The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes, and the other financial information included in this Annual Report on Form 10-K.
This Form 10-K contains forward-looking statements. The words "anticipated," "believe," "expect," "plan," "intend," "seek," "estimate," "project," "could," "may," and similar expressions are intended to identify forward-looking statements. These statements include, among others, information regarding future operations, future capital expenditures, and future net cash flow. Such statements reflect our management's current views with respect to future events and financial performance and involve risks and uncertainties, including, without limitation, our ability to raise additional capital to fund our operations, obtaining
FDAand other regulatory authorization to market our drug and biological products, successful completion of our clinical trials, our ability to achieve regulatory authorization to market our L-glutamine treatment for SCD, our ability to commercialize our L-glutamine treatment for SCD; our reliance on third party manufacturers for our drug products, market acceptance of our products, our dependence on licenses for certain of our products, our reliance on the expected growth in demand for our products, exposure to product liability and defect claims, development of a public trading market for our securities, and various other matters, many of which are beyond our control. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove to be incorrect, actual results may vary materially and adversely from those anticipated, believed, estimated or otherwise indicated. Consequently, all of the forward-looking statements made in this Form 10-K are qualified by these cautionary statements and accordingly there can be no assurances made with respect to the actual results or developments.
We are a biopharmaceutical company engaged in the discovery, development and commercialization of innovative treatments and therapies primarily for rare and orphan diseases. We 60
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are initially focusing our drug development efforts on sickle cell disease, or SCD, a genetic disorder. Our lead product candidate is an oral pharmaceutical grade L-glutamine treatment that demonstrated positive clinical results in our completed Phase 3 clinical trial for sickle cell anemia and sickle ß0-thalassemia, two of the most common forms of SCD. Recently, we obtained positive efficacy results from a 230 patient randomized, double-blind, placebo-controlled, parallel-group, multi-center Phase 3 clinical trial which enrolled adult and pediatric patients, as young as five years of age, across 31 sites in
the United States. Top-line data revealed a statistically significant 25% reduction in the median frequency of sickle cell crises (p=0.008) and a 33% reduction in the median frequency of hospitalizations (p=0.018), both over a 48-week time period. We intend to submit a New Drug Application, or NDA, to the U.S. Food and Drug Administration, or FDA, to demonstrate substantial evidence of effectiveness and a well-tolerated safety profile, which are regulatory criteria for approval, of our product candidate for the treatment of SCD in both adult and pediatric patients as young as five years of age. We intend to include the results of this Phase 3 clinical trial in our submission to the FDAof a NDA for our L-glutamine product for the treatment of SCD. The FDAgenerally requires that NDAs include the results of two Phase 3 clinical trials to demonstrate substantial evidence of the effectiveness of a drug. The FDAhas in some cases accepted evidence from one clinical study to support a finding of substantial evidence of effectiveness. A change in the law under the Modernization Act made clear that the FDAmay consider data from only one adequate and well-controlled clinical investigation and confirmatory evidence if the FDAdetermines that such evidence is sufficient to establish effectiveness. In a guidance document titled "Providing Clinical Evidence of Effectiveness for Human Drug and Biological Products" ( May 1998), the FDAstated that reliance on a single study is generally limited to situations in which a trial has demonstrated a clinically meaningful effect on mortality, irreversible morbidity, or prevention of a disease with a potential serious outcome, and where confirmation of the result in a second trial would be impractical or unethical. We believe a second study of an orphan drug to treat a rare condition, such as SCD, would not be required if the single study satisfies the factors the FDAtakes into consideration. The factors the FDAconsiders for accepting a single study include, but are not limited to, having large multi-centered studies, consistent data across subgroups, multiple endpoints, and statistically very persuasive findings. Our single Phase 3 clinical trial was multi-centered with multiple endpoints, and we believe the final results will be consistent across subgroups and statistically very persuasive to the FDA. However, there can be no assurance that the FDAwill accept this single study as sufficient to demonstrate substantial evidence of effectiveness. To a lesser extent, we are also engaged in the marketing and sale of NutreStore L-glutamine powder for oral solution, which has received FDAapproval, as a treatment for Short Bowel Syndrome, or SBS, in patients receiving specialized nutritional support when used in conjunction with a recombinant human growth hormone that is approved for this