ITEM 2.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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You should read the following discussion of our financial condition and results of operations together with the unaudited interim 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, 2020. These risks could cause our actual results to differ materially from any future performance suggested below.
Diffusion Pharmaceuticals: Enhancing Oxygen, Fueling Life
We are an innovative biopharmaceutical company developing novel therapies that enhance the body’s ability to deliver oxygen to the areas where it is needed most. Our lead product candidate, TSC, is being developed to enhance the diffusion of oxygen to tissues with low oxygen levels, also known as hypoxia, a serious complication of many of medicine’s most intractable and difficult-to-treat conditions. In addition to TSC, our product candidate DFN-529, a novel, allosteric PI3K/Akt/mTOR pathway inhibitor, is in early-stage development.
Highlights from the First Quarter of 2021
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Completion of Dosing in TSC TCOM Trial – In March 2021, we completed enrollment and dosing of all 30 participants in the first of our three Oxygenation Trials, the TSC TCOM Trial, a Phase 1 trial utilizing a transcutaneous oxygen monitoring device to evaluate the pharmacodynamic effects of TSC on peripheral tissue oxygenation. We anticipate collection and analysis of topline data from the TSC TCOM Trial will be completed and announced by the end of the second quarter of 2021.
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Completion of TSC COVID Trial - In February 2021, we completed dosing of the twenty-fourth and final patient in our TSC COVID Trial evaluating TSC in hospitalized COVID-19 patients and announced that the primary endpoint was met, with no dose-limiting toxicities or serious adverse events observed among any patients in the study, including those who received the highest dose of 1.5 mg/kg every 6 hours. Evaluation of secondary endpoint data from this safety and tolerability trial remains ongoing and we anticipate topline data from these secondary endpoint analyses will be completed and announced before the end of May 2021.
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February 2021 Equity Offering – In February 2021, we completed the February 2021 Offering, an underwritten, public offering of approximately 33.7 million shares of our common stock for a purchase price to the public of $1.025 per share, resulting in aggregate net proceeds to the Company of $31.1 million, after deducting underwriting commissions, discounts, expenses and other offering costs. As a result, combined with our other cash and cash equivalents as of March 31, 2021, we expect that our existing cash and cash equivalents will enable us to fund our operating expenses and capital expenditures (including our planned clinical trials) through 2023.
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TSC Development Update
In November 2020, we announced plans to modify the TSC development program with the intent of accomplishing two principal strategic objectives: 1) Optimize the clinical dose and dosing frequency for TSC; and 2) Evaluate TSC in clinical models designed to establish proof of concept for improvement in oxygenation. Given the totality of available data, including clinical data from the more than 200 subjects included in our TSC clinical studies to-date, we have initiated a plan to execute three, short-term TSC Oxygenation Trials during 2021, to be conducted in the U.S. and funded with cash-on-hand, to explore the relationship between TSC dose and change in oxygenation.
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TSC TCOM Trial: TSC's Effects on Peripheral Tissue Oxygenation
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The first of the three Oxygenation Trials was the TSC TCOM Trial, for which the treatment of study participants was both commenced and completed dosing in March 2021. The transcutaneous oxygen monitoring, device directly measures the release of oxygen from the blood vessels through the skin and is commonly used to predict the likelihood of wound healing, the potential for success with hyperbaric therapy, and to map the appropriate location for limb amputation. The study was a double-blind, randomized, placebo-controlled study in healthy volunteers breathing 100% oxygen designed to test single, ascending doses of TSC in an attempt to establish the dose-response relationship between TSC and enhanced oxygen delivery. Thirty healthy volunteers were enrolled and randomized into one of six subgroups with each subject receiving supplemental oxygen and a single intravenous dose of placebo or one of five different doses of TSC ranging from 0.5 mg/kg to 2.5 mg/kg in a before/after design. The study was designed and statistically powered to evaluate the pharmacodynamic effects of TSC on peripheral tissue oxygenation. We anticipate data collection and analyses from the TSC TCOM Trial will be completed and topline data will be announced by the end of the second quarter of 2021. Dosing data from the TSC TCOM Trial will also be used to guide dose selection for the TSC Induced Hypoxia Trial and TSC DLCO Trial.
