, 2017 reflected a net decrease in cash from changes in net operating assets and liabilities of $1.2 million, primarily due to an increase in our prepaid expenses.

There was no cash provided by or used in the Company’s investing activities for the six months ended June 30, 2018.

Net cash provided by investing activities for the six months ended June 30, 2017 consisted primarily of cash received from the Reverse Merger of $23.3 million.

Net cash provided by financing activities for the six months ended June 30, 2018 was comprised of $7.5 million in net proceeds from the Equity Distribution Agreement for the sale of approximately 2.3 million shares of Novus common stock. Cash provided by significant financing activities in the six months ended June 30, 2017 consisted of $4.0 million in proceeds from the Stock Purchase Agreement for the purchase of 400,400 shares of Novus common stock and proceeds from the exercise of warrants in the amount of $3.1 million.

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

Contractual Arrangements

No material changes to contractual obligations and commitments occurred during the six months ended June 30, 2018.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements as defined in the rules and regulations of the SEC.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

Our cash as of June 30, 2018 consisted of readily available cash in bank accounts. Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates. However, because of the short-term nature of the instruments in our portfolio, a sudden change in market interest rates would not be expected to have a material impact on Novus’s financial condition or results of operations. We do not believe that our cash or cash equivalents have significant risk of default or illiquidity. While we believe our cash is not subject to excessive risk, we cannot provide absolute assurance that in the future our investments will not be subject to adverse changes in market value. In addition, we maintain significant amounts of cash at one or more financial institutions that are in excess of federally insured limits.

25


Item 4. Controls and Procedures.

Definition and Limitations of Disclosure Controls

Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this report, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including the Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Our management evaluates these controls and procedures on an ongoing basis.

There are inherent limitations to the effectiveness of any system of disclosure controls and procedures. These limitations include the possibility of human error, the circumvention or overriding of the controls and procedures and reasonable resource constraints. In addition, because we have designed our system of controls based on certain assumptions, which we believe are reasonable, about the likelihood of future events, our system of controls may not achieve its desired purpose under all possible future conditions. Accordingly, our disclosure controls and procedures provide reasonable assurance, but not absolute assurance, of achieving their objectives.

Evaluation of Disclosure Controls and Procedures

Our Principal Executive Officer and our Principal Financial Officer, after evaluating the effectiveness of our disclosure controls and procedures, believe that as of the end of the period covered by this report, our disclosure controls and procedures were effective in providing the requisite reasonable assurance that material information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and is accumulated and communicated to our management, including our Principal Executive Officer and Principal Financial Officer, as appropriate to allow timely decisions regarding the required disclosure.

Changes in Internal Control Over Financial Reporting

There has been no change in our internal control over financial reporting identified in connection with our evaluation that occurred during our most recent fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

26


PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

Information pertaining to legal proceedings is provided under the heading “Legal Proceedings” in Note 6, Commitments and Contingencies, to the condensed consolidated financial statements and is incorporated by reference herein.

Item 1A. Risk Factors.

Investing in our common stock involves a high degree of risk. You should consider carefully the risks described below, together with the other information included or incorporated by reference in our annual report on Form 10-K and subsequent reports filed with the Securities and Exchange Commission. If any of the following risks occur, our business, financial condition, results of operations and future growth prospects could be materially and adversely affected. In these circumstances, the market price of our common stock could decline.

Unless otherwise indicated, references to the terms the “combined company”, “Novus”, the “Company”, “we”, “our”, and “us” refer to Otic Pharma, Ltd., and subsidiary (“Otic”) prior to the consummation of the Reverse Merger, and Novus Therapeutics, Inc., upon the consummation of the Reverse Merger described herein. The term “Tokai” refers to the Tokai Pharmaceuticals, Inc., and its subsidiaries (“Tokai”) prior to the Reverse Merger.

Risks Related to Our Operations

We have incurred significant operating losses since our inception and expect that we will continue to incur losses over the next several years and may never achieve or maintain profitability.

Since inception, Otic, the accounting acquirer in the Reverse Merger, has incurred significant operating losses. As of December 31, 2017, the Company had an accumulated deficit of $27.5 million. The Company’s net loss for the six months ended June 30, 2018 is $6.0 million and the Company has an accumulated deficit of $33.5 million.

We are focused primarily on developing OP-02 as a potential first-in-class treatment option for patients at risk for or with otitis media (“OM” or middle ear inflammation with or without infection). We have not manufactured a current Good Manufacturing Procedures (“cGMP”) batch of OP-02 suitable for clinical trials. Subject to successful completion of formulation development and manufacture of a cGMP batch, we expect to initiate a phase 1 clinical program in 2018 to explore the safety and tolerability of OP-02 in healthy subjects, plus additional phase 1 studies in patients. The phase 1 program will evaluate single and repeated intranasal doses of OP-02. Upon completion of the phase 1 program, Novus intends to initiate phase 2 studies of OP-02, with an initial focus on prevention of OM in children. We expect that it will be several years, if ever, before we have a product candidate ready for commercialization. If we are unable to successfully complete the formulation of OP-02 and begin to generate clinical data for this program, we may have greater difficulty raising additional capital on favorable terms, or at all.

We expect to continue to incur significant expenses and increasing operating losses for the foreseeable future. The net losses that we incur may fluctuate significantly from quarter to quarter. We anticipate that our expenses will increase substantially if and as we:

 

continue formulation development of our product candidates;

 

continue nonclinical and clinical development of our product candidates;

 

seek to identify and acquire additional product candidates;

 

acquire or in-license other products and technologies;

 

enter into collaboration arrangements with regards to product discovery or development;

 

develop manufacturing processes;

 

seek marketing approvals for any of our product candidates that successfully complete clinical trials;

 

establish a sales, marketing and distribution infrastructure to commercialize any products for which we may obtain marketing approval;

 

maintain, expand and protect our intellectual property portfolio;

 

hire additional personnel;

27


 

add operational, financial and management information systems and personnel, including personnel to support our product development and planned future commercialization efforts; and

 

operate as a public company.