indication. Our indirect wholly owned subsidiary, Newfield Nutrition Corporation, sells L-glutamine as a nutritional supplement under the brand name AminoPure through retail stores in multiple states and via importers and distributors in Japan, Taiwanand South Korea. Since inception, we have generated minimal revenues from the sale and promotion of NutreStore and AminoPure. Prior to the fourth quarter of 2013, the Company considered itself a Development Stage Entity in accordance with Accounting Standards Codification (ASC) 915, Development Stage Entities, as defined by the Financial Accounting Standards Board(FASB). In the fourth quarter of 2013, the Company reassessed its status as a development stage entity. The Company had substantially completed development of its primary product and completed development of an initial business infrastructure in the fourth quarter of 2013. Therefore, the Company has determined that it is no longer a development stage enterprise, commencing principal operations during the fourth quarter of fiscal 2013. As a result of this change in reporting status, the Company has removed from its financial statements all 'cumulative since inception' financial information that is required by ASC 915. 61
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October 2010, we formed Emmaus Medical Japan, Inc., referred to as "EM Japan", a wholly-owned subsidiary of Emmaus Medical, Inc., that markets and sells AminoPure in Japanand other countries in Asia. EM Japanalso manages our distributors in Japanand may also import other medical products and drugs in the future. In November 2011, we formed Emmaus Medical Europe, Ltd., referred to as "EM Europe", a wholly-owned subsidiary of Emmaus Medical, Inc., whose primary focus is expanding our business in Europe. Our corporate structure is illustrated as follows: [[Image Removed: GRAPHIC]]
Pursuant to an Agreement and Plan of Merger dated
April 21, 2011, which we refer to as the Merger Agreement, by and among us, AFH Merger Sub, Inc., our wholly-owned subsidiary, which we refer to as AFH Merger Sub, AFH Advisory and Emmaus Medical, Emmaus Medical merged with and into AFH Merger Sub on May 3, 2011with Emmaus Medical continuing as the surviving entity, which we refer to as the Merger. Upon the closing of the Merger, we changed our name from " AFH Acquisition IV, Inc." to " Emmaus Holdings, Inc." Subsequently, on September 14, 2011, we changed our name from " Emmaus Holdings, Inc." to " Emmaus Life Sciences, Inc." Our future capital requirements are substantial and may increase beyond our current expectations depending on many factors, including, but not limited to: the duration and results of the clinical trials for our various products going forward; unexpected delays or developments when seeking regulatory approvals; the time and cost in preparing, filing, prosecuting, maintaining and enforcing patent claims; current and future unexpected developments encountered in implementing our business development and commercialization strategies; the outcome of litigation; and further arrangements, if any, with collaborators. Until we can generate a sufficient amount of product revenue, future cash requirements are expected to be financed through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements. As of December 31, 2013, our accumulated deficit is $49.8 millionand we had cash and cash equivalents of $3.6 million. Since inception we have had minimal revenues and have been required to rely on funding from sales of equity securities and borrowings from officers and stockholders. Currently, we estimate we will need approximately 62
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We also own a minority interest of less than 1% in CellSeed, Inc., a Japanese company listed on the
Tokyo Stock Exchange, which is engaged in research and development of regenerative medicine products and the manufacture and sale of temperature-responsive cell culture equipment. In collaboration with CellSeed, we are engaged in research and development of cell sheet engineering regenerative medicine products and the future commercialization of such products. Financial Overview Revenue Since our inception in 2000, we have had limited revenue from the sale of NutreStore, an FDAapproved prescription drug to treat short bowel syndrome, or SBS, and AminoPure, a nutritional supplement. We have funded operations principally through the private placement of equity securities and debt financings. Emmaus Medical's operations to date have been primarily limited to staffing, licensing and promoting products for SBS, outsourcing distribution and sales activities, developing clinical trials for sickle cell treatment, manufacturing products and maintaining and improving its patent portfolio. Currently, we generate revenue through the sale of NutreStore L-glutamine powder for oral solution as a treatment for SBS as well as AminoPure, a nutritional supplement. Pursuant to the sublicense agreement for the SBS Patent, we are required to pay an annual royalty equal to 10% of adjusted gross sales of NutreStore to CATO Holding Company, or Cato. We made royalty payments to Cato in the amount of $855in May 2012and $6,870in October 2013. Management expects that any revenues generated from the sale of NutreStore and AminoPure will fluctuate from quarter to quarter based on the timing of orders and the amount of product sold. Cost of Sales
Cost of sales includes the raw materials, packaging, shipping and distribution costs of NutreStore and AminoPure.
