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 Reports on Form 10-Q for the quarterly periods ended March 31, 2021 and June 30, 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 a 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.

TSC Development Update

Our Lead Indication: Using TSC to Treat Hypoxic Solid Tumors

Solid tumors comprise approximately 90% of all adult cancers and, according to the American Cancer Society, roughly 1.9 million new cancer cases will be diagnosed in the U.S. during 2021.  It is also well-documented in the scientific literature that the prevalence of hypoxic regions across numerous primary solid tumor types directly contributes to treatment resistance whether it be radiotherapy, chemotherapy, and immunotherapy, increasing the metastatic potential of these tumors and the probability of unsuccessful treatment. We believe TSC’s novel mechanism of action lends itself to treating this unmet medical need, so we are designing our Hypoxic Solid Tumor Program to support the use of TSC as a treatment of hypoxic solid tumors.

This program is being designed based on previously obtained data that we believe support the potential benefits of TSC as a treatment for hypoxic solid tumors, including preclinical evidence supporting TSC’s enhancement of radiotherapy and clinical evidence of TSC's effects in unresectable glioblastoma multiforme tumors from our previous Phase 2 study evaluating TSC in patients with GBM treated with standard of care radiation and chemotherapy. Additionally, with the outcome of the TCOM Trial, originally reported in June 2021, we believe we now have direct evidence of TSC's ability to enhance oxygenation in humans, including additional dosing information that will be integral to designing a clinical study to treat hypoxic solid tumors. 

Our plan is to use the information obtained to date on TSC to submit a briefing document related to our development plan for discussion with the FDA during the first quarter of 2022.  In addition to questions about clinical trial design and chemistry, manufacturing, and controls, we anticipate the submission will include the information required to obtain FDA feedback on potential accelerated pathways to approval for TSC. In addition, the results of the Altitude Trial and ILD-DLCO Trial, which we anticipate reporting during the first half of 2022 as further described below under the heading, “Our Oxygenation Trials,” will also be used to further guide the design of the program.  We believe receiving FDA feedback on the proposed regulatory pathway underlying our Hypoxic Solid Tumor Program will enhance the probability of successfully developing and, if approved, commercializing TSC for use as a treatment for hypoxic solid tumors.

Accordingly, the start of the first study in our Hypoxic Solid Tumor Program, which we currently expect to be a Phase 2 clinical trial, will be subject to the timing of FDA feedback and the availability of clinical drug supply. 

Our Oxygenation Trials

TCOM Trial: TSC's Effects on Peripheral Tissue Oxygenation

In June 2021, we reported a positive trend in oxygenation from our TCOM Trial, which evaluated the effect of TSC versus placebo on peripheral tissue oxygenation in healthy normal volunteers using transcutaneous oxygen monitoring. Analysis of the primary endpoint data indicated a positive dose-response trend in TCOM readings with TSC as compared to placebo that persisted through the measurement period, and the trends observed in the primary endpoint data indicated an improvement in peripheral oxygenation with TSC with no evidence of hyperoxygenation.

In September 2021, we issued a letter to our stockholders including a further discussion of the results of the TCOM Trial, as well as certain additional facts and figures from our supplemental analysis of the study data.

Figure 1. Effects of TSC on transcutaneous oxygen pressure (tcpO2). The graph was created by subtracting the median placebo response from the dose and time matched median TSC response.

For example, the chart above was created by subtracting the median response observed in the TCOM Trial's placebo group from the median response observed in each TSC dosage group at each of the measurement times during the one-hour period following dosing. As you can see in the chart, these data indicate peripheral tissue oxygenation increased relative to the placebo group following TSC administration and persisted through the one-hour measurement period, particularly at the two highest doses tested (2.0 mg/kg and 2.5 mg/kg).

We believe the results of the TCOM Trial provide clinical evidence that TSC facilitates the passive diffusion of oxygen from areas of high concentration to areas of low concentration without causing hyperoxygenation and, accordingly, represent a positive and meaningful step towards the accomplishment of the overall strategic objectives of our Oxygenation Trials set forth in November 2020. Moreover, the doses at which the largest effects of TSC were observed in the TCOM study are higher than the doses tested in any of the recent clinical trials of TSC, and these data obtained from the TCOM Trial is being used to guide the design of our remaining Oxygenation Trials – the Altitude Trial and the ILD-DLCO Trial.