To become and remain profitable, we must develop and eventually commercialize a product or products with significant market potential. This will require us to be successful in a range of challenging activities, including completing clinical trials of our product candidates, obtaining marketing approval for these product candidates and manufacturing, marketing and selling those products for which we obtain marketing approval. We may never succeed in these activities and, even if we do, may never generate revenues that are significant or large enough to achieve profitability. If we do achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis. Our failure to become and remain profitable would decrease the value of the Company, could impair our ability to raise capital, maintain our nonclinical and clinical development efforts, and expand our business or continue our operations and may require us to raise additional capital that may dilute the ownership interest of common stockholders. A decline in the value of the Company could also cause stockholders to lose all or part of their investment.

We are early in our development efforts and have only two drug candidates, OP-02 and OP-01. If we are unable to successfully develop and commercialize any drug candidate, or if we experience significant delays in doing so, our business will be materially harmed.

We currently do not have any products that have gained regulatory approval. We have invested substantially all of our efforts and financial resources in product development, including funding our formulation development, nonclinical, and clinical studies. Our ability to generate product revenues, which we do not expect will occur for several years, if ever, will depend heavily on the successful development and eventual commercialization of one or more drug candidates. As a result, our business is substantially dependent on our ability to successfully complete the development of and obtain regulatory approval for our or additional product candidates.

We have not yet demonstrated an ability to successfully overcome many of the risks and uncertainties frequently encountered by companies in new and rapidly evolving fields, particularly in the pharmaceutical area. For example, to execute our business plan, we will need to successfully:

 

execute formulation, clinical, and nonclinical development activities;

 

manufacture drug product;

 

in-license or acquire other product candidates and advance them through clinical development;

 

obtain required regulatory approvals for the development and commercialization of OP-02 or other product candidates;

 

maintain, leverage and expand our intellectual property portfolio;

 

build and maintain robust sales, distribution and marketing capabilities, either on our own or in collaboration with strategic partners;

 

gain market acceptance for OP-02, OP-01 and other product candidates;

 

obtain and maintain adequate product pricing and reimbursement;

 

develop and maintain any strategic relationships we elect to enter into; and

 

manage our spending as costs and expenses increase due to product manufacturing, nonclinical development, clinical trials, regulatory approvals, post-marketing commitments, and commercialization.

If we are unsuccessful in accomplishing these objectives, we may not be able to successfully develop and commercialize our or other product candidates, and our business will suffer.

Our short operating history may make it difficult to evaluate the success of our business to date and to assess our future viability.

We are an early development stage pharmaceutical company. Our ongoing operations to date have been limited to organizing and staffing the Company, business planning, raising capital, acquiring and developing technology, identifying potential product candidates, undertaking nonclinical studies, and, up until the consummation of the Reverse Merger, early stage

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clinical studies of our most advanced product candidate, OP-01. Subsequent to the completion of the Reverse Merger, we paused the OP-01 development program and began focusing substantially all of our resources on the advancement of our surfactant program (OP-02) for middle ear disease. Operations related to OP-02 include arranging for third party vendors to formulate and manufacture material using current Good Manufacturing Procedures (“cGMP”) and preparing for phase 1 clinical studies. We have not yet demonstrated our ability to successfully complete large-scale, pivotal clinical trials, obtain marketing approvals, manufacture a commercial scale product or arrange for a third party to do so on our behalf, or conduct sales and marketing activities necessary for successful product commercialization. It can take many years to develop a new medicine from the time it is discovered to when it is available for treating patients. Consequently, any predictions made about our future success or viability based on our short operating history to date may not be as accurate as they could be if we had a longer operating history.

In addition, as an early stage business, we may encounter unforeseen expenses, difficulties, complications, delays and other known and unknown factors. To successfully market any of our product candidates, we will need to transition from a company with a clinical development focus to a company capable of supporting commercial activities. We may not be successful in such a transition.

Drug development involves a lengthy and expensive process with an uncertain outcome, including failure to demonstrate safety and efficacy to the satisfaction of the FDA or similar regulatory authorities outside the United States. We may incur additional costs or experience delays in completing, or ultimately be unable to complete, the formulation and commercialization of our product candidates.

We have not manufactured a cGMP batch of OP-02 suitable for clinical trials. Formulation development for OP-02 is ongoing. Subject to successful completion of formulation development and manufacture of a cGMP batch, we expect to initiate a phase 1 clinical program in 2018.

Reformulation work for OP-01 to explore adding a second active ingredient (anesthetic) to address immediate relief of ear pain associated with Acute Otitis Externa (infection/inflammation of the outer ear canal) commenced in 2016, but was subsequently put on hold in 2017 until further funding is obtained. At such time as when we recommence development of OP-01, additional clinical studies with the new OP-01 combination formulation (antibiotic + anesthetic) will need to be conducted. There is a risk that additional nonclinical and/or clinical safety studies will be required by the FDA or similar regulatory authorities outside the United States and/or that subsequent studies will not match results seen in prior studies.

Given the early stage of development for both products, the risk of failure for both of our product candidates is high. Before obtaining marketing approval from regulatory authorities for the sale of any product candidate, we must complete formulation development for our products, conduct nonclinical trials, and then conduct extensive clinical trials to demonstrate the safety and efficacy of our product candidates in humans. Formulation development, nonclinical and clinical testing are all expensive activities, difficult to design and implement, and can take years to complete. The outcome of nonclinical and clinical trials is inherently uncertain. Failure can occur at any time during the development program, including during the clinical trial process. Further, the results of nonclinical studies and early clinical trials of our product candidates, as well as earlier generation formulations may not be predictive of the results of later-stage clinical trials. Interim results of a clinical trial do not necessarily predict final results. Moreover, nonclinical and clinical data are often susceptible to varying interpretations and analyses, and many companies that have believed their product candidates performed satisfactorily in nonclinical and clinical trials have nonetheless failed to obtain marketing approval of their products. It is impossible to predict when or if any of our product candidates will prove effective and safe in humans, or will receive regulatory approval.