Research and Development Expenses
Research and development costs consist of expenditures for new products and technologies, which primarily involve fees paid to the contract research organization, or CRO, payroll-related expenses, study site payments, consultant fees, and activities related to regulatory filings, manufacturing development costs and other related supplies. Product candidates, as they move from preclinical studies to clinical studies, generally have higher development costs particularly in the later stage clinical studies, such as Phase 2 and 3 trials, as compared to those in earlier stages of development, such as preclinical studies and Phase 1 trials. This is primarily due to the increased size, expanded scope and generally longer duration of later stage clinical studies. The most significant clinical trial expenditures are related to the CRO costs and the payments to study sites. The contract with the CRO is based on time and material expended, whereas the study site agreements are based on per patient costs as well as other pass-through costs, including, but not limited to, start-up costs and institutional review board fees. The financial terms of these agreements are subject to negotiation and vary from contract to contract and may result in uneven payment flows. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones. Future research and development expenses will depend on any new products or technologies that may be introduced in the pipeline. In addition, we cannot forecast with any degree of certainty which product candidate(s) may be subject to future collaborations, when such arrangements will be secured, 63
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if at all, and to what degree, if any, such arrangements would affect our development plans and capital requirements. We currently estimate that we will need an additional
$2.0 millionto administratively close out the post-clinical aspects of our Phase 3 clinical trial and submit a NDA to the FDA. Our current cash burn rate is approximately $0.7 millionper month. We estimate that the cost to us to develop products based on corneal cell sheet technology in the United Stateswill be approximately $3.0 million, in addition to the $8.5 millionfee payable to CellSeed under the Research Agreement. This estimate includes the anticipated cost of obtaining FDAapproval for the corneal cell sheets and assumes that we will need the FDAto approve a BLA for the corneal cell sheets, rather than a NDA. We estimate that we will need another $2.0 millionto commercialize any approved products based on corneal cell sheet technology. In addition, we estimate that we will need $2.5 millionfor research related to other cell sheet applications and to build a cGMP laboratory to establish the infrastructure and production capabilities related to regenerative medicine products. At this time, no research and development costs are associated with NutreStore and AminoPure. At this time, due to the inherently unpredictable nature of the drug development and regulatory approval processes, we are unable to estimate with any degree of certainty the amount of costs which will be incurred for clinical programs. Clinical development timelines, the probability of success and development costs can differ materially from expectations and can vary widely. These and other risks and uncertainties relating to product development are described in this Annual Report on Form 10-K under the headings "Risk Factors-Risks Related To Development Of Our Product Candidates," "Risk Factors-Risks Related to our Reliance on Third Parties," and "Risk Factors-Risks Related To Regulatory Approval Of Our Drug Candidates And Other Legal Compliance Matters."
General and Administrative Expenses
General and administrative expenses consist principally of salaries and related costs for personnel in executive, finance, business development, information technology, marketing, and legal functions. Other general and administrative expenses include share-based compensation, facility costs, patent filing costs, and professional fees for legal, consulting, auditing and tax services. Inflation has not had a material impact on our general and administrative expenses over the past two years.
The cost of compliance with environmental laws has not been material over the past two years and any such costs are included in general and administrative costs. Inventories Inventories consist of finished goods and work-in-process and are valued based on a first-in, first-out basis and at the lower of cost or market value. All of the purchases during the year ended
December 31, 2013were from two vendors and during 2012 were from one vendor.
Critical Accounting Policies
Management's discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in
the United States, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses. On an ongoing basis, we evaluate these estimates and judgments, including those described below. We base our estimates on our historical experience and on various other assumptions that we believe to be reasonable under the present circumstances. These estimates and assumptions form the basis for 64
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making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates. While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements which is provided at the end of this Form 10-K, we believe that the following accounting policies are the most critical to assist you in fully understanding and evaluating our reported financial results and affect the more significant judgments and estimates that we use in the preparation of our financial statements.