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TSC Induced Hypoxia Trial: TSC's Effects Under Induced Hypoxic Conditions
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The second TSC Oxygenation Trial is our planned TSC Induced Hypoxia Trial, which will evaluate the effects of TSC on maximal oxygen consumption, or VO2, and partial pressure of blood oxygen, or PaO2, in normal healthy volunteers subjected to incremental levels of physical exertion while exposed to hypoxic and hypobaric conditions. The TSC Induced Hypoxia Trial is expected to be a double-blind, randomized, placebo-controlled study, and primary endpoints in the study will be change from baseline in VO2 and PaO2 after receiving a single intravenous dose of TSC. The study will be statistically powered to evaluate the difference in effect of TSC versus placebo on oxygen availability and consumption. We anticipate this study will be initiated and completed in the second half of 2021, with topline results available within two months of study completion.
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TSC DLCO Trial: TSC's Effects on Oxygen Transfer Efficiency
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The third TSC Oxygenation Trial is our planned TSC DLCO Trial, which will evaluate the effects of TSC on the diffusion of carbon monoxide through the lungs, also known as DLCO, in patients with previously diagnosed interstitial lung disease who have a baseline DLCO test result that is abnormal. DLCO testing is commonly performed as part of standard pulmonary function testing and aids in the diagnosis or dyspnea, also known as shortness of breath, as well as to track improvement or progression over time on prescribed treatments. DLCO provides a surrogate measure of oxygen transfer efficiency, or uptake, from the alveoli of the lungs, through the plasma, and onto hemoglobin within red blood cells. The TSC DLCO Trial is expected to be a double-blind, randomized, placebo-controlled study which will test varied doses of TSC in an attempt to establish the exposure-response relationship between TSC and oxygen transfer efficiency. The study will be statistically powered to evaluate the difference in effect of TSC versus placebo on improvement in DLCO. We anticipate this study will be initiated and completed in the second half of 2021, with topline results available within two months of study completion.
We believe positive data from any one or more of the three Oxygenation Trials would provide evidence of a definitive effect of TSC on oxygenation. If such positive data are obtained from one or more of the Oxygenation Trials, we expect to announce in the fourth quarter of 2021 the identity of up to two hypoxia-related indications in which TSC would be studied as part of our clinical development strategy aimed at supporting regulatory approval and commercialization of TSC. The plan would be to initiate the identified clinical studies in the first quarter of 2022.
Financial Summary
As of March 31, 2021, we had cash and cash equivalents of $46.6 million. We have incurred operating losses since inception, have not generated any product sales revenue and have not achieved profitable operations. We incurred a net loss of $4.6 million for the three months ended March 31, 2021. Our accumulated deficit as of March 31, 2021 was $110.6 million, and we expect to continue to incur substantial losses in future periods. We also anticipate that our operating expenses will increase substantially as we continue to advance the development of TSC, including any costs related to:
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our ongoing and planned clinical trials, including the ongoing and planned TSC Oxygenation Trials and our Planned Hypoxia-related Indication Trials;
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any additional studies we may undertake, including other preclinical and clinical studies to support the filing of any new drug application with the U.S. Food and Drug Administration;
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other research, development, and manufacturing activities designed to develop and optimize formulation, manufacturing processes, dosage, dose forms, and other characteristics prior to regulatory approval;
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the maintenance, expansion, and protection our global intellectual property portfolio;
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the hiring of additional clinical, manufacturing, scientific, sales, or other personnel; and
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investments in operational, financial, and management information systems.
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We intend to use our existing cash and cash equivalents for working capital and to fund the research and development of TSC, including the TSC TCOM Trial, the TSC VO2 Trial, and the TSC DLCO Trial. We expect that our cash and cash equivalents as of March 31, 2021 will enable us to fund our operating expenses and capital expenditure requirements, including expected costs related to the planned TSC Oxygenation Trials and our Planned Hypoxia-related Indication Trials through 2023.
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
R&D expenses include, but are not limited to, third-party CRO arrangements and employee-related expenses, including salaries, benefits, stock-based compensation, and travel expense reimbursement. R&D 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 studies. As we advance our product candidates, we expect the amount of R&D costs will continue to increase for the foreseeable future. R&D costs are charged to expense as incurred.