We may experience delays in our clinical trials, and we do not know whether planned clinical trials will begin or enroll subjects on time, need to be redesigned or be completed on schedule, if at all. There can be no assurance that the FDA will not put any of our product candidates on clinical hold in the future. There is also no assurance that the European Medicines Agency (the “EMA”), the Medicines & Healthcare Products Regulatory/Agency (the “MHRA”), the UK regulatory authority or other regulatory agency and/or Investigational Review Board/Ethics Committee will allow a study with our product candidates to proceed. We may experience numerous unforeseen events during, or as a result of, clinical trials that could delay or prevent our ability to receive marketing approval or commercialize our product candidates. Clinical trials may be delayed, suspended or prematurely terminated for a variety of reasons, such as:

 

delay or failure in reaching agreement with the EMA, MHRA, FDA or a comparable foreign regulatory authority on a trial that we want to execute;

 

delay or failure in obtaining authorization to commence a trial or inability to comply with conditions imposed by a regulatory authority regarding the design of a clinical study;

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delays in reaching, or failure to reach, agreement on acceptable clinical trial contracts or clinical trial protocols with prospective trial sites;

 

delays or failure in completing formulation work as a prerequisite to commencing manufacture of clinical trial supplies;

 

inability, delay, or failure in identifying and maintaining a sufficient number of trial sites, many of which may already be engaged in other clinical programs;

 

delay or failure in recruiting and enrolling suitable subjects to participate in a trial;

 

delay or failure in having subjects complete a trial or return for post-treatment follow-up;

 

clinical sites and investigators deviating from trial protocol, failing to conduct the trial in accordance with regulatory requirements, or dropping out of a trial;

 

lack of adequate funding to continue the clinical trial, including the incurrence of unforeseen costs due to enrollment delays, requirements to conduct additional clinical studies and increased expenses associated with the services of our contract research organizations (“CROs”) and other third parties;

 

clinical trials of our product candidates may produce negative or inconclusive results, and we may decide, or regulators may require us, to conduct additional clinical trials or abandon product development programs;

 

the number of patients required for clinical trials of our product candidates may be larger than we anticipate, enrollment in these clinical trials may be slower than we anticipate, or participants may drop out of these clinical trials at a higher rate than we anticipate;

 

we may experience delays or difficulties in the enrollment of patients that our product candidates are designed to target;

 

our third-party contractors may fail to comply with regulatory requirements or meet their contractual obligations to us in a timely manner, or at all;

 

we may have difficulty partnering with experienced CROs and study sites that can identify patients that our product candidates are designed to target and run our clinical trials effectively;

 

regulators or institutional review boards (“IRBs”) may require that we or our investigators suspend or terminate clinical research for various reasons, including noncompliance with regulatory requirements or a finding that the participants are being exposed to unacceptable health risks;

 

the cost of clinical trials of our product candidates may be greater than we anticipate;

 

the supply or quality of our product candidates or other materials necessary to conduct clinical trials of our product candidates may be insufficient or inadequate; or

 

there may be changes in governmental regulations or administrative actions.

If we are required to conduct additional clinical trials or other testing of our product candidates beyond those that we currently contemplate, if we are unable to successfully complete clinical trials of our product candidates or other testing, if the results of these trials or tests are not positive or are only modestly positive, or if there are safety concerns, we may:

 

be delayed in obtaining marketing approval for our product candidates;

 

not obtain marketing approval at all;

 

obtain approval for indications or patient populations that are not as broad as intended or desired;

 

obtain approval with labeling that includes significant use or distribution restrictions or safety warnings that would reduce the potential market for our products or inhibit our ability to successfully commercialize our products;

 

be subject to additional post-marketing restrictions and/or testing requirements; or

 

have the product removed from the market after obtaining marketing approval.

Our product development costs will also increase if we experience delays in testing or marketing approvals. We do not know whether any of our nonclinical studies or clinical trials will need to be restructured or will be completed on schedule, or at all. Significant nonclinical or clinical trial delays also could shorten any periods during which we may have the exclusive

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right to commercialize our product candidates or may allow our competitors to bring products to market before we do and impair our ability to successfully commercialize our product candidates and may harm our business and results of operations.

If we experience delays or difficulties in the enrollment of patients in clinical trials, our receipt of necessary regulatory approvals could be delayed or prevented and expenses for the development of our product candidates could increase.

We may not be able to initiate or continue clinical trials for our product candidates if we are unable to locate and enroll a sufficient number of eligible patients to participate in these trials to demonstrate safety and efficacy. We have yet to initiate the first clinical studies of OP-02 and we do not know whether the planned clinical trials will enroll subjects in a timely fashion, require redesign of essential trial elements or be completed on its projected schedule. In addition, competitors may have ongoing clinical trials for product candidates that treat related or the same indications as our product candidates, and patients who would otherwise be eligible for our clinical trials may instead enroll in clinical trials of our competitors’ product candidates. Our inability to enroll a sufficient number of patients for our clinical trials would result in significant delays and could require us to abandon one or more clinical trials altogether.

Patient enrollment is affected by other factors including:

 

the eligibility criteria for the study in question;

 

the perceived risks and benefits of the product candidate under study;

 

the efforts to facilitate timely enrollment in clinical trials;

 

the inability to identify and maintain a sufficient number of trial sites, many of which may already be engaged in other clinical trial programs, including some that may be for the same disease indication;

 

seasonality of disease(s) being studied;

 

the patient referral practices of physicians;

 

the proximity and availability of clinical trial sites for prospective patients;

 

ambiguous or negative interim results of our clinical trials, or results that are inconsistent with earlier results;

 

feedback from regulatory authorities, IRBs, ethics committees (“ECs”), or data safety monitoring boards, or results from earlier stage or concurrent nonclinical and clinical studies, that might require modifications to the protocol;

 

decisions by regulatory authorities, IRBs, ECs, or the Company, or recommendations by data safety monitoring boards, to suspend or terminate clinical trials at any time for safety issues or for any other reason; and

 

unacceptable risk-benefit profile or unforeseen safety issues or adverse effects.

Enrollment delays in our clinical trials may result in increased development costs for our product candidates, which would cause the value of the Company to decline and limit our ability to obtain additional financing.

If serious adverse events or unacceptable side effects are identified during the development of our product candidates, we may need to abandon or limit our development of some of our product candidates.

If our product candidates are associated with undesirable effects in nonclinical or clinical trials or have characteristics that are unexpected, we may need to interrupt, delay or abandon their development or limit development to more narrow uses or subpopulations in which the undesirable side effects or other characteristics are less prevalent, less severe or more acceptable from a risk-benefit perspective. OP-02 has not been evaluated in any human clinical studies. OP-02 is an early product candidate, and the side effect profile in humans has not been fully established. Currently unknown, drug-related side effects may be identified through OP-02 clinical studies and, as such, these possible drug-related side effects could affect patient recruitment, the ability of enrolled subjects to complete the trial, or result in potential product liability claims. Future reformulation of OP-01 may result in a product with an unacceptable side effect profile. Any occurrences of clinically significant adverse events with our product candidates may harm our business, financial condition and prospects significantly.