Notes Payable, Convertible Notes Payable and Warrants
From time to time, we obtain financing in the form of notes payable and/or notes with detachable warrants, some of which are convertible into shares of our common stock and some of which are issued to related parties. We analyze all of the terms of our convertible notes and related detachable warrants to determine the appropriate accounting treatment, including determining whether conversion features are required to be bifurcated and treated as derivative liabilities, allocation of fair value of the issuance to the debt instrument, detachable stock purchase warrant, and any beneficial conversion features, and the applicable classification of the convertible notes payable and warrants as debt, equity or temporary equity (mezzanine). We allocate the proceeds from the issuance of a debt instrument with detachable stock purchase warrants to the two elements based on the relative fair values of the debt instrument without the warrants and of the warrants themselves at the time of issuance. We account for the portion of the proceeds allocated to warrants in additional paid-in capital and the remaining proceeds are allocated to the debt instrument. The allocation to debt instrument results in a discount to notes payable which is amortized using the effective interest method to interest expense over the expected term of the note. We include the intrinsic value of the embedded conversion feature of convertible notes payable in the discount to notes payable, which is amortized and charged to interest expense over the expected term of the note. We also estimate the total fair value of any beneficial conversion feature and accompanying warrants in allocating debt proceeds. The proceeds allocated to the beneficial conversion feature are determined by taking the estimated fair value of shares issuable under the convertible notes less the fair value of the number of shares that would be issued if the conversion rate equaled the fair value of our common stock as of the date of issuance. In situations where the debt includes both a beneficial conversion feature and a warrant, the proceeds are allocated to the warrants and beneficial conversion feature based on the pro-rata fair value. We use the Black Scholes-Merton option pricing model to determine the fair value of our warrants. Notes payable to related parties and interest expense and accrued interest to related parties are separately identified in our consolidated financial statements. We also disclose significant terms of all transactions with related parties. Share-based Compensation We recognize compensation cost for share-based compensation awards during the service term of the recipients of the share-based awards. The fair value of share-based awards is calculated using the Black-Scholes-Merton pricing model. The Black-Scholes-Merton model requires subjective assumptions regarding future stock price volatility and expected time to exercise, which greatly affect the calculated values. The expected term of awards granted is derived from historical data on awards exercised and post-vesting employment termination behavior. The risk-free rate selected to value any particular grant is based on the U.S. Treasury rate that corresponds to the vesting period of the grant effective as of the date of the grant. The expected volatility is based on the historical volatility of the common stock of comparable publicly traded companies. These factors could change, affecting the determination of stock-based awards expense in future periods. 65
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Fair Value of Common Stock
The fair value of the common stock underlying our share-based awards was determined on each grant date by our board of directors, with input from management, primarily based on recent sales of equity and equity related financial instruments to non-affiliated purchasers in arm's length negotiated transactions, as well as other factors our board of directors considered relevant to the valuation of our common stock. Given the absence of a public trading market for our common stock, our board of directors exercised reasonable judgment and considered a range of objective and subjective factors to estimate the fair value of our common stock. More specifically, the fair value of the underlying shares was determined based on recent arms-length sales of our equity to third parties and other factors determined by management to be relevant to the valuation of such shares, including: º • º progress of our research and development efforts; º •
º our operating results and financial condition, including our levels of
available capital resources;
º our stages of development and material risks related to our business;
º • º the achievement of enterprise milestones, including entering into collaboration or license agreements and our progress in clinical trials; º • º the valuation of publicly-traded companies in the life sciences and biotechnology sectors, as well as recently completed mergers and acquisitions of peer companies; º • º equity market conditions affecting comparable public companies; º • º the likelihood of achieving a liquidity event for the shares of common stock, such as an initial public offering given prevailing market and biotechnology sector conditions; and º • º that the grants involved illiquid securities.
Fair Value Measurements
We define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. We measure fair value under a framework that provides a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described as follows:
Level 1: Inputs to the valuation methodology are unadjusted quoted prices
for identical assets or liabilities in active markets that we have the ability to access. Level 2: Inputs to the valuation methodology include: º • º Quoted prices for similar assets or liabilities in active markets; º • º Quoted prices for identical or similar assets or
inactive markets; º • º Inputs other than quoted prices that are observable for the asset or liability; º • º Inputs that are derived principally from or corroborated by observable market data by correlation or other means. If the asset or liability has a specified (contractual) term, the Level 2 input must be observable for substantially the full term of the asset or liability. Level 3: Inputs to the valuation methodology are unobservable and significant to the fair value measurement. 66
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The asset's or liability's fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value assigned to marketable securities is determined by obtaining quoted prices on nationally recognized securities exchanges, and are classified as Level 1 investments at
December 31, 2013. The fair value of our debt instruments is not materially different from their carrying values as presented. The fair value of our convertible debt instruments was determined based on Level 2 inputs. The carrying value of the debt was discounted based on allocating proceeds to other financial instruments within the arrangement as discussed in Note 6 to our consolidated financial statements.