We believe the two remaining Oxygenation Trials, the Altitude Trial and the ILD-DLCO Trial, remain integral to our overall development plan for TSC, as they are intended to provide further information regarding TSC’s mechanism of action and dose response characteristics, as well as support for what we view as the broad therapeutic potential of TSC to treat a variety of conditions complicated by hypoxia.  As described below, the Altitude Trial is designed to provide specific information on TSC’s effects on oxygen consumption and the ILD-DLCO Trial is designed to evaluate the effects of TSC on the uptake of oxygen through the lungs.  Accordingly, we intend to continue to execute the Altitude Trial and the ILD-DLCO Trial to develop this additional data in parallel with designing our Hypoxic Solid Tumor Program.

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 trial will evaluate the difference in effect of TSC on oxygen availability and consumption compared to placebo. We expect to dose the first patient in the Altitude Trial in the coming days, to complete dosing of patients in the study in late December 2021 or early January 2022, and anticipate reporting topline results from the study within two months of 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 evaluate the difference in effect of TSC on improvement in DLCO, as well as distance covered in a standard six-minute walk test. We anticipate initiating the ILD-DLCO Trial in the late fourth quarter of 2021 and completing the study in the first quarter of 2022, with topline results reported within two months of study completion.

Further, during the third quarter of 2021, we received clearance of our IND for TSC from the Pulmonary, Allergy, and Critical Care division of the FDA, an important step as we prepare to initiate the ILD-DLCO Trial. This also represents the fourth division with which we have an open IND for TSC – joining the Cardiology and Nephrology, Neurology, and Oncology divisions – which we believe underscores TSC’s broad therapeutic potential to treat a variety of conditions complicated by hypoxia.

The information we expect to obtain from the Altitude Trial and ILD-DLCO Trial during the first half of 2022 — particularly when combined with the information we have acquired over the last year from the TCOM Trial and our COVID-19 Trial — will continue to refine and enhance our understanding of TSC’s mechanism of action, dose-response effects, and, more specifically, effects on oxygen consumption and uptake of oxygen through the lungs.  In addition to providing insights regarding additional, non-oncology indications in which the TSC platform may have potential, the results of the Altitude Trial and ILD-DLCO Trial will also inform our design of our Hypoxic Solid Tumor Program studies. 

TSC Supply Chain Update

As broadly reported by companies across industrial sectors, supply chain disruptions, shortages, and other issues have been widespread during 2021, and we have also recently been subject to delays and interruptions in our TSC drug supply. As previously reported in our Annual Report , TSC is currently manufactured by our primary CMO partner at a facility that now manufactures COVID-19 vaccines under the Defense Production Act. In response these delays and interruptions, we are in the process of evaluating opportunities to increase the robustness of our drug supply and overall supply chain to be more responsive to our needs.

We are actively managing this process and believe we are taking the necessary steps to ensure the availability of high-quality drug supply to support the next steps in TSC’s development. However, TSC is a freeze-dried, injectable product requiring a sophisticated manufacturing process. As a result, any change to all or a portion of our manufacturing process, together with uncertainty regarding the general availability of manufacturing materials as a result of more general global supply chain shortages and disruptions, could affect the cost and timing of the available clinical study drug supply of TSC.

Organizational Update

Enhancing Our Organization, Embracing Remote Work

During the third quarter, we continued to enhance our operating team with the addition of new employees in a variety of functions across our organization, including clinical operations, CMC, finance, and, more recently, medical writing. As part of our growth strategy, we have embraced the remote work culture that became prevalent at many organizations during the COVID-19 pandemic. We believe our people are critical to our ability to efficiently and successfully execute our stated strategy, and this remote operating paradigm allows us to enhance our available pool of talented human resources while also conserving financial resources. For example, in November 2021, we negotiated and entered into an agreement providing for the early termination of our lease of the Carlton Avenue facility in Charlottesville, Virginia. We also believe in the power of collaboration. In turn, and in lieu of the fixed office and laboratory space previously available to us under that agreement, we have recently entered into short term agreements to utilize membership-based co-working space in both Charlottesville, Virginia and Philadelphia, Pennsylvania. We believe these arrangements will permit our team combine the advantages of remote and in-person work in environments intended to foster creativity and innovation.

Financial Summary

As of September 30, 2021, we had cash and cash equivalents of $40.3 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 $12.2 million and $20.6 million for the three and nine months ended September 30, 2021, respectively. Our accumulated deficit as of September 30, 2021 was $126.5 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. We expect that our cash and cash equivalents as of September 30, 2021 will enable us to fund our operating expenses and capital expenditure requirements 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.

Intangible Asset Impairment Charge

In the third quarter of 2021, the Company made a determination to no longer dedicate resources to the Company’s DFN-529 intangible asset and any future development efforts were abandoned.  In connection with this decision, the Company concluded that DFN-529 was impaired in its entirety.

