CervoMed Inc.: Form 10-Q for the period ended Jun 30, 2017

You should read the following discussion of our financial condition and results of operations together with the unaudited interim condensed consolidated financial statements and the notes thereto included elsewhere in this report and other financial information included in this report. The following discussion may contain predictions, estimates and other forward looking statements that involve a number of risks and uncertainties, including those discussed under “Part I — Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Special Note Regarding Forward Looking Statements” in this report and under “Part I — Item 1A. Risk Factors” in our annual report on Form 10-K for the fiscal year ended December 31, 2016. These risks could cause our actual results to differ materially from any future performance suggested below.

Business Overview

We are a clinical stage biotechnology company focused on extending the life expectancy of cancer patients by improving the effectiveness of current standard-of-care treatments, including radiation therapy and chemotherapy. We are developing our lead product candidate, transcrocetinate sodium, also known as trans sodium crocetinate, or TSC, for use in the many cancer types in which tumor oxygen deprivation (“hypoxia”) is known to diminish the effectiveness of current treatments. TSC is designed to target the cancer’s hypoxic micro-environment, re-oxygenating treatment-resistant tissue and making the cancer cells more susceptible to the therapeutic effects of standard-of-care radiation therapy and chemotherapy.

Our lead development programs target TSC against cancers known to be inherently treatment-resistant, including brain cancers and pancreatic cancer. A Phase 2 clinical program, completed in the second quarter of 2015, evaluated 59 patients with newly diagnosed glioblastoma multiforme (“GBM”). This open label, historically controlled study demonstrated a favorable safety and efficacy profile for TSC combined with standard of care, including a 37% improvement in overall survival over the control group at two years. A particularly strong efficacy signal was seen in the inoperable patients, where survival of TSC-treated patients at two years was increased by almost four-fold over the controls. At an End-Of-Phase 2 Meeting, the U.S. Food and Drug Administration, or FDA, provided Diffusion with extensive guidance on the design for a Phase 3 trial of TSC in newly diagnosed, GBM patients. We believe focusing on the inoperable patient group in Phase 3 should reduce the needed number of patients from over 400 to around 230, which is expected to provide cost savings, while the strength of the Phase 2 efficacy signal in the inoperable patient subset should make the showing of significant clinical gain in Phase 3 more likely. Due to its novel mechanism of action, TSC has safely re-oxygenated a range of tumor types in our preclinical and clinical studies. Diffusion believes its therapeutic potential is not limited to specific tumors, thereby making it potentially useful to improve standard-of-care treatments of other life-threatening cancers. Additional planned studies include a Phase 2 trial in pancreatic cancer and a study in brain metastases, with a study initiation subject to receipt of additional funding or collaborative partnering. We also believe that TSC has potential application in other indications involving hypoxia, such as neurodegenerative diseases and emergency medicine. For example, our stroke program is now in advanced discussions with doctors from UCLA and the University of Virginia, with whom we have established a joint team dedicated to developing a program to test TSC in the treatment of stroke, with an in-ambulance trial of TSC in stroke under consideration. Planning for such a trial is on-going.

In addition to the TSC programs, we are exploring alternatives regarding how best to capitalize upon our product candidate, RES-529, which may include possible out-licensing and other options. RES-529 is a novel PI3K/Akt/mTOR pathway inhibitor which has completed two Phase 1 clinical trials for age-related macular degeneration and was in preclinical development in oncology, specifically GBM. RES-529 has shown activity in both in vitro and in vivo glioblastoma animal models and has been demonstrated to be orally bioavailable and can cross the blood brain barrier.

Summary of Current Product Candidate Pipeline

The following table, as of June 30, 2017, summarizes the targeted clinical indications for Diffusion’s lead molecule, TSC:

Financial Summary

In March 2017, we completed a $25.0 million private placement of our securities by offering units consisting of one share of our Series A convertible preferred stock and a warrant to purchase one share of our common stock for each share of Series A convertible preferred stock purchased in the offering. We sold 12,376,329 units and received approximately $22.1 million in aggregate net cash proceeds from the private placement, after deducting commissions and other expenses of approximately $2.9 million. In addition, we granted our placement agent in the offering warrants to purchase an aggregate of 1,179,558 shares of our common stock as compensation for its services.