Securities available-for-sale are recorded at cost and any increases or decreases in fair market value are recorded as unrealized gains or losses, net of taxes in accumulated other comprehensive income. We monitor these investments for impairment and make appropriate reductions in carrying values when necessary.
Revenue is recognized when there is persuasive evidence that an arrangement exists, delivery has occurred, the price is fixed and determinable and collection is reasonably assured. With prior written approval of the Company, in certain situations, product is returnable only by our direct customers for a returned goods credit, for product that is expired, damaged in transit, or which is discontinued, withdrawn or recalled. The Company estimates its sales returns based upon its prior sales and return history and accrues a Sales Return Allowance at the time of sale. Historically, sales returns have been 67
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immaterial. The Company pays royalties on an annual basis based on existing license arrangements. These royalties are recognized as cost of goods sold upon sale of the products. Year Ended December 31, 2013 2012(1) REVENUES, Net
$ 390,911 $ 543,058COST OF GOODS SOLD 196,395 183,673 GROSS PROFIT 194,516 359,385 OPERATING EXPENSES Research and development 2,436,585 2,966,583 Selling 516,599 402,601 General and administrative 10,078,954 8,022,326 Transaction costs 1,014,019 - 14,046,157 11,391,510 LOSS FROM OPERATIONS (13,851,641 ) (11,032,125 ) OTHER INCOME (EXPENSE) Gain on debt extinguishment - 300,312 Realized gain (loss) on securities available-for-sale 399,068 (24,490 ) Gain on derecognition of accounts payable 341,361
Change in fair value of derivative liabilities 932,000 - Interest and other income 103,987 37,649 Interest expense (2,173,561 ) (3,422,220 ) (397,145 ) (3,108,749 ) LOSS BEFORE INCOME TAXES (14, 248,786 ) (14,140,874 ) INCOME TAXES (BENEFIT) (182,438 ) 7,246 NET LOSS
$ (14,066,348 )) $ (14,148,120 )NET LOSS PER COMMON SHARE $ (0.53 ) $ (0.58 )WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 26,585,578 24,482,759
º See Note 2 to consolidated financial statements.
Net Losses. Net losses remained approximately the same at
$14.1 millionfor the years ended December 31, 2013and 2012. As of December 31, 2013, we had an accumulated deficit of approximately $49.8 million. Losses, partially offset by revenue from commercialized products, will continue as we advance our L-glutamine treatment for SCD toward regulatory approval and potential commercialization. As a result, we anticipate that we will continue to incur net losses and be unprofitable for the foreseeable future. Revenues, Net. Revenues, Net decreased $0.2 million, or 28%, to $0.4 millionfrom $0.6 millionfor the years ended December 31, 2013and 2012, respectively. Sales decreased primarily due to decreases in the number of units sold of our AminoPure® product. There were no sales returns of NutreStore® product in the years ended December 31, 2013and 2012. The Company estimates its sales returns based upon its prior sales and return history. Historically, sales returns have been very nominal. The Company continues to monitor its returns and will adjust its estimates based on its actual sales return experience. 68
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Cost of Goods Sold. Cost of goods sold remained approximately the same at
$0.2 millionfor the years ended December 31, 2013and 2012. Cost of goods sold includes costs for raw material, packaging, testing, shipping and costs related to scrapped inventory. No scrapped inventory expense was realized for the years ended December 31, 2013and 2012. All of the purchases during the year ended December 31, 2013were from two vendors and in 2012 were from one vendor. Purchases from the two vendors amounted to 79% and 21% during the year ended December 31, 2013. Research and Development Expenses. Research and development expenses decreased $0.5 million, or 18%, to $2.4 millionfrom $2.9 millionfor the years ended December 31, 2013and 2012, respectively. This decrease was primarily due to decreases in our CRO costs and other related costs of our Phase 3 clinical trial as the total number of active study patients decreased due to study patients completing participation in the study during 2013 after the trial reached full enrollment in December of 2012. Selling Expenses. Selling expenses increased $0.1 million, or 28%, to $0.5 millionfrom $0.4 millionfor the year ended December 31, 2013and 2012, respectively. The increase largely resulted from a scaling up of the NutreStore promotion efforts. Selling expenses included the costs for distribution, promotion, travel, tradeshows and exhibits related to NutreStore and AminoPure. General and Administrative Expenses. General and administrative expenses increased $2 million, or 26%, to $10 millionfrom $8 millionfor the years ended December 31, 2013and December 31, 2012, respectively. The increase was primarily due to a $1.9 millionincrease in stock based compensation from $3.2 millionin 2012 to $5.1 millionin 2013. The Company utilized stock based compensation to retain and provide an incentive for the Company's management, staff and board of directors. Increases in payroll, insurance and other expenses were offset by decreases in professional fees. Transaction Expenses. Transaction costs increased $1.0 millionfrom $0due to costs associated with the Company's 2013 private placement of units that were allocated to the derivative warrant liability. Other Income and Expense. Total other income and expense has decreased by $2.7 million, or 87%, to $0.4 millionfrom $3.1 millionfor the years ended December 31, 2013and 2012, respectively. The lower interest expense is due to a $1.6 milliondecrease in the amortization of debt discount of convertible notes and promissory notes which reached maturity in 2013, partially offset by an increase of $0.4 millionin interest expense on debt obligations as a result of higher outstanding debt balances. The increase was primarily due to an increase in fair value of derivative liabilities of $0.9 million(with no corresponding amount for 2012), a gain on derecognition of accounts payables of $0.3 millionand lower interest expense of $1.2 million.
