Good morning, and welcome to the Discovery Labs Inc. Second Quarter Financial Results and Business Update. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Will Roberts. Please go ahead, sir..

Thank you, Denise, and good morning to everybody joining Discovery Labs' call this morning. Today's call is to discuss the 2014 second quarter financial results, as well as recent business updates. Before we begin, I want to remind you that today's conference call will contain forward-looking statements.

These statements relate to future events or the company's future financial performance.

Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from any future results expressed and/or implied by such statements, especially those inherent in the process of discovering, developing and commercializing our products.

Listeners are cautioned not to rely on these forward-looking statements, as actual results could vary materially from those described as a result of a number of factors, including those set forth in our 2013 annual report on Form 10-K and on any subsequent SEC filings.

And with that, I'll turn the call over to John Cooper, Discovery Labs' Chief Executive Officer.

John?.

Thank you very much, and good morning, everybody. We issued a press release this morning with our earnings and some updates regarding our key programs. I certainly hope everybody's had a chance to see that. If not, then, of course, we'll cover that this morning.

We've organized this call to first start with an overview of our progress, and the progress is all about what we're trying to accomplish, and I'll use the term long term. We feel very confident in the technology platform that we have.

Again, we believe we have the world's foremost leading surfactant, peptide-containing synthetic surfactant, that mimics what we all have in our lungs. And we have a desire, a belief, a goal to use this surfactant, develop this surfactant, so that years from now, there is basically a new medical capability that's available to critical care medicine.

And we're starting in the field of neonatology, a field that has, as we've mentioned many times, I would say, been limited in terms of the development of surfactant technology.

The 2 animal-derived surfactants, they've been very effective, they've been very helpful, they've changed the course of neonatal medicine, but we believe our technology platform is that next leap, that next change in neonatal medicine, in applying it to respiratory distress syndrome.

That's where we're going to focus today in our programs with SURFAXIN and with AEROSURF. I'm joined today by Dr. Rusty Clayton. The majority of our prepared remarks will be covered by Dr. Clayton on the AEROSURF program, a program that is very exciting.

We are in the throes of a Phase IIa clinical program that we've been looking forward to for a long, long, long time, and it's good to know that we're in the middle of that. We're moving forward. We're excited about it. Dr. Clayton is going to take us through some of the details, at least the details that we can share today.

But the program is a very exciting program. In general, the program overall remains on track. We have a Phase II program that remains on track to be completed in the second half of 2015.

We will be going through the Phase IIa portion of that, there have been some changes to that, we believe changes to the good that are very instrumental in our learnings, and we'll be updating that. Now being very straightforward, the data from that program was expected to be available later this quarter.

We're now adjusting that into the fourth quarter. But Dr. Clayton will take us through that and I think you'll find the reasons for doing so as being smart and compelling. Next, we are -- I'm also joined here by Dr. Tom Miller, who is our Chief Operating Officer. Dr. Miller will take us through the progress we're making on SURFAXIN.

Remember, we've said for long time, SURFAXIN represents the first step in the application of our technology in the application of a peptide-containing synthetic surfactant to help these very fragile premature infants with respiratory distress syndrome. We've said for a long time that we were be going to be very measured and very deliberate.

Very important that the experiences within the hospital community in the United States are comfortable with the product, comfortable with what they see and begin to adopt that product. That will take time. And we're focus, of course, on gaining formulary acceptance throughout the, again, the United States on -- with hospitals.

And really, key, building very strong long-lasting relationships with key centers of influence. If we do that, if we do that successfully, at some point, can't today exactly predict, but at some point, an inflection point will kick in. And it's our goal to make sure that, at some point in time in the future, we've done everything to make that happen.

And Dr. Miller will take us through that. And I'm also joined today by Mr. John Tattory, our Chief Financial Officer, and John will provide the financial results for the company. And of course, we are all available during the Q&A session of this call.