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Risks Related to Our Financial Position and Need for Additional Capital

We will need substantial additional funding. If we are unable to raise capital when needed, we would be compelled to delay, reduce or eliminate our product development programs or commercialization efforts.

We expect our expenses to increase in parallel with our ongoing activities, particularly as we continue our nonclinical and clinical development, identify new clinical candidates and initiate clinical trials of, and seek marketing approval for, our product candidates. In addition, if we obtain marketing approval for any of our product candidates, we expect to incur significant commercialization expenses related to product sales, marketing, manufacturing and distribution. If we are unable to raise capital when needed or on attractive terms, we would be forced to delay, reduce or eliminate our nonclinical and clinical development programs or any future commercialization efforts.

Based upon current operating plans, we expect our current working capital will be sufficient to fund our operations for at least the next 12 months from the date of issuance of this report. We will require additional capital to complete the development and commercialization of OP-02 or other product candidates, and may also need to raise additional funds to pursue other development activities related to additional product candidates that we may develop. Our funding needs may fluctuate significantly based on a number of factors, such as:

 

the scope, progress, results and costs of formulation development and manufacture of drug product to support nonclinical and clinical development of our product candidates;

 

the extent to which we enter into additional collaboration arrangements regarding product discovery or development, or acquire or in-license products or technologies;

 

our ability to establish additional collaborations with favorable terms, if at all;

 

the costs, timing and outcome of regulatory review of our product candidates;

 

the costs of future commercialization activities, including product sales, marketing, manufacturing and distribution, for any of our product candidates for which we receive marketing approval;

 

revenue, if any, received from commercial sales of our product candidates, should any of our product candidates receive marketing approval; and

 

the costs of preparing, filing and prosecuting patent applications, maintaining and enforcing our intellectual property rights and defending intellectual property-related claims.

Identifying potential product candidates and conducting formulation development, nonclinical testing and clinical trials is a time-consuming, expensive and uncertain process that takes years to complete, and we may never generate the necessary data or results required to obtain marketing approval and achieve product sales. In addition, our product candidates, if approved, may not achieve commercial success. Our commercial revenues, if any, will be derived from sales of products that we do not expect to be commercially available for several years, if at all. Accordingly, we will need to continue to rely on additional financing to achieve our business objectives. Adequate additional financing may not be available to us on acceptable terms, or at all.

Raising additional capital may cause dilution to our stockholders, restrict our operations or require us to relinquish rights to our technologies or product candidates.

Until such time, if ever, as we can generate substantial product revenues, we expect to finance our cash needs through a combination of equity offerings and debt financings. We do not have any committed external source of funds. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of common stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of common stockholders. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends.

We cannot be certain that additional funding will be available on acceptable terms, or at all. If we are unable to raise additional funds when needed, we may be required to delay, limit, reduce or terminate our product development or future commercialization efforts.

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Future sales of shares by existing stockholders could cause the Company’s stock price to decline.

If existing stockholders of the Company sell, or indicate an intention to sell, substantial amounts of the Company’s common stock in the public market, the trading price of the common stock of the combined company could decline. At June 30, 2018, the Company had approximately 9.4 million shares of common stock outstanding.

The Share Purchase Agreement by and among Tokai, Otic, and stockholders of Otic contained a lock-up covenant from the Otic stockholders, which expired on November 5, 2017. The lock-up covenant prevented any Otic stockholder from offering, selling, or otherwise disposing of, directly or indirectly, any securities of the Company, or otherwise enter into a transaction that would have similar effect for 180 days following the closing of the Reverse Merger. Concurrent with the Reverse Merger, the company completed the Private Placement. A registration statement covering the resale of the shares of Company common stock issuable in connection with the Private Placement is in effect, allowing up to 400,400 shares of common stock to be sold in the public market. Further, as of November 7, 2017, shares held by directors, executive officers of the Company and other affiliates are eligible for sale in the public market, subject to volume limitations under Rule 144 under the Securities Act.

Because the Reverse Merger resulted in an ownership change under Section 382 of the Internal Revenue Code, for Tokai, Tokai’s pre-merger net operating loss carryforwards and certain other tax attributes are subject to limitations. The net operating loss carryforwards and other tax attributes of Otic and of the post-merger Company may also be subject to limitations as a result of ownership changes.

If a corporation undergoes an “ownership change” within the meaning of Section 382 of the Code, the corporation’s net operating loss carryforwards and certain other tax attributes arising from before the ownership change are subject to limitations on use after the ownership change. In general, an ownership change occurs if there is a cumulative change in the corporation’s equity ownership by certain stockholders that exceeds 50 percentage points over a rolling three-year period. Similar rules may apply under state tax laws. The Reverse Merger resulted in an ownership change for Tokai and, accordingly, Tokai’s net operating loss carryforwards and certain other tax attributes may be subject to limitations (or disallowance) on their use after the Reverse Merger. Otic’s net operating loss carryforwards may also be subject to limitation as a result of prior shifts in equity ownership and/or the transaction. Additional ownership changes in the future could result in additional limitations on Tokai’s, Otic’s and the post-merger Company’s net operating loss carryforwards. Consequently, even if the Company achieves profitability, it may not be able to utilize a material portion of Tokai’s, Otic’s, or the post-merger Company’s net operating loss carryforwards and other tax attributes, which could have a material adverse effect on cash flow and results of operations.

Risks Related to Regulatory Approval of Our Product Candidates and Other Legal Compliance Matters

If we are not able to obtain, or if there are delays in obtaining, required regulatory approvals, or the approvals may be for a narrow indication, we may not be able to commercialize our product candidates, and our ability to generate revenue may be materially impaired.