We anticipate that our operating expenses will increase for, among others, the following reasons:
º as a result of increased payroll, expanded infrastructure and higher consulting, legal, accounting and investor relations costs, and director and officer insurance premiums associated with being a public company; º • º to support research and development activities, which we expect to expand as development of our product candidate(s) continue; and º • º to build a sales and marketing team before we receive regulatory
approval of a product candidate in anticipation of commercial launch.
Liquidity and Capital Resources
Based on our losses to date, anticipated future revenue and operating expenses, debt repayment obligations and cash and cash equivalents balance of
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have sufficient operating capital for our business without raising additional capital. We incurred losses of
$14.1 millionfor each of the years ended December 31, 2013and 2012. We had an accumulated deficit at December 31, 2013of $49.8 million. We anticipate that we will continue to incur net losses for the foreseeable future as we incur expenses for the commercialization of L-glutamine as a prescription drug for the treatment of sickle cell disease, the development of the corneal cell sheets technology and the expansion of corporate infrastructure, including costs associated with being a public reporting company. We have previously relied on private equity offerings, debt financings, and loans, including loans from related parties. As part of this effort, we have received various loans from stockholders as discussed below. As of December 31, 2013, we had total outstanding notes payable of $11.5 million, consisting of $2.9 millionof non-convertible promissory notes and $8.6 millionof convertible notes. Of the $11.5 millionaggregate outstanding principal amount of notes outstanding as of December 31, 2013, approximately $8.2 millionwill become due and payable within one year. Our failure to raise capital as and when needed would have a negative impact on our financial condition and our ability to pursue our business strategies, including the commercialization of our L-glutamine product for SCD and the development of cell sheet technology in the United States. As described in Note 2 to the consolidated financial statements, the Company has had recurring operating losses, has a significant amount of notes payable and other obligations due within the next year and projected operating losses, including as a result of the expected costs relating to the commercialization of our L-glutamine treatment for SCD, that exceed both the existing cash balances and cash expected to be generated from operations for at least the next year. In order to meets its expected obligations, management intends to raise additional fund through equity and debt offerings and partnership agreements. However, due to the uncertainty of our ability to meet our current operating and capital expenses, there is substantial doubt about our ability to continue as a going concern as the continuation and expansion of our business is dependent upon obtaining further financing, successful and sufficient market acceptance of our products, successful partnership arrangements and, finally, achieving a profitable level of operations. In addition, we may attempt to raise additional funds through public financings, collaborations with other companies or financing from other sources. Additional funding may not be available in amounts or on terms which are acceptable to us, if at all. On April 8, 2011, pursuant to our Research Agreement with CellSeed, we agreed to pay CellSeed $8.5 millionwithin 30 days of the completion of all of the following: (i) the execution of the Research Agreement; (ii) the execution of an Individual Agreement; and (iii) CellSeed's delivery of the accumulated information package, as defined in the Research Agreement. Pursuant to the Individual Agreement with CellSeed, we agreed to pay $1.5 millionto CellSeed and a royalty to be agreed upon by the parties. We paid the $1.5 milliondue to CellSeed pursuant to the Individual Agreement in February 2012. We currently anticipate that the additional $8.5 millionpayment obligation under the Research Agreement will become due and payable after we begin to generate revenues from the commercialization of our L-glutamine treatment for SCD. If the payment obligation becomes due and payable prior to our generation of revenue from the commercialization of our L-glutamine treatment for SCD, we will need to seek other funding sources, including the sale of additional equity, debt securities, and partnership arrangements, in order to make the payment. CellSeed may terminate these agreements if we are unable to make timely payments as required under the agreements. In addition to the $8.5 millionwe have agreed to pay CellSeed pursuant to the Research Agreement, we currently estimate that we will need an additional $2.0 millionto administratively close out the post-clinical aspects of our Phase 3 clinical trial and submit a NDA to the FDA. Our current cash burn rate is approximately $0.7 millionper month.