At June 30, 2017, we had cash and cash equivalents of $7.4 million and a certificate of deposit of $10.0 million. We have incurred operating losses since inception, have not generated any product sales revenue and have not achieved profitable operations. We had net income of $20.4 million and incurred a net loss of $8.3 million for the three and six months ended June 30, 2017, respectively. Our net income for the three months ended June 30, 2017 was primarily related to the remeasurement of our common stock warrant liability at June 30, 2017 which resulted in a $23.4 million gain (see Notes 7 and 10 to the accompanying unaudited condensed consolidated financial statements). Our accumulated deficit as of June 30, 2017 was $68.4 million, and we expect to continue to incur substantial losses in future periods. We anticipate that our operating expenses will increase substantially as we continue to advance our lead, clinical-stage product candidate, TSC. We anticipate that our expenses will substantially increase as we:

• complete regulatory and manufacturing activities and commence our planned Phase II and III clinical trials for TSC;
• continue the research, development and scale-up manufacturing capabilities to optimize products and dose forms for which we may obtain regulatory approval;
• conduct other preclinical and clinical studies to support the filing of a New Drug Application (“NDA”) with the FDA;
• maintain, expand and protect our global intellectual property portfolio;
• hire additional clinical, manufacturing, and scientific personnel; and
• add operational, financial and management information systems and personnel, including personnel to support our drug development and potential future commercialization efforts.

We intend to use our existing cash and cash equivalents for working capital and to fund the research and development of TSC for use in the treatment of GBM, pancreatic cancer, stroke and brain metastases. We believe that our cash and cash equivalents and our certificate of deposit as of June 30, 2017 will enable us to fund our operating expenses and capital expenditure requirements through March 2018. However, we will need to secure additional funding in the future, from one or more equity or debt financings, collaborations, or other sources, in order to carry out all of our planned research and development activities with respect to TSC and our other product candidates.

As disclosed in our definitive proxy statement (the “Proxy Statement”) filed with the Securities and Exchange Commission (“SEC”) on May 1, 2017, we intend to offer up to $20.0 million of shares of our Series B convertible preferred stock, $0.001 par value per share (“Series B Preferred Stock”), at an offering price of $2.10 per share with each share of Series B Preferred Stock being initially convertible into one share of our common stock, subject to adjustment. For each share of Series B Preferred Stock purchased in the offering, the investor shall receive a 5-year warrant to purchase one share of common stock with an exercise price equal to $2.31. The offering was approved by our stockholders on June 15, 2017. There is no assurance that we will successfully close an offering at such terms due to the current trading prices of our common stock or for any other reason.

THE FOREGOING STATEMENT IS NOT AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SHARES OF OUR PREFERRED STOCK, SHARES OF OUR COMMON STOCK OR ANY OTHER SECURITIES.

Financial Operations Overview

Revenues

We have not yet generated any revenue from product sales. We do not expect to generate revenue from product sales for the foreseeable future.

Research and Development Expense

Research and development costs are charged to expense as incurred. These costs include, but are not limited to, expenses related to third-party contract research arrangements, employee-related expenses, including salaries, benefits, stock-based compensation and travel expense reimbursement, as well as impairment of our in-process research and development, or IPR&D, assets. Research and development activities are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical trials. As we advance our product candidates, we expect the amount of research and development costs will continue to increase for the foreseeable future.

General and Administrative Expense

General and administrative expenses consist principally of salaries and related costs for executive and other personnel, including stock-based compensation, expenses associated with investment bank and other financial advisory services, and travel expenses. Other general and administrative expenses include costs associated with the Merger, professional fees that were incurred in connection with preparing to operate and operating as a public company, facility-related costs, communication expenses and professional fees for legal, patent prosecution and maintenance, and consulting and accounting services.

Interest Expense, Net

Interest expense, net consists principally of the interest expense recorded in connection with our convertible debt instruments offset by the interest earned from our cash and cash equivalents.

Change in Fair Value of Warrant Liabilities, Warrant Related Expenses, and Other Financing Expenses

In connection with our private placement in March 2017, we recorded warrant expense associated with the change in fair value of the common stock warrants from issuance, the excess fair value of the common stock warrants over the gross cash proceeds from the Series A convertible preferred stock offering, and placement agent commissions and other offering costs.

Results of Operations for Three Months Ended June 30, 2017 Compared to Three Months Ended June 30, 2016

The following table sets forth our results of operations for the three months ended June 30, 2017 and 2016.

We recognized $1.2 million in research and development expenses during the three months ended June 30, 2017 compared to $1.4 million during the three months ended June 30, 2016. The decrease in research and development expense was attributable to a $0.7 million decrease in expense associated with animal toxicology studies and a $0.1 million decrease in stock-based compensation expense, partially offset by a $0.5 million increase in API and drug manufacturing costs and a $0.1 million increase in salary related expenses. We expect that our research and development expenses will increase significantly in future periods compared to prior year periods due to our anticipated efforts to advance our technologies and product candidates.