Our product candidates must be approved by the FDA pursuant to a new drug application in the United States and by other regulatory authorities outside the United States prior to commercialization. The process of obtaining marketing approvals, both in the United States and outside the United States, is expensive and takes several years, if approval is obtained at all, and can vary substantially based upon a variety of factors, including the type, complexity and novelty of the product candidates involved. Failure to obtain marketing approval for a product candidate will prevent us from commercializing the product candidate. We have not received approval to market any of our product candidates from regulatory authorities in any country. We have no experience in filing and supporting the applications necessary to gain marketing approvals for ear, nose, or throat (ENT) products and may engage third-party consultants to assist in this process. Securing marketing approval requires the submission of extensive nonclinical and clinical data, and other supporting information to regulatory authorities for each therapeutic indication to establish the product candidate’s safety and efficacy. Securing marketing approval also requires the submission of information about the product formulation and manufacturing process to, and inspection of manufacturing facilities by, the regulatory authorities. Our product candidates may not be effective, may be only moderately effective or may prove to have undesirable or unintended side effects, toxicities or other characteristics that may preclude our obtaining marketing approval or prevent or limit commercial use. Regulatory authorities have substantial discretion in the approval process and may refuse to accept any application or may decide that our data are insufficient for approval and require additional nonclinical, clinical or other data. In addition, varying interpretations of the data obtained from nonclinical and clinical studies could delay, limit or prevent marketing approval of a product candidate. Changes in marketing approval policies during the development period, changes in or the enactment of additional statutes or

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regulations, or changes in regulatory review for each submitted product application, may also cause delays in or prevent the approval of an application.

Any marketing approval we ultimately obtain may be for fewer or more limited indications than requested or subject to restrictions or post-approval commitments that render the approved product not commercially viable or its market potential significantly impaired. In addition, regulatory agencies may not approve the labeling claims that are necessary or desirable for the successful commercialization of our product candidates.

If we experience delays in obtaining approval or if we fail to obtain approval of our product candidates, the commercial prospects for our product candidates may be harmed and our ability to generate revenues will be materially impaired.

Failure to obtain marketing approval in international jurisdictions would prevent our product candidates from being marketed outside the United States.

In order to market and sell our products in the European Union and other international jurisdictions outside of the United States, we or our third-party collaborators must obtain separate marketing approvals and comply with numerous and varying regulatory requirements. The approval procedure varies among countries and may require additional nonclinical, clinical or health outcome data. In addition, the time required to obtain approval may differ substantially amongst international jurisdictions. The regulatory approval process outside the United States generally includes all the risks associated with obtaining FDA approval. In addition to regulatory approval, in many countries outside the United States, it is required that the product be approved for reimbursement before the product can be approved for sale in that country. We or these third parties may not obtain approvals from regulatory authorities outside the United States on a timely basis, if at all. Approval by the EMA, MHRA, or FDA does not ensure approval by regulatory authorities in other countries or jurisdictions, and approval by one regulatory authority outside the United States does not ensure approval by regulatory authorities in other countries or jurisdictions or by the FDA. We may not be able to file for marketing approvals and may not receive necessary approvals to commercialize our products in any market.

Any product candidate for which we obtain marketing approval will be subject to extensive post-marketing regulatory requirements and could be subject to post-marketing restrictions or withdrawal from the market, and we may be subject to penalties if we fail to comply with regulatory requirements or if we experience unanticipated problems with our products, when and if any of them are approved.

Our product candidates and the activities associated with their development and commercialization, including their testing, manufacture, recordkeeping, labeling, storage, approval, advertising, promotion, sale and distribution, are subject to comprehensive regulation that are specific to those defined by regulatory authorities in the countries where the product is approved. In the United States and other countries that follow the International Conference on Harmonization (ICH), these requirements include submissions of safety and other post-marketing information and reports, registration and listing requirements, cGMP requirements relating to manufacturing, quality control, quality assurance and corresponding maintenance of records and documents, including periodic inspections by the FDA and other regulatory authorities, requirements regarding the distribution of samples to physicians and recordkeeping.

The FDA, or other regulatory authorities, may also impose requirements for costly post-marketing studies or clinical trials and surveillance to monitor the safety or efficacy of the product. The FDA closely regulates the post-approval marketing and promotion of drugs to ensure drugs are marketed only for the approved indications and in accordance with the provisions of the approved labeling. The FDA imposes stringent restrictions on manufacturers’ communications regarding use of their products and if we promote our products beyond their approved indications, we may be subject to enforcement action for off-label promotion. Violations of the federal Food, Drug, and Cosmetic Act relating to the promotion of prescription drugs may lead to investigations alleging violations of federal and state healthcare fraud and abuse laws, as well as state consumer protection laws.

In addition, later discovery of previously unknown adverse events or other problems with our products, manufacturers or manufacturing processes, or failure to comply with regulatory requirements, may yield various results, including:

 

restrictions on such products, manufacturers or manufacturing processes;

 

restrictions on the labeling or marketing of a product;

 

restrictions on product distribution or use;

 

requirements to conduct post-marketing studies or clinical trials;

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warning or untitled letters;

 

withdrawal of the products from the market;

 

refusal to approve pending applications or supplements to approved applications that we submit;

 

recall of products;

 

fines, restitution or disgorgement of profits or revenues;

 

suspension or withdrawal of marketing approvals;

 

refusal to permit the import or export of our products;

 

product seizure; or

 

injunctions or the imposition of civil or criminal penalties.

Non-compliance with European Union requirements regarding safety monitoring or pharmacovigilance, and with requirements related to the development of products for the pediatric population, can also result in significant financial penalties. Similarly, failure to comply with the European Union’s requirements regarding the protection of personal information can also lead to significant penalties and sanctions.

Recently enacted and future legislation may increase the difficulty and cost for us to obtain marketing approval of and commercialize our product candidates and affect the prices we may obtain.

In the United States and some foreign jurisdictions, there have been a number of legislative and regulatory changes and proposed changes regarding the healthcare system that could prevent or delay marketing approval of our product candidates, restrict or regulate post-approval activities and affect our ability to profitably sell any product candidates for which we obtain marketing approval.

For example, in 2010, President Obama signed into law the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act (collectively, the “PPACA”). Among the provisions of the PPACA of importance to our potential product candidates are the following:

 

an annual, nondeductible fee on any entity that manufactures or imports specified branded prescription drugs and biologic agents;

 

an increase in the statutory minimum rebates a manufacturer must pay under the Medicaid Drug Rebate Program;

 

expansion of healthcare fraud and abuse laws, including the False Claims Act and the Anti-Kickback Statute, new government investigative powers, and enhanced penalties for noncompliance;

 

a new Medicare Part D coverage gap discount program, in which manufacturers must agree to offer 50% point-of-sale discounts off negotiated prices;

 

extension of manufacturers’ Medicaid rebate liability;

 

expansion of eligibility criteria for Medicaid programs;

 

expansion of the entities eligible for discounts under the Public Health Service pharmaceutical pricing program;

 

new requirements to report financial arrangements with physicians and teaching hospitals;

 

a new requirement to annually report drug samples that manufacturers and distributors provide to physicians; and

 

a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in, and conduct comparative clinical effectiveness research, along with funding for such research.