So we'll try to move this briefly as we possibly can, but yet tell compelling information, honest information in terms of where we stand, so then we can get to Q&A. So with that, I'd like to turn the call over to our Chief Operating Officer, Dr. Tom Miller..

Thank you, John. And good morning, everyone. Thanks for taking time out of your schedule to join this morning. Second quarter of 2014 was our second full quarter on the U.S. market with SURFAXIN. We are making progress, very calculated and deliberate progress, as John indicated. We are seeing traction in the U.S.

market for SURFAXIN, as we begin to enable a change in the treatment paradigm from a dependence on animal-derived medications that's been -- that have been in place for more than 20 years. There is only one option to animal-derived surfactants today, and that is SURFAXIN, the first and only synthetic peptide-containing therapeutic surfactant.

It's not just the synthetic nature of SURFAXIN that makes it an exciting alternative. SURFAXIN is a purposely designed surfactant, designed to closely match the function of human surfactant that helps us all breathe somewhat effortlessly.

It has been designed to reduce surfactant inactivation, which occurs frequently in the neonatal lung under the diagnosis of respiratory distress syndrome. And it has also been designed to provide the right volumetric dose to optimize therapeutic surfactant distribution throughout the neonatal lung.

In addition to the impactful clinical observations that we've shared with this audience a number of times. These are important attributes that are important to differentiate SURFAXIN from animal-derived surfactants. But progress takes time, as John indicated.

Remember that our strategy is to target a focus universe of hospitals, including 30 centers of influence and certain related hospital systems first, as these centers will implement usage by peripheral hospitals through affiliations.

Also, as we've discussed in the past, in order to convert a center of influence to SURFAXIN utilization or any hospital, as we've indicated and defined our implementation strategy, we do not employ a traditional sales model.

But rather, we use an integrated approach that includes professional sales representatives, a field-based medical affairs team and efforts to optimize the reach of our educational initiatives. I'll remind you that as of our last call in early May, we were either on formulary or allowed restricted use in 10 facilities.

We had good progress since that point in time, and SURFAXIN can now be used in 15 centers in the United States.

Based upon our current calendar per pharmacy and therapeutic committees, which is the committee that ultimately approves utilization for products in a facility, for the rest of the quarter and throughout the balance of 2014, we think this upward trend should continue and potentially accelerate.

I'm also happy to report that 3 of our 15 hospitals that currently have allowable surfactant use are among our 30 center of influence facilities. We started the targeted effort in the second quarter, so we're enthusiastic at about the 10% penetration into this very important strategic initiative early on.

When we look across these 15 facilities, in which we're either on formulary or allowed restricted use, I'm also happy to indicate that we're exclusive in 4 of these facilities. Out of the gate, we assumed a relatively low likelihood of facility exclusivity early on in launch.

And while we don't know if we can grow and maintain this percentage, it's certainly a very good start, and I'm very proud of the field team's efforts in this regard. We've discussed at length the challenges associated with potential time frames associated with getting a new hospital product off the formulary.

The neonatologist interest in our product is high, but as we've discussed, the primary challenge is locking down the time frame for pharmacy and therapeutic committee meetings, and assurance that, that schedule won't change. For example, nearly 50% of our P&T meetings have been rescheduled many multiple times.

That's the reality of introducing a new hospital product today. But once that meeting takes place, we have been successful the overwhelming majority of time, so it's tangible and delivered progress.

In addition, as John indicated, I think it's important to note that as we work through the development of these relationships, as we advance the surfactant initiatives, these relationships with key centers and thought leaders can be effectively leveraged for AEROSURF program.

And the neonatal community is quite excited about the potential future for this exciting program as well. At the same time, [ph] the NICU teams around the country and continue to hear excitement around AEROSURF, it's clear that we have a tremendous opportunity -- potential opportunity in front of us.

And with that, as John indicated, we wanted to provide some progress on AEROSURF as well. So I'll turn the call over to Dr. Clayton.

Rusty?.