General and Administrative Expense
G&A expenses consist principally of salaries and related costs for executive and other personnel, including stock-based compensation, other employee benefit costs, expenses associated with investment bank and other financial advisory services, and travel expenses. Other G&A expenses include, facility-related costs, communication expenses and professional fees for legal, patent prosecution and maintenance, consulting, accounting, and other professional services.
Interest Income
Interest income is interest earned from our cash and cash equivalents.
Income Tax Benefit
Prior to 2021, we recognized income tax benefit to utilize indefinite deferred tax liabilities as a source of income against indefinite lived portions of our deferred tax assets. As of December 31, 2020, we recognized the full income tax benefit allowed by the 2017 Tax Act to utilize indefinite deferred tax liabilities as a source of income against indefinite lived portions of our deferred tax assets. Our NOLs and tax credit carryforwards are subject to review and possible adjustment by the Internal Revenue Service and state tax authorities. NOL and tax credit carryforwards may become subject to an annual limitation in the event of a greater than 50.0% cumulative change in the ownership interest of significant stockholders over a three year period, as defined under Sections 382 and 383 of the Internal Revenue Code as well as similar state provisions. These limitations may, in certain cases, limit the amount of income tax benefit that can be utilized annually to offset taxable income or tax liabilities in future periods. The amount of the annual limitation is determined based on the Company’s value immediately prior to the ownership change, and subsequent ownership changes may further affect the limitation in future years. In 2019, due to the significant changes to our stockholder base as a result of the equity financing we complete during that year, we performed an analysis under Section 382 of the Internal Revenue Code and, as a result, reduced the magnitude of our NOL carryforwards to account for the ownership changes. In addition, the cumulative benefit of our NOLs was remeasured, resulting in tax expense recognized during the year ended December 31, 2019. We have not yet performed an analysis to determine whether or not ownership changes that have occurred in year ended December 31, 2020 or during the three months ended March 31, 2021 give rise to any further limitations.
Results of Operations for Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020
The following table sets forth our results of operations for the three months ended March 31, 2021, and 2020.
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Three Months Ended March 31,
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2021
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2020
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Change
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Operating expenses:
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Research and development
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$
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2,916,378
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$
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1,534,467
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$
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1,381,911
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General and administrative
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1,743,510
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1,393,808
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349,702
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Depreciation
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24,447
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27,020
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(2,573
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Loss from operations
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4,684,335
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2,955,295
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1,729,040
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Other income:
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Interest income
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(40,416
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)
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(34,100
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)
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(6,316
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)
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Loss from operations before income tax benefit
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(4,643,919
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)
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(2,921,195
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)
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(1,722,724
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)
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Income tax benefit
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—
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(362,380
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)
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362,380
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Net loss
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$
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(4,643,919
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)
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$
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(2,558,815
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)
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$
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(2,085,104
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)
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We recognized $2.9 million in research and development expenses during the three months ended March 31, 2021 compared to $1.5 million during the three months ended March 31, 2020. A significant portion of this increase was attributable to the $0.7 million of costs incurred related to our TSC COVID Trial, which was initiated in September 2020, and $0.6 million of costs incurred related to our TSC TCOM trial, which was initiated in March 2021. Manufacturing costs also increased by $0.5 million to support these trials. Additionally, salaries and wages increased by $0.2 million. These increases were slightly offset by decreases of $0.5 million and $0.1 million related to the wind-down of our TSC Stroke Trial and our TSC GBM Trial, respectively.
General and administrative expenses increased by $0.3 million during the three months ended March 31, 2021 compared to the three months ended March 31, 2020, mainly due to an increase in salaries and wages, stock-based compensation and professional fees, including additional amounts related to increased headcount and costs associated with the separation of former executives that will not recur in future years.
The increase in interest income for the three months ended March 31, 2021 compared to the three months ended March 31, 2020 is primarily attributable to having a larger cash and cash equivalents balance earning more interest during the three months ended March 31, 2021 compared to the three months ended March 31, 2020.