In addition, other legislative changes have been proposed and adopted since the PPACA was enacted. These changes included aggregate reductions to Medicare payments to providers of up to 2% per fiscal year, starting in 2013. In January 2013, President Obama signed into law the American Taxpayer Relief Act of 2012, which, among other things, reduced Medicare payments to several providers, and increased the statute of limitations period for the government to recover overpayments to providers from three to five years. Further, under the current Trump administration there may be additional regulatory changes, as well as the potential repeal (in whole or in part) of the PPACA, that could negatively affect insurance coverage and/or drug prices. Any such new laws may result in additional reductions in Medicare and other healthcare funding.

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We expect that the PPACA, as well as other healthcare reform measures that may be adopted in the future, may result in more rigorous coverage criteria and in additional downward pressure on the price that we receive for any approved product. Any reduction in reimbursement from Medicare or other government programs may result in a similar reduction in payments from private payers. The implementation of cost containment measures or other healthcare reforms may prevent us from being able to generate revenue, attain profitability, or commercialize our products.

Legislative and regulatory proposals have been made to expand post-approval requirements and restrict sales and promotional activities for pharmaceutical products. Additionally, legislation has been introduced to repeal the PPACA. We cannot be sure whether additional legislative changes will be enacted, or whether the FDA regulations, guidance or interpretations will be changed, or what the impact of such changes on the marketing approvals of our product candidates, if any, may be. In addition, increased scrutiny by the U.S. Congress of the FDA’s approval process may significantly delay or prevent marketing approval, as well as subject us to more stringent product labeling and post-marketing testing and other requirements.

Laws, restrictions, and other regulatory measures are also imposed by healthcare laws and regulations in international jurisdictions and in those jurisdictions we face the same issues as in the United State regarding difficulty and cost for us to obtain marketing approval and commercialization of our product candidates and which may affect the prices we may obtain.

Governments outside the United States tend to impose strict price controls, which may adversely affect our revenues, if any.

In some countries, particularly the countries of the European Union, the pricing of prescription pharmaceuticals is subject to governmental control. In these countries, pricing negotiations with governmental authorities can take considerable time after the receipt of marketing approval for a product. To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of our product candidate to other available therapies. If reimbursement of our products is unavailable or limited in scope or amount, or if pricing is set at unsatisfactory levels, our business could be harmed, possibly materially.

Our relationships with customers and third-party payers will be subject to applicable anti-kickback, fraud and abuse and other healthcare laws and regulations, which could expose us to criminal sanctions, civil penalties, program exclusion, contractual damages, reputational harm and diminished profits and future earnings.

Healthcare providers, physicians and third-party payers play a primary role in the recommendation and prescription of any product candidates for which we receive marketing approval. Our future arrangements with third-party payers and customers may expose us to broadly applicable fraud and abuse and other healthcare laws and regulations that may constrain the business or financial arrangements and relationships through which we market, sell and distribute the products for which we receive marketing approval. Restrictions under applicable federal and state healthcare laws and regulations include the following:

 

the federal healthcare anti-kickback statute prohibits, among other things, persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in cash or in kind, to induce or reward either the referral of an individual for, or the purchase, order or recommendation of, any good or service, for which payment may be made under federal and state healthcare programs such as Medicare and Medicaid;

 

the federal False Claims Act imposes civil penalties, including civil whistleblower or qui tam actions, against individuals or entities for knowingly presenting, or causing to be presented, to the federal government, claims for payment that are false or fraudulent or making a false statement to avoid, decrease or conceal an obligation to pay money to the federal government;

 

the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act, imposes criminal and civil liability for executing a scheme to defraud any healthcare benefit program and also imposes obligations, including mandatory contractual terms, with respect to safeguarding the privacy, security and transmission of individually identifiable health information;

 

the federal false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false statement in connection with the delivery of or payment for healthcare benefits, items or services;

 

the federal transparency requirements under the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, require manufacturers of covered drugs, devices,

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biologics and medical supplies to report to the Department of Health and Human Services information related to physician payments and other transfers of value and physician ownership and investment interests; and

 

analogous state laws and regulations, such as state anti-kickback and false claims laws, may apply to sales or marketing arrangements and claims involving healthcare items or services reimbursed by non-governmental third-party payers, including private insurers, and some state laws require pharmaceutical companies to comply with the pharmaceutical industry’s voluntary compliance guidelines and the relevant compliance guidance promulgated by the federal government in addition to requiring drug manufacturers to report information related to payments to physicians and other healthcare providers or marketing expenditures.

Some state laws require pharmaceutical companies to comply with the pharmaceutical industry’s voluntary compliance guidelines and the relevant compliance guidance promulgated by the federal government and may require drug manufacturers to report information related to payments and other transfers of value to physicians and other healthcare providers or marketing expenditures. State and foreign laws also govern the privacy and security of health information in some circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.

Efforts to ensure that our business arrangements with third parties will comply with applicable healthcare laws and regulations will involve substantial costs. It is possible that governmental authorities will conclude that our business practices may not comply with current or future statutes, regulations or case law involving applicable fraud and abuse or other healthcare laws and regulations. If our operations are found to be in violation of any of these laws or any other governmental regulations that may apply to us, we may be subject to significant civil, criminal and administrative penalties, damages, fines, exclusion from government funded healthcare programs, such as Medicare and Medicaid, and the curtailment or restructuring of our operations. If any of the physicians or other providers or entities with whom we expect to do business are found to be not in compliance with applicable laws, they may be subject to criminal, civil or administrative sanctions, including exclusions from government funded healthcare programs.

Laws, restrictions, and other regulatory measures are also imposed by anti-kickback, fraud and abuse, and other healthcare laws and regulations in international jurisdictions and in those jurisdictions we face the same issues as in the United State regarding exposure to criminal sanctions, civil penalties, program exclusion, contractual damages, reputational harm, and diminished profits and future earnings.

If we fail to comply with environmental, health and safety laws and regulations, we could become subject to fines or penalties or incur costs that could harm our business.