Thanks, Tom. Good morning, everybody, and thanks for joining us on today's call. As Tom mentioned, there's a lot of excitement around the AEROSURF program, not only here at Discovery Labs, but also in the neonatal committee.

The reason for that is that there continues to be a growing trend towards the use of nasal CPAP in the respiratory support of preterm babies.

The neonatologists favor nasal CPAP as a respiratory support vehicle because of a -- there's evidence and a belief that if you endotracheally intubate and mechanically ventilate these babies, there's a potential to cause lung injury that could be long term. The problem with this strategy is that these babies are surfactant-deficient.

And we know that they would benefit from early surfactant therapy, but there's really no way to deliver surfactant without instrumenting the airway. So when the neonatologist institutes nasal CPAP as the primary and first respiratory therapy for these babies, they have to forgo a surfactant therapy.

As a consequence, the previously published literature and the presented studies in major meetings has suggested that 30% to up to 70% of these preterm infants that are started on nasal CPAP go on to require endotracheal intubation and mechanical ventilation.

Obviously then, this defeats the purpose of nasal CPAP, because now you're instrumenting the airway. And even worse, if these babies receive surfactant, it's delayed surfactant therapy. AEROSURF is designed to allow for the delivery of sufficient quantities of aerosolized KL4 surfactant for these babies who are receiving nasal CPAP.

And we believe that this technology may decrease the number of babies that require intubation and mechanical ventilation.

If the AEROSURF program is successful, AEROSURF will potentially revolutionize the practice by enabling neonatologists to support the substantial population of the preterm infants with nasal CPAP, while decreasing the risk of endotracheal intubation and mechanical ventilation.

So with that as a backdrop, I'd like to talk a little bit about the AEROSURF Phase II clinical program. We started off the AEROSURF Phase II clinical program with a study that's designed to assess the safety and tolerability of 3 sequential increasing doses of aerosolized KL4 surfactant.

And we refer to this initial study as the Phase II study -- Phase IIa study.

And there is a subsequent study in the Phase II program which we refer to as the Phase IIb study, which is designed to provide an estimate of the size of the clinical effect of the KL4 surfactant treatment, the aerosolized KL4 surfactant treatment, provide further safety information and also confirm the optimum dose that we would potentially use in the Phase III trial.

In the Phase IIa study, which is currently well underway, we have been enrolling 29- to 32-week gestation infants, and comparing the physiologic data and clinical observations from control infants receiving only nasal CPAP and versus infants receiving nasal CPAP plus aerosolized KL4 surfactant.

The primary focus of this study is to demonstrate safety and tolerability of the aerosolized KL4 surfactant, but also, we will be looking for some physiological indications that will suggest the potential therapeutic benefit to the aerosolized surfactant therapy.

It's important to note that once we show safety and tolerability in this study, we can advance to the Phase IIb study, where we expect to demonstrate both physiologic and clinical evidence of the beneficial therapeutic effect in infants ranging from 26- to 34-week gestation infants.

Success in these sequential studies should allow us to properly design the Phase III study that will demonstrate efficacy and safety. Overall, for our Phase II clinical program, we believe that we remain on track to complete this program in the second half of 2015.

So let me now turn to the -- specifically to the Phase IIa study and spend a few moments to talk about some of the things we've learned so far from the Phase II study as it is being conducted. I should mention that this study is the first in a clinical program that is testing a drug-device combination.

The drug being tested is KL4 surfactant, and the device being tested is the capillary aerosol generator. The KL4 surfactant product, you already know very well, it's the same surfactant in SURFAXIN. The difference is that we are using a lyophilized dosage form of the product prior to aerosolization.

And instead of delivering it by intratracheal instillation, we're delivering it by aerosolization. I want to spend a moment on our aerosolization technology, which is truly innovative and plays a key role in the success with the program.

I'm delighted to say that we're pleased with the way our novel aerosolization technology, the capillary aerosol generator, has been performing.