General and administrative expenses were $1.8 million during the three months ended June 30, 2017 compared to $2.3 million during the three months ended June 30, 2016. The decrease in general and administrative expense was primarily due to a $0.8 million decrease in professional fees, partially offset by an increase in salary and stock-based compensation expense of $0.2 million.

The increase in interest expense for the three months ended June 30, 2017 compared to the three months ended June 30, 2016 is primarily attributable to the issuance of our convertible promissory note with a notional value of $1.9 million in September 2016.

In connection with the private placement of our Series A convertible preferred stock and common stock warrants, we determined the warrants to be classified as liabilities and subject to remeasurement at each reporting period. As a result of the liability classification, during the three months ended June 30, 2017, we recorded a $23.4 million gain for the change in fair value of our common stock warrant liabilities which was primarily attributable to the decrease in the market price for our common stock.

Results of Operations for Six Months Ended June 30, 2017 Compared to Six Months Ended June 30, 2016

The following table sets forth our results of operations for the Six Months Ended June 30, 2017 and 2016.

We recognized $2.2 million in research and development expenses during the six months ended June 30, 2017 compared to $3.8 million during the six months ended June 30, 2016. The decrease in research and development expense was attributable to a $0.9 million decrease in expense related to our pancreatic cancer program, a $0.9 million decrease in animal toxicology expenses and a $0.4 million decrease in stock-based compensation expense. This decrease was partially offset by a $0.5 million increase in API manufacturing costs and a $0.1 million increase in salary related expenses. We expect that our research and development expenses will increase significantly in future periods compared to prior year periods due to our anticipated efforts to advance our technologies and product candidates.

General and administrative expenses were $3.3 million during the six months ended June 30, 2017 compared to $6.2 million during the six months ended June 30, 2016. The decrease in general and administrative expense was primarily due to a $2.7 million decrease in costs attributable to the reverse merger transaction in January 2016, a decrease in insurance related expenses of $0.4 million and a $0.1 million decrease in other expenses. This decrease was offset by an increase in salary and stock-based compensation expense of $0.4 million.

The increase in interest expense for the six months ended June 30, 2017 compared to the six months ended June 30, 2016 is primarily attributable to the issuance of our convertible promissory note with a notional value of $1.9 million in September 2016.

In connection with the private placement of our Series A convertible preferred stock and common stock warrants, we determined the warrants to be classified as liabilities and subject to remeasurement at each reporting period. As a result of the liability classification, for the six months ended June 30, 2017, we recorded a $10.5 million gain for the change in fair value of our common stock warrant liabilities which was primarily attributable to the decrease in the market price for our common stock. We also recognized $10.2 million in excess fair value of the common stock warrants over the gross proceeds from our private placement and $2.9 million in placement agent commissions and other offering costs.

Liquidity and Capital Resources

Working Capital

To date, we have funded our operations primarily through the sale and issuance of preferred stock, common stock and convertible promissory notes. In March 2017, we sold 12,376,329 units, consisting of shares of Series A convertible preferred stock and warrants to purchase shares of common stock in a private placement and received approximately $22.1 million in aggregate net cash proceeds, after deducting commissions and other expenses of approximately $2.9 million. As of June 30, 2017, we had $7.4 million in cash and cash equivalents, $10.0 million in a certificate of deposit, working capital deficit of $11.8 million and an accumulated deficit of $68.4 million. We expect to continue to incur net losses for the foreseeable future. We intend to use our existing cash and cash equivalents to fund our working capital and research and development of our product candidates.

Cash Flows

The following table sets forth our cash flows for the six months ended June 30, 2017 and 2016:

Operating Activities

Net cash used in operating activities of $6.2 million during the six months ended June 30, 2017 was primarily attributable to our net loss of $8.3 million and our net change in operating assets and liabilities of $1.3 million. This amount was offset by $2.6 million in non-cash, warrant related and other financing expenses and $0.7 million in stock-based compensation expense. The net change in our operating assets and liabilities is primarily attributable to the decrease in our accounts payable due to the timing of payments to our vendors, offset by an increase in accrued expenses due to additional accrued interest and dividends as well as an increase in prepaid expenses, mainly related to insurance costs.

Net cash used in operating activities of $7.5 million during the six months ended June 30, 2016 was primarily attributable to our net loss of $10.0 million and was offset by $2.2 million of non-cash charges and $0.4 million for the net change in our operating assets and liabilities. Non-cash charges primarily consisted of stock-based compensation and common stock issued for advisory services.