We may incur substantial costs in order to comply with current or future environmental, health and safety laws and regulations. These current or future laws and regulations may impair our nonclinical or clinical development or production efforts. Our failure to comply with these laws and regulations also may result in substantial fines, penalties or other sanctions.

Risks Related to the Commercialization of Our Product Candidates

Even if any of our product candidates receives marketing approval, we may fail to achieve the degree of market acceptance by physicians, patients, third-party payers and others in the medical community necessary for commercial success.

If any of our product candidates receives marketing approval, we may nonetheless fail to gain sufficient market acceptance by physicians, patients, third-party payers and others in the medical community. In addition, physicians, patients and third-party payers may prefer other novel products to ours. If our product candidates do not achieve an adequate level of acceptance, we may not generate significant product revenues and we may not become profitable. The degree of market acceptance of our product candidates, if approved for commercial sale, will depend on a number of factors, including:

 

the efficacy and safety and potential advantages and disadvantages compared to alternative treatments;

 

the ability to offer our products for sale at competitive prices;

 

the convenience and ease of administration compared to alternative treatments;

 

the willingness of the target patient population to try new therapies and of physicians to prescribe these therapies;

 

the strength of our marketing and distribution support;

 

the availability of third-party coverage and adequate reimbursement, including patient cost-sharing programs such as copays and deductibles;

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the ability to develop or partner with third-party collaborators to develop companion diagnostics;

 

the prevalence and severity of any side effects; and

 

any restrictions on the use of our products together with other medications.

If our current product candidates, or a future product candidate receives marketing approval and we, or others, later discover that the product is less effective than previously believed or causes undesirable side effects that were not previously identified, the ability to market the product could be compromised.

Clinical trials are conducted in carefully defined subsets of patients who have agreed to enter into clinical trials. Consequently, it is possible that our clinical trials may indicate an apparent beneficial effect of a product candidate that is greater than the actual positive effect in a broader patient population or alternatively fail to identify undesirable side effects. If, following approval of a product candidate, we, or others, discover that the product is less effective than previously believed or causes undesirable side effects that were not previously identified, any of the following events could occur:

 

regulatory authorities may withdraw their approval of the product or seize the product;

 

the product may be required to be recalled or changes may be required to the way the product is administered;

 

additional restrictions may be imposed on the marketing of, or the manufacturing processes for, the product;

 

regulatory authorities may require the addition of labeling statements, such as a “black box” warning or a contraindication;

 

the creation of a Medication Guide outlining the risks of the previously unidentified side effects for
distribution to patients;

 

additional restrictions may be imposed on the distribution or use of the product via a Risk Evaluation and Mitigation Strategy;

 

we could be sued and held liable for harm caused to patients;

 

the product may become less competitive; and

 

our reputation may suffer.

Any of these events could have a material and adverse effect on our operations and business. The commercial prospects for our product candidates may be harmed and our ability to generate revenues will be materially impaired.

We currently have no marketing and sales force. If we are unable to establish effective marketing and sales capabilities or enter into agreements with third parties to market and sell our product candidates, we may not be able to effectively market and sell our product candidates, if approved, or generate product revenues.

We currently do not have a marketing or sales team for the marketing, sales and distribution of any of our product candidates that are able to obtain regulatory approval. In order to commercialize any product candidates, we must build on a territory-by-territory basis marketing, sales, distribution, managerial and other non-technical capabilities or make arrangements with third parties to perform these services, and we may not be successful in doing so. If our product candidates receive regulatory approval, we intend to establish an internal sales and marketing team with technical expertise and supporting distribution capabilities to commercialize our product candidates, which will be expensive and time-consuming, will require significant attention of our executive officers to manage and may nonetheless fail to effectively market and sell our product candidates. Any failure or delay in the development of our internal sales, marketing and distribution capabilities would adversely impact the commercialization of any of our products that we obtain approval to market. With respect to the commercialization of all or certain of our product candidates, we may choose to collaborate, either globally or on a territory-by-territory basis, with third parties that have direct sales forces and established distribution systems, either to augment our own sales force and distribution systems or in lieu of our own sales force and distribution systems. If we are unable to enter into such arrangements when needed on acceptable terms or at all, we may not be able to successfully commercialize any of our product candidates that receive regulatory approval or any such commercialization may experience delays or limitations. If we are not successful in commercializing our product candidates, either on our own or through collaborations with one or more third parties, our future product revenue will suffer and we may incur significant additional losses.

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We face substantial competition, which may result in others discovering, developing or commercializing competing products before or more successfully than we do.

The development and commercialization of new drug products is highly competitive. We face competition with respect to our current product candidates, and will face competition with respect to any product candidates that we may seek to develop or commercialize in the future, from major pharmaceutical companies, specialty pharmaceutical companies and biotechnology companies worldwide. There are a number of large pharmaceutical and biotechnology companies that currently market and sell products or are pursuing the development of products for the treatment of the disease indications for which we are developing our product candidates. Some of these competitive products and therapies are based on scientific approaches that are the same as or similar to our approach, and others are based on entirely different approaches. Potential competitors also include academic institutions, government agencies and other public and private research organizations that conduct research, seek patent protection and establish collaborative arrangements for research, development, manufacturing and commercialization.

In OM, there are currently no drug therapies approved for the treatment or prevention of OM. We expect that OP-02 will compete primarily with a surgery where the tympanic membrane is perforated to improve drainage and ventilation of the middle ear (myringotomy or tympanostomy tube insertions) as a means of preventing recurrent or chronic OM. We may also compete with a medical device that uses a small intranasal balloon inserted into the Eustachian tube to facilitate ventilation of the Eustachian tube in patients with Eustachian tube dysfunction of a particular type. Surgery may continue to be the preferred treatment for OM in children whereas the intranasal balloon may be the preferred treatment for Eustachian tube dysfunction in adults. Patients may be prescribed concurrent antibiotic therapy for acute OM, but these products will not be competitive with, but likely used in conjunction with OP-02.

Specifically, there are a number of companies developing or marketing treatments for AOE, including many major pharmaceutical and biotechnology companies. We expect that OP-01 will face competition from numerous FDA-approved therapeutics, including CIPRODEX® and numerous other branded and generic ear anti-infectives.

Our commercial opportunity could be reduced or eliminated if our competitors develop and commercialize products that are safer, more effective, have fewer or less severe side effects, are more convenient or are less expensive than any products that we may develop. In addition, our ability to compete may be affected in many cases by insurers or other third-party payers seeking to encourage the use of generic products.