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

The Company recorded an income tax benefit of $0.4 million during the three and nine months ended September 30, 2021, respectively. The income tax benefit was due to the tax effect of the reduction in the deferred tax liability associated with the basis difference from the IPR&D indefinite lived intangible asset. The Company maintains a full valuation allowance against its deferred tax assets due to the Company’s history of losses as of September 30, 2021.

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. 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 nine months ended September 30, 2021 give rise to any further limitations.

We recognized $2.1 million in R&D expenses during the three months ended September 30, 2021 compared to $3.1 million during the three months ended September 30, 2020. This decrease was due to lower project spending due to the completion and/or wind-down of our clinical studies evaluating TSC in Covid-19, GBM, and stroke.

We recognized a non-recurring $8.6 million non-cash impairment charge related to the write down of our DFN-529 IPR&D asset.

G&A expenses were $1.9 million during the three months ended September 30, 2021 compared to $2.1 million during the three months ended September 30, 2020. The decrease in G&A expenses was primarily due to a $0.5 million decrease in salaries related to executive separation payments recorded in the prior year period as well as a $0.2 million decrease in outside legal and professional fees. This decrease was partially offset by an increase in salaries and other costs associated with the hiring of new employees to support our R&D efforts as well as an increase in insurance costs.

We recognized an income tax benefit of $0.4 million due to the tax effect of the reduction in the deferred tax liability associated with the basis differences from the DFN-529 IPR&D intangible asset that was written down in the third quarter of 2021. We recognized an income tax benefit of $0.8 million during the three months ended September 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.

We recognized $7.0 million in R&D expenses during the nine months ended September 30, 2021 compared to $6.8 million during the nine months ended September 30, 2020. This increase was primarily attributable to a $1.2 million increase in expense related to drug manufacturing as described in part above under the heading “TSC Supply Chain Update.” and a $0.6 million increase in salary and related expenses due to increases in headcount. These increases were offset by lower project spending due to the completion and/or wind-down of our clinical studies evaluating TSC in Covid-19, GBM, and stroke.

We recognized a nonrecurring $8.6 million non-cash impairment charge related to the write down of our DFN-529 IPR&D asset.

G&A expenses were $5.5 million during the nine months ended September 30, 2021 compared to $5.0 million during the nine months ended September 30, 2020. The increase in G&A expense was primarily due to a $1.0 million increase in salaries and other costs associated with the hiring of new employees. These amounts were slightly offset by $0.5 million in salaries related to executive separation payments recorded in the prior year period.

We recognized an income tax benefit of $0.4 million due to the tax effect of the reduction in the deferred tax liability associated with the basis differences from the DFN 529 IPR&D intangible asset that was written down in the third quarter of 2021. We recognized an income tax benefit of $1.7 million during the nine 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.

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 September 30, 2021, we had $40.3 million in cash and cash equivalents, working capital of $38.0 million and an accumulated deficit of $126.5 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 $11.5 million during the nine months ended September 30, 2021 was primarily attributable to our net loss of $20.6 million and a change in our deferred income taxes of $0.4 million. These amounts were partially offset by a $8.6 million non cash impairment charge in connection with the write down of our DFN-529 IPR&D asset, $0.6 million in stock-based compensation expense, and a net change in our operating assets and liabilities of $0.2 million.

Net cash used in operating activities of $10.2 million during the nine months ended September 30, 2020 was primarily attributable to our net loss of $10.1 million and our change in deferred income taxes of $1.7 million. These amounts were partially offset by a net change in operating assets and liabilities of $1.4 million, $0.6 million in stock-based compensation expense, and $0.1 million in depreciation expense. The net change in our operating assets and liabilities was primarily attributable to an increase in accounts payable and accrued expenses and was slightly offset by 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 nine months ended September 30, 2021, which was attributable to net proceeds of $31.1 million received from the sale of our common stock in connection with the February 2021 Offering and $2.2 million in proceeds received from the exercise of previously issued common stock warrants.

Net cash provided by financing activities of $17.9 million during the nine months ended September 30, 2020, was primarily attributable to $10.8 million in gross proceeds received in connection with the May 2020 Offering and $8.0 million in gross proceeds received in connection with the exercise of previously outstanding warrants to purchase common stock. These cash inflows were offset in part by the payment of $1.0 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 the TSC platform, as well as associated investments into our manufacturing, regulatory, and other related capabilities. As of the date of this Quarterly Report, most our cash resources for clinical development are dedicated to our remaining Oxygenation Trials and our Hypoxic Solid Tumor Program, near-term investments intended to improve the quality and robustness of our supplier relationships and overall supply chain, and general operating expenses. 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 September 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, including as a result of unanticipated market shocks, such as the COVID-19 pandemic and ongoing global supply chain disruptions, or inflationary pressure. 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.