Our cash flow from operations is not adequate and our future capital requirements will be substantial and may increase beyond our current expectations depending on many factors including, but not limited to: the number, duration and results of the clinical trials for our various products going
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forward; unexpected delays or developments in seeking regulatory approvals; the time and cost in preparing, filing, prosecuting, maintaining and enforcing patent claims; other unexpected developments encountered in implementing our business and commercialization strategies; the outcome of litigation; and further arrangements, if any, with collaborators. We will rely, in part, on sales of AminoPure for revenues, which we expect will increase due to the expected growth in its export volume as the Company has added additional distributors and expanded retail markets outside of
the United States. Revenues from NutreStore are currently not significant and we are unsure whether sales of NutreStore will increase. Until we can generate a sufficient amount of product revenue, future cash needs are expected to be financed through public or private equity offerings, debt financings, loans, including loans from related parties, or other sources, such as strategic partnership agreements and corporate collaboration and licensing arrangements. Until we can generate a sufficient amount of product revenue, there can be no assurance of the availability of such capital on terms acceptable to us (or at all). For the years ended December 31, 2013and 2012, we borrowed varying amounts pursuant to convertible notes and non-convertible promissory notes, the majority of which have been issued to our stockholders. As of December 31, 2013and December 31, 2012, the amounts outstanding under convertible notes and non-convertible promissory notes totaled $8.6 millionand $2.9 million, respectively. The convertible notes and non-convertible promissory notes carry interest from 0% to 11% and, except for a convertible note in the principal amount of $0.5 millionare unsecured. Interest on 0% loans was imputed at the incremental borrowing rate of 6.25% per annum. The net proceeds of the loans were used for working capital. 71
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The table below lists our outstanding notes payable as of
Shares Shares Underlying Underlying Principal Discount Carrying Principal as Principal Discount Carrying Principal as Outstanding Amount Amount of Outstanding Amount Amount of Year Interest Term of December 31,
2013 2013 2013 2012 2012 2012 2012 Convertible notes payable 2009 6.5% 5 years
$3.05 $ 254,460$ - $ 254,46083,366 $ 294,355$ - $ 294,35596,436 2010 0 ~ 6.0% 5 years $3.0574,000 8,308 65,692 24,248 74,000 13,420 60,580 24,248 2011 10% 5 years $3.05500,000 - 500,000 163,809 500,000 - 500,000 163,809 2012 10% Due on $3.30~$3.60 251,100 - 251,100 71,000 4,307,107 69,179
demand ~ 2 years 2013 10% Due on
$3.30~$3.60 6,913,606 215,798 6,697,808 1,998,215 - - - - demand ~ 2 years $ 7,993,166 $ 224,106 $ 7,769,0602,340,638 $ 5,175,462 $ 82,599 $ 5,092,8631,526,418 Current $ 4,955,868 $ 153,396 $ 4,802,4721,438,033 $ 4,056,007 $ 69,179
$ 3,037,298 $ 70,710 $ 2,966,588902,605 $ 1,119,455 $ 13,420 $ 1,106,035355,496 Convertible notes payable-related party 2012 10% Due on $3.30 $ 373,000$
demand 2013 10% 1 year
$3.60187,706 - 187,706 52,141 278,642 9,491 269,151 77,403 $ 560,706$ - $ 560,706165,171 $ 667,442 $ 26,575 $ 640,867195,222 Current $ 560,706$ - $ 560,706165,171 $ 667,442 $ 26,575 $ 640,867195,222 Notes payable 2012 2% ~ 11% Due on NA $ 833,335 $ 18,265 $ 815,070- $ 1,782,060 $ 214,350 $ 1,567,710- demand ~ 2 years 2013 2% ~ 10% Due on NA 1,150,000 - 1,150,000 - - - - - demand ~ 2 years $ 1,983,335 $ 18,265 $ 1,965,070- $ 1,782,060 $ 214,350 $ 1,567,710- Current $ 1,783,335 $ 18,265 $ 1,765,070- $ 1,082,060 $ 214,350 $ 867,710- Non-current $ 200,000$ - $ 200,000- $ 700,000$ - $ 700,000- Notes payable-related party 2009 6.5% Due on NA $ - $ - $ - - $ 272,800$ - $ 272,800- demand 2011 8% 2 years NA - - - - 200,000 - 200,000 - 2012 1% ~ 11% Due on NA 880,062 4,421 875,641 - 3,207,133 608,602 2,598,531 - demand ~ 2 years 2013 8% Due on NA 50,000 - 50,000 - - - - - demand $ 930,062 $ 4,421 $ 925,641- $ 3,679,933 $ 608,602 $ 3,071,331- Current $ 930,062 $ 4,421 $ 925,641- $ 3,679,933 $ 608,602 $ 3,071,331- Grand Total $ 11,467,269$