Generic products are currently available, with additional products expected to become available over the coming years, potentially creating pricing pressure. If our product candidates achieve marketing approval, we expect that they will be priced at a significant premium over competitive generic products.

Many of the companies against which we are competing or against which we may compete in the future have significantly greater financial resources and expertise in research and development, manufacturing, conducting nonclinical studies, conducting clinical trials, obtaining regulatory approvals and marketing approved products than we do. Mergers and acquisitions in the pharmaceutical and biotechnology industries may result in even more resources being concentrated among a smaller number of our competitors. Smaller and other early stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. These third parties compete with us in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient registration for clinical trials, as well as in acquiring technologies complementary to, or necessary for, our programs.

The insurance coverage and reimbursement status of newly approved products is uncertain. Failure to obtain or maintain adequate coverage and reimbursement for new or current products could limit our ability to market those products and decrease our ability to generate revenue.

The availability and extent of reimbursement by governmental and private payers is essential for most patients to be able to afford expensive treatments. Sales of our product candidates will depend substantially, both domestically and internationally, on the extent to which the costs of our product candidates will be paid by health maintenance, managed care, pharmacy benefit and similar healthcare management organizations, or reimbursed by government health administration authorities, private health coverage insurers and other third-party payers. If reimbursement is not available, or is available only to limited levels, we may not be able to successfully commercialize our product candidates. Even if coverage is provided, the approved reimbursement amount may not be high enough to allow us to establish or maintain pricing sufficient to realize a sufficient return on our investment.

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There is significant uncertainty related to the insurance coverage and reimbursement of newly approved products. In the United States, the principal decisions about reimbursement for new medicines are typically made by the Centers for Medicare & Medicaid Services (“CMS”), an agency within the U.S. Department of Health and Human Services, as CMS decides whether and to what extent a new medicine will be covered and reimbursed under Medicare. Private payers tend to follow CMS to a substantial degree. It is difficult to predict what CMS will decide with respect to reimbursement for fundamentally novel products such as ours, as there is no body of established practices and precedents for these new products. Reimbursement agencies in Europe may be more conservative than CMS. Outside the United States, international operations are generally subject to extensive governmental price controls and other market regulations, and we believe the increasing emphasis on cost-containment initiatives in Europe, Canada, and other countries has and will continue to put pressure on the pricing and usage of our product candidates. In many countries, the prices of medical products are subject to varying price control mechanisms as part of national health systems. In general, the prices of medicines under such systems are substantially lower than in the United States. Other countries allow companies to fix their own prices for medicines, but monitor and control company profits. Additional foreign price controls or other changes in pricing regulation could restrict the amount that we are able to charge for our product candidates. Accordingly, in markets outside the United States, the reimbursement for our products may be reduced compared with the United States and may be insufficient to generate commercially reasonable revenues and profits.

Moreover, increasing efforts by governmental and third-party payers, in the United States and internationally, to cap or reduce healthcare costs may cause such organizations to limit both coverage and level of reimbursement for new products approved and, as a result, they may not cover or provide adequate payment for our product candidates. Increased expense is incurred to cover costs of health outcome focused research used to generate data necessary to justify the value of our products in order to secure reimbursement. We expect to experience pricing pressures in connection with the sale of any of our product candidates, due to the trend toward managed healthcare, the increasing influence of health maintenance organizations and additional legislative changes. The downward pressure on healthcare costs in general, particularly prescription drugs and surgical procedures and other treatments, has become very intense. As a result, increasingly high barriers are being erected to the entry of new products into the healthcare market.

In addition, many private payers contract with commercial vendors who sell software that provide guidelines that attempt to limit utilization of, and therefore reimbursement for, certain products deemed to provide limited benefit to existing alternatives. Such organizations may set guidelines that limit reimbursement or utilization of our products.

Product liability lawsuits against us could cause us to incur substantial liabilities and to limit commercialization of any products that we may develop.

We face an inherent risk of product liability exposure related to the testing of our product candidates in human clinical trials and will face an even greater risk if we commercially sell any products that we may develop. If we cannot successfully defend against claims that our product candidates or products caused injuries, we will incur substantial liabilities. Regardless of merit or eventual outcome, liability claims may result in:

 

decreased demand for any product candidates or products that we may develop;

 

injury to our reputation and significant negative media attention;

 

withdrawal of clinical trial participants;

 

significant costs to defend the related litigation;

 

substantial monetary awards to trial participants or patients;

 

loss of revenue;

 

reduced resources of our management to pursue our business strategy; and

 

the inability to commercialize any products that we may develop.

We currently hold $2 million in product liability insurance coverage in the aggregate, with a per incident limit of $2 million, which may not be adequate to cover all liabilities that we may incur. We may need to increase our insurance coverage as we expand our clinical trials or if we commence commercialization of our product candidates. Insurance coverage is increasingly expensive. We may not be able to maintain insurance coverage at a reasonable cost or in an amount adequate to satisfy any liability that may arise.

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Risks Related to Our Dependence on Third Parties

Future development collaborations may be important to us. If we are unable to enter into or maintain these collaborations, or if these collaborations are not successful, our business could be adversely affected.

For some of our product candidates, we may in the future determine to seek to collaborate with pharmaceutical and biotechnology companies for development or commercialization of our product candidates. We face significant competition in seeking appropriate collaborators. Our ability to reach a definitive agreement for any collaboration will depend, among other things, upon our assessment of the collaborator’s resources and expertise, the terms and conditions of the proposed collaboration and the proposed collaborator’s evaluation of a number of factors. If we are unable to reach agreements with suitable collaborators on a timely basis, on acceptable terms, or at all, we may have to curtail the development of a product candidate, reduce or delay its development program or one or more of our other development programs, delay its potential development schedule or reduce the scope of research activities, or increase our expenditures and undertake discovery or nonclinical development activities at our own expense. If we fail to enter into collaborations and do not have sufficient funds or expertise to undertake the necessary development activities, we may not be able to further develop our product candidates or continue to develop our product candidates, and our business may be materially and adversely affected.

Future collaborations we may enter into may involve the following risks:

 

collaborators may have significant discretion in determining the efforts and resources that they will apply to these collaborations;

 

collaborators may not perform their obligations as expected;