During the three months ended March 31, 2020, we recognized income tax benefit of $0.4 million during the three months ended March 31, 2020, to reflect the utilization of indefinite deferred tax liabilities as a source of income against indefinite lived portions of the our deferred tax assets. Prior to 2021, we recognized the full income tax benefit allowed by the 2017 Tax Act to utilize indefinite deferred tax liabilities as a source of income against indefinite lived portions of our deferred tax assets. No additional benefit was recognized during the three months ended March 31, 2021 as the benefit was fully realized in prior periods.
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. As of March 31, 2021, we had $46.6 million in cash and cash equivalents, working capital of $45.2 million and an accumulated deficit of $110.6 million. We expect to continue to incur net losses for the foreseeable future. We intend to use our existing cash and cash equivalents to fund our working capital and research and development of our product candidates.
Cash Flows
The following table sets forth our cash flows for the three months ended March 31, 2021 and 2020:
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Three Months Ended March 31,
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Net cash (used in) provided by:
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2021
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2020
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Operating activities
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$
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(5,176,370
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)
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$
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(3,504,314
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)
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Financing activities
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33,295,752
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155,193
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Net increase (decrease) in cash and cash equivalents
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$
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28,119,382
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$
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(3,349,121
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)
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Operating Activities
Net cash used in operating activities of $5.2 million during the three months ended March 31, 2021 was primarily attributable to our net loss of $4.6 million and our net change in operating assets and liabilities of $0.7 million. This amount was offset by $0.2 million in stock-based compensation expense and depreciation expense. The net change in our operating assets and liabilities is primarily attributable to a decrease in our accrued expenses and other current liabilities due to the timing of our payments to our vendors and employees as well as an increase in our prepaid expenses, deposits and other current assets.
Net cash used in operating activities of $3.5 million during the three months ended March 31, 2020 was primarily attributable to our net loss of $2.6 million, our net change in operating assets and liabilities of $0.8 million and our change in deferred income taxes of $0.4 million. This amount was offset by $0.2 million in stock-based compensation expense and depreciation expense. The net change in our operating assets and liabilities is primarily attributable to a decrease in our accounts payable and accrued expenses due to the timing of our payments to our vendors and employees as well as an increase in our prepaid expenses, deposits and other current assets.
Financing Activities
Net cash provided by financing activities was $33.3 million during the three months ended March 31, 2021, which was attributable to net proceeds of $31.1 million received from the sale of our common stock and $2.2 million in proceeds received from the exercise of common stock warrants.
Net cash provided by financing activities was $0.2 million during the three months ended March 31, 2020, which was attributable to the $0.4 million in proceeds received from the exercise of common stock warrants, offset by approximately $0.2 million in payments for offering costs.
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 TSC. Our operations have consumed substantial amounts of cash since inception and we expect to continue to spend substantial amounts of cash to advance the clinical development of TSC, DFN-529, and our other product candidates. As of the date of this Annual Report, most our cash resources for clinical development are dedicated to our ongoing and planned TSC Oxygenation Trials and our Planned Hypoxia-related Indication Trials. While we believe we have adequate cash resources to continue operations through 2023, we anticipate that we will need additional funding in order to complete development of TSC which, if available, could be obtained through additional capital raising transactions, entry into strategic partnerships or collaborations, or alternative financing arrangements.
As of March 31, 2021, we did not have any credit facilities in place under which we could borrow funds or any other sources of committed capital. In the future, we may seek to raise additional funds through various sources. However, 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 TSC or our product candidates, or we may need to obtain funds through collaborations or otherwise on terms 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 adequate additional capital as and when required in the future, we could be forced to cease development activities and terminate our operations, and you could experience a complete loss of your investment.
To the extent that we raise additional capital in the future through the sale of our common stock or securities convertible or exchangeable for common stock such as common stock warrants, convertible preferred stock, or convertible debt instruments, the interests of our current stockholders may be diluted or otherwise impacted. 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.
Critical Accounting Policies
The Critical Accounting Policies included in our Form 10-K for the year ended December 31, 2020, filed with the SEC pursuant to Section 13 or 15(d) under the Securities Act on March 16, 2021 have not changed.