Investing Activities

During the six months ended June 30, 2017, we purchased a certificate of deposit in the amount of $10.0 million and had approximately $64,000 in fixed asset purchases. During the six months ended June 30, 2016, net cash provided by investing activities was $8.5 million and was attributable to the cash acquired in connection with the reverse merger transaction with RestorGenex.

Financing Activities

Net cash provided by financing activities was $22.1 million during the six months ended June 30, 2017, which was attributable to the $22.1 million in proceeds received upon the closing of our Series A private placement offset by approximately $43,000 in payments for related offering costs. There were no cash related financing activities during the six months ended June 30, 2016.

Capital Requirements

We expect to continue to incur substantial expenses and generate significant operating losses as we continue to pursue our business strategy of developing our lead product candidate, TSC, for use in the treatment of GBM, pancreatic cancer, stroke and brain metastases.

To date, we have funded our ongoing business operations and short-term liquidity needs, primarily through the sale and issuance of preferred stock, common stock and convertible promissory notes. We expect to continue this practice for the foreseeable future. We believe our cash and cash equivalents and our certificate of deposit as of June 30, 2017 will be sufficient to fund our planned operations through March 2018.

As of June 30, 2017, we did not have credit facilities under which we could borrow funds or any other sources of committed capital. We may seek to raise additional funds through various sources, such as equity and debt financings, or through strategic collaborations and license agreements. We can give no assurances that we will be able to secure additional sources of funds to support our operations, or if such funds are available to us, that such additional financing will be sufficient to meet our needs or be on terms acceptable to us. This risk may increase if economic and market conditions deteriorate. If we are unable to obtain additional financing when needed, we may need to terminate, significantly modify or delay the development of our product candidates and our operations, or we may need to obtain funds through collaborators that may require us to relinquish rights to our technologies or product candidates that we might otherwise seek to develop or commercialize independently. If we are unable to raise any additional capital in the near-term and/or we cannot significantly reduce our expenses and are forced to terminate our operations, investors may experience a complete loss of their investment.

To the extent that we raise additional capital through the sale of our common stock, the interests of our current stockholders may be diluted. If we issue additional preferred stock or convertible debt securities, it could affect the rights of our common stockholders or reduce the value of our common stock or any outstanding classes of preferred stock. In particular, specific rights granted to future holders of preferred stock or convertible debt securities may include voting rights, preferences as to dividends and liquidation, conversion and redemption rights, sinking fund provisions, and restrictions on our ability to merge with or sell our assets to a third party. Debt 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.

As disclosed in the Proxy Statement, we intend to offer up to $20.0 million of shares of our Series B Preferred Stock at an offering price of $2.10 per share with each share of Series B Preferred Stock being initially convertible into one share of our common stock, subject to adjustment. For each share of Series B Preferred Stock purchased in the offering, the investor will receive a 5-year warrant to purchase one share of common stock with an exercise price equal to $2.31. The proposed terms of this offering are described in more detail in the Proxy Statement. The offering was approved by our stockholders on June 15, 2017. There is no assurance that we will successfully close such an offering at such terms due to the current trading prices of our common stock or for any other reason.

On May 26, 2017, we received received a written notice from NASDAQ indicating we were not in compliance with Nasdaq Listing Rule 5550(b)(2) because the market value of our listed securities had been below $35.0 million for the previous 30 consecutive business days. NASDAQ also noted that as of such date the Company also did not meet the alternative requirements under Nasdaq Listing Rule 5550(b)(1), due to the Company's failure to maintain stockholders' equity of at least $2.5 million, or Nasdaq Listing Rule 5550(b)(3), due to the Company's failure to generate net income from continuing operations during its last fiscal year or during two of its last three fiscal years. We have 180 calendar days from the date of the notice, or until November 20, 2017, to regain compliance with the minimum market value of listed securities requirement or the minimum stockholders’ equity requirement. In the event that we are unable to regain compliance, it could adversely affect our ability to obtain future funding.

THE FOREGOING STATEMENT IS NOT AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY SHARES OF OUR PREFERRED STOCK, SHARES OF OUR COMMON STOCK OR ANY OTHER SECURITIES.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements, as defined by the rules and regulations of the SEC that have or are reasonably likely to have a material effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources. As a result, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these arrangements.