$ 10,372,7711,721,640 72
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Subsequent to the fiscal year ended
December 31, 2013, the Company entered into financing arrangements as set forth below. The total amount of these loans amounted to $1.7 million, all of which were newly issued notes to replace previously issued notes that had reached maturity. Principal Annual Term of Conversion Notes issued after December 31, 2013 Amounts Interest Rate Notes Price Convertible note $ 254,32010 % 2 years $ 3.05On Demand up to Convertible notes 336,606 10 % 1 year $ 3.60On Demand up to Promissory notes 833,335 11 % 2 years NA On Demand up to Promissory notes-related party 252,165 11 % 2 years NA Total $ 1,676,426We are required to pay royalties which are recognized as an expense upon sale of the related products. We are required to pay a royalty to Cato equivalent to 10% of our adjusted gross sales of NutreStore calculated on an annual basis. The 10% royalty is calculated at the end of the year and accrued on an annual basis. Once commercialized and pursuant to an addendum to the license agreement with LA BioMed, we agreed to pay royalties to LA BioMed during the term of the agreement equal to 4.5% of net sales of Licensed Products in the United Statesuntil lifetime royalty payments made to LA BioMed total $100,000, at which time the royalty rate will decrease to 2.5% of net sales of the Licensed Products. No royalties will be paid to LA BioMed for Licensed Products sold or distributed, or Licensed Methods practiced, on a non-profit basis. Royalty payments are due within 45 days of the end of each fiscal quarter, with the last payment due 45 days after the termination of the agreement. Any payments not made when due accrue interest on and after the due date at a rate equal to the prime interest rate quoted by the Bank of America on the date the payment is due, with interest being compounded on the last day of each calendar quarter. Cash Flows
Net cash used in operating activities
Net cash flows used in operating activities increased by
$2.0 million, or 30%, to $8.4 millionfrom $6.4 millionfor the years ended December 31, 2013and 2012, respectively. The increase in cash flows used in operating activities of $2.0 millionwas a direct result of general and administrative expenses increasing by $2.0 millionand transaction costs increasing by $1.0 million. Other non-cash adjustments to cash flows used in operating activities mainly offset each other, with a decrease in the fair value of derivative liabilities of $0.9 million, a decrease of $0.3 millionin gains on derecognition of accounts payable, a decrease in realized gain on securities available-for-sale offset by an increase in share-based compensation of $1.9 million.
Net cash used in investing activities
Net cash flows from (used in) investing activities increased by
$2.1 millionto $0.6 millionfrom ($1.5) millionfor the years ended December 31, 2013and 2012, respectively. The decrease was mainly due to a decrease in the payments of license fees of $1.5 millionand proceeds from the sale of marketable securities in 2013 totaling $0.6 million. No other investing activities occurred in the years ended December 31, 2013and 2012.
Net cash from financing activities
Net cash flows from financing activities increased by
$3.0 million, or 37%, to $11.1 millionfrom $8.1 millionfor the years ended December 31, 2013and 2012, respectively, primarily as a result of a $6.4 millionincrease in the issuance of common stock and warrants, a decrease of $2.5 millionin proceeds from the issuance of notes payable and convertible notes payable, and a decrease of 73
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$1.1 millionin payments of notes payable and convertible notes payable. A total of $2.6 millionof promissory and convertible notes payable were converted into shares of our common stock during the year ended December 31, 2013, compared to $0.0 millionfor the year ended December 31, 2012.
Since our inception, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities.