DFFN Diffusion Pharmaceuticals Inc

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 and under “Part II—Other Information – Item 1A. Risk Factors” in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2021. 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.

TSC Second Quarter Development Update

In May 2021, we announced final results of our COVID Trial, which we initiated in 2020 due to a belief in the potential of TSC to improve low tissue oxygen levels, a common complication of COVID-19. The study’s primary objective was to evaluate the safety and tolerability of TSC administered on a more frequent dosing regimen not previously tested in a clinical trial setting, and the secondary and exploratory endpoints for the trial included time to improvement in World Health Organization ordinal scale by day 7 and through day 29, time on oxygen supplementation, and hospital length of stay. Although the study was not designed or powered to evaluate efficacy, the study’s external safety monitoring committee observed that patients receiving the 1.5 mg/kg dose had improved outcomes in these secondary and exploratory endpoints compared to those receiving lower doses.

In June 2021, the Company reported a positive trend in oxygenation from the TCOM Trial. The TCOM Trial was designed to evaluate the effect of TSC versus placebo on peripheral tissue oxygenation in healthy normal volunteers. Topline results based upon analyses of primary endpoint data indicated, as compared to placebo, a positive dose-response trend in TCOM readings after TSC administration that persisted through the measurement period with no evidence of hyperoxygenation. TSC was also safe and well-tolerated at all doses tested.

The TCOM Trial was a randomized, double-blind, placebo controlled, pharmacokinetic and pharmacodynamic study of TSC that enrolled and dosed 30 healthy volunteers. Trial participants were randomized into one of six subgroups, each of which received 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. All trial participants received supplemental oxygen during equivalent, one-hour monitoring periods before and after TSC or placebo was administered while subjects were continuously monitored with TCOM sensors applied to their lower extremity. The primary endpoint evaluated the relative change in TCOM readings from baseline after TSC administration compared to placebo.

TSC Development Plans for 2021 and 2022

We remain focused on our over-arching clinical development plan announced in November 2020 designed to accomplish 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. As part of this plan, we are currently focused on the execution of our three, short-term Oxygenation Trials to explore the relationship between TSC dose and change in oxygenation. These studies are being conducted in the U.S. during 2021in and will be funded with cash-on-hand.

The positive trend observed in the TCOM Trial is being used to guide dose selection in the additional Oxygenation Trials planned for the latter part of 2021 -- the Altitude Trial, followed by  the ILD-DLCO Trial.

Altitude Trial: TSC’s Effects Under Induced Hypoxic Conditions

This trial will be a double-blind, randomized, placebo-controlled study 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 (i.e., simulated altitude). The study is designed to evaluate the effect of TSC on oxygen availability and consumption compared to placebo. We anticipate initiating and completing the Altitude Trial in the fourth quarter of 2021, with topline results available within one to two months of study completion.

ILD-DLCO Trial: TSC's Effects on Oxygen Transfer Efficiency

This trial will be a double-blind, randomized, placebo-controlled study which will evaluate the effects of TSC on the diffusion of carbon monoxide through the lungs, or DLCO, in patients with previously diagnosed interstitial lung disease who have an abnormal baseline DLCO test result. DLCO will act as 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 study will be statistically powered to evaluate the difference in effect of TSC on improvement in DLCO, as well as distance covered in a standard six-minute walk test.

We now anticipate initiating the ILD-DLCO Trial in the late fourth quarter of 2021 and completing the trial in the first quarter of 2022, with topline results available within one to two months of study completion.

Planned Phase 2 Hypoxia-related Indication Trial

We expect to announce in the fourth quarter of 2021 the initial indication in which TSC will be studied to support the planned pathway for regulatory approval and to initiate the Planned Phase 2 Hypoxia-related Indication Trial during the first half of 2022, funded with cash-on-hand.

Organizational Update

During the second quarter, we enhanced our operating team with the addition of new employees in the areas of administration, quality assurance, clinical operations, and finance. In addition, in connection with our annual meeting of stockholders in June 2021, Jane Hollingsworth was elected as the new Chair of our board of directors and Diana Lanchoney, M.D. and Eric Francois were newly elected to our board of directors.

We believe the totality of these organizational additions has already had a significant, positive impact on our ability to develop, implement and execute on our corporate strategy and development plans and position us well to build shareholder value through our next stage of growth.

Financial Summary

As of June 30, 2021, we had cash and cash equivalents of $43.3 million. We have incurred operating losses since inception, have not generated any product revenue and have not achieved profitable operations. We incurred net losses of $3.8 million and $8.4 million for the three and six months ended June 30, 2021, respectively. Our accumulated deficit as of June 30, 2021 was $114.3 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 the development of TSC, including any costs related to:

We intend to use our existing cash and cash equivalents for working capital and to fund the research and development of TSC, including the Altitude Trial and the ILD-DLCO Trial. We expect that our cash and cash equivalents as of June 30, 2021 will enable us to fund our operating expenses and capital expenditure requirements, including expected costs related to the planned Oxygenation Trials and our Planned Hypoxia-related Indication Trial(s) 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

We recognize income tax benefit 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 completed 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 the year ended December 31, 2020 or during the three or six months ended June 30, 2021 give rise to any further limitations.

We recognized approximately $2.0 million in R&D expenses during the three months ended June 30, 2021 compared to approximately $2.2 million during the three months ended June 30, 2020. This decrease was attributable to $0.7 million related to the wind-down of our trial evaluating TSC in the treatment of glioblastoma multiforme brain cancer. Additionally, costs related to our COVID Trial decreased by $0.2 million during the three months ended June 30, 2021. These decreases were offset by increases of $0.3 million in salaries and wages, increases of $0.2 million for costs related to our TCOM trial, which was initiated and completed in March 2021, and increases of $0.2 million in other research and development expenses.

G&A expenses were $1.8 million during the three months ended June 30, 2021 compared to $1.5 million during the three months ended June 30, 2020. The increase in G&A expenses was primarily due to a $0.3 million increase in salaries, wages and stock-based compensation expenses, including additional amounts related to increased headcount and costs associated with the separation of former executives which will not recur in future years. Additionally, insurance and other general and administrative expenses increased by $0.1 million during the period. These increases were offset by a decrease of $0.1 million in professional service fees.

We recognized an income tax benefit of $0.5 million during the three months ended June 30, 2020 to reflect the utilization of indefinite deferred tax liabilities as a source of income against indefinite lived portions of 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 June 30, 2021 as the benefit was fully realized in prior periods.

We recognized $4.9 million in R&D expenses during the six months ended June 30, 2021 compared to $3.7 million during the six months ended June 30, 2020. A significant portion of this increase was attributable to $0.8 million of costs related to our TCOM trial, which was initiated and completed in March 2021, and $0.5 million of costs incurred related to our COVID Trial, which was initiated in September 2020 and completed in February 2021. Manufacturing costs also increased by $0.6 million to support these trials. Additionally, salaries and wages increased by $0.5 million. These increases were offset by decreases of $0.8 million and $0.3 million related to the wind-down of our trials evaluating TSC in the treatment of glioblastma multiforme brain cancer and stroke, respectively.

G&A expenses were $3.6 million during the six months ended June 30, 2021 compared to $2.9 million during the six months ended June 30, 2020. The increase in G&A expense was primarily due to a $0.6 million increase in salaries, wages and stock-based compensation expense, including additional amounts related to increased headcount and costs associated with the separation of former executives which will not recur in future years. Additionally, insurance and other general and administrative expenses increased by $0.1 million during the period.

We recognized an income tax benefit of $0.9 million during the six months ended 2020, to reflect the utilization of indefinite deferred tax liabilities as a source of income against indefinite lived portions of 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 six months ended June 30, 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 June 30, 2021, we had $43.3 million in cash and cash equivalents, working capital of $41.8 million and an accumulated deficit of $114.3 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.

Operating Activities

Net cash used in operating activities of $8.5 million during the six months ended June 30, 2021 was primarily attributable to our net loss of $8.4 million and our net change in operating assets and liabilities of $0.6 million. This amount was offset by $0.5 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 $6.6 million during the six months ended June 30, 2020 was primarily attributable to our net loss of $5.7 million, our deferred income taxes of $0.9 million and our net change in operating assets and liabilities of $0.5 million. These amounts were offset by $0.3 million in stock-based compensation expense, and $0.1 million in depreciation expense. The net change in our operating assets and liabilities is primarily attributable to an increase in our prepaid expenses, deposits and other current assets, which was slightly offset by an increase in accounts payable.

Financing Activities

Net cash provided by financing activities was $33.3 million during the six months ended June 30, 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 $18.0 million during the six months ended June 30, 2020, which was attributable to the $10.8 million in gross proceeds received upon the sale of our common stock and warrants plus $8.0 million in gross proceeds received from the exercise of common stock warrants. These cash inflows were offset in part by the payment of $0.8 million in financing 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 Quarterly Report, most of our cash resources for clinical development are dedicated to our Oxygenation Trials and our Planned Hypoxia-related Indication Trial. 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 June 30, 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.