Critical Accounting Policies

The Critical Accounting Policies included in our Form 10-K for the year ended December 31, 2016, filed with the SEC pursuant to Section 13 or 15(d) under the Securities Act on March 31, 2017, as amended to this date, have not changed, except as follows:

Estimated fair value of Common Stock Warrants

Common stock warrants issued in conjunction with our Series A convertible preferred stock offering are accounted for as freestanding financial instruments. These warrants are classified as liabilities on our condensed consolidated balance sheet and are recorded at their estimated fair value. At the end of each reporting period, changes in the estimated fair value during the period are recorded in our condensed consolidated statement of operations. We will continue to adjust these liabilities for changes in fair value until the earlier of their exercise, termination, or other form of settlement. The estimated fair value of common stock warrants is determined by using the Black-Scholes option-pricing model.

Special Note Regarding Forward-Looking Statements

This report includes forward-looking statements. We may, in some cases, use terms such as “believes,” “estimates,” “anticipates,” “expects,” “plans,” “intends,” “may,” “could,” “might,” “will,” “should,” “approximately” or other words that convey uncertainty of future events or outcomes to identify these forward-looking statements. Forward-looking statements appear in a number of places throughout this Quarterly Report and include statements regarding our intentions, beliefs, projections, outlook, analyses or current expectations concerning, among other things, our ongoing and planned preclinical development and clinical trials, the timing of and our ability to make regulatory filings and obtain and maintain regulatory approvals for our product candidates, our intellectual property position, the degree of clinical utility of our products, particularly in specific patient populations, our ability to develop commercial functions, expectations regarding clinical trial data, our results of operations, cash needs, financial condition, liquidity, prospects, growth and strategies, the industry in which we operate and the trends that may affect the industry or us.

By their nature, forward-looking statements involve risks and uncertainties because they relate to events, competitive dynamics and industry change, and depend on the economic circumstances that may or may not occur in the future or may occur on longer or shorter timelines than anticipated. Although we believe that we have a reasonable basis for each forward-looking statement contained in this Quarterly Report, we caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition and liquidity, and the development of the industry in which we operate may differ materially from the forward-looking statements contained in this Quarterly Report. In addition, even if our results of operations, financial condition and liquidity, and the development of the industry in which we operate are consistent with the forward-looking statements contained in this Quarterly Report, they may not be predictive of results or developments in future periods.

Actual results could differ materially from our forward-looking statements due to a number of factors, including risks related to:

• our ability to obtain additional financing;
• our estimates regarding expenses, future revenues, capital requirements and needs for additional financing;
• our ability to continue as a going concern;
• obtaining and maintaining intellectual property protection for our product candidates and our proprietary technology;
• the success and timing of our preclinical studies and clinical trials;
• the difficulties in obtaining and maintaining regulatory approval of our products and product candidates, and the labeling under any approval we may obtain;
• our failure to recruit or retain key scientific or management personnel or to retain our executive officers;
• the accuracy of our estimates of the size and characteristics of the potential markets for our product candidates and our ability to serve those markets;
• regulatory developments in the United States and foreign countries;
• our ability to operate our business without infringing the intellectual property rights of others;
• recently enacted and future legislation regarding the healthcare system;
• our ability to satisfy the continued listing requirements of the NASDAQ Capital Market or any other exchange that our securities may trade on in the future;
• our plans and ability to develop and commercialize our product candidates;
• the rate and degree of market acceptance of any of our product candidates;
• the success of competing products that are or may become available; and
• the performance of third parties, including contract research organizations and manufacturers.

You should also read carefully the factors described in the “Risk Factors” section of our Annual Report on Form 10-K filed with the SEC on March 31, 2017, as amended, and elsewhere in our public filings to better understand the risks and uncertainties inherent in our business and underlying any forward-looking statements. As a result of these factors, we cannot assure you that the forward-looking statements in this Quarterly Report on Form 10-Q will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all.

Any forward-looking statements that we make in this Quarterly Report speak only as of the date of such statement, and, except as required by applicable law, we undertake no obligation to update such statements to reflect events or circumstances after the date of this Quarterly Report or to reflect the occurrence of unanticipated events. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless expressed as such, and should only be viewed as historical data.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) that are designed to provide reasonable assurance that information required to be disclosed by us in the reports 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 that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, we recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and we are required to apply our judgment in evaluating the cost-benefit relationship of possible internal controls. Our management evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered in this report. Based on that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of such period to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding disclosure.

Change in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended) that occurred during the quarter ended June 30, 2017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A - “Risk Factors,” in our Annual Report on Form 10-K for the year ended December 31, 2016 and our Quarterly Report on Form 10-Q for the period ended March 31, 2017, which could materially affect our business, financial condition or future results.

As of the date of this Quarterly Report on Form 10-Q, there have been no material changes with respect to the Company’s risk factors previously disclosed on Form 10-K for the year ended December 31, 2016 and Form 10-Q for the period ended March 31, 2017.