As early as in the 1990s, the need to deliver aerosolized surfactant in preterm infants, or to other populations for that matter, has been limited by the aerosolization technologies that are currently available on the market.

These technologies are designed to deliver small quantities of aqueous medications, but, for the last 25 years, has not been able to adequately aerosolize a sufficient quantity of surfactant, either for preterm babies or for other populations.

Our development work with regard to the capillary aerosol generator has demonstrated that this device can maintain a sufficient output of KL4 surfactant aerosol with the appropriate respirable properties, such as particle size, for as long as we need to, a feat that, at least to our knowledge, no other current aerosol generator can duplicate.

Our technology has been performing quite well in the clinic so far in the Phase IIa study. The application of the aerosol is reported to be fitting nicely into the workflow of the neonatal intensive care unit, and the infants are tolerating aerosol very well.

The clinicians using this device has had a positive experience thus far, and everybody involved in the trial is remaining very enthusiastic regarding their participation in the study. With respect to the trial results, this Phase IIa study is an open label study.

Now, we're not going to provide a blow-by-blow account of the enrollment and the clinical results before the study is completed.

However, we are prepared to share that, at this point, we are very pleased with the physiologic data and clinical observations we have seen thus far, and we have not seen any concerning safety signals associated with the AEROSURF administration to date. We've also learned some other interesting things as we move along through this study.

As we're actively screening the population of interest that is 29- to 32-week gestation infants for potential enrollment, we've also had the opportunity to make observations in other gestational age groups. We believe that these observations would assist us in the future studies of AEROSURF.

As an example, we've discovered that the number of 33- to 34-week gestation infants who could meet our eligibility criteria and potentially benefit from aerosolized KL4 surfactant is much larger than our prior research suggested.

As a result of this learning, we have amended our protocol to include 33- to 34-week gestation infants in our Phase IIa study, and we'll also apply this learning to the remainder of the clinical program and we'll also apply this learning to our thinking about the AEROSURF opportunity in general.

Now, let's get into details about the Phase IIa enrollment study population and timing. In the early summer, we experienced a period of slow enrollment. From the end of June forward, our enrollment rate has picked up, and we're now at the expected rate of enrollment.

Also, since we've expanded our patient population to include 33- to 34-week gestation infants, we've also had to expand our number of controls, so that the total number of infants in the study will now be 42 rather than 36.

For these reasons, we are adjusting our expectation regarding the completion of the Phase IIa study to the fourth quarter of this year. Once we finish this study, we anticipate moving into the Phase IIb study. As we look forward to the Phase IIb study, we are currently adding on additional clinical study sites in anticipation of this study.

As I've mentioned before and Tom mentioned, there's a lot of interest in the neonatal intensive care community in participating in the clinical program, and we expect to have no issues finding interested neonatal intensive care units who want to participate in the study.

We expect that we'll have to pick the best neonatal intensive care units out there for this participation. We also expect that the current Phase IIa sites will also participate in the Phase IIb study, and we're evaluating and onboarding additional clinical sites, as I said before.

In addition, we are preparing to complete the manufacture of more investigational drug products and more investigational devices.

We believe that these preparations, along with our ongoing learnings from the current Phase II study, will allow us to transition smoothly into the Phase IIb study, and we expect to complete that study in the second half of 2015.

So in summary, nasal CPAP continues to be heavily used in preterm infants, and the subsequent need for endotracheal intubation and mechanical ventilation continues to be a significant problem for these infants as well as for the neonatologists to treat them.

We are pleased with the performance of the capillary aerosol generator, the feedback from the clinicians regarding the use of the capillary aerosol generator and the clinical observations we have seen to date. In short, we are very pleased with what we have seen thus far. But remember, this study has not yet completed.

We expect that the Phase IIa study will complete in the fourth quarter of 2014, and we are well underway in our preparations to smoothly transition into Phase IIb. With that, I'll turn the call over to John Tattory for an overview of our financial results for the second quarter.

John?.

Thanks, Rusty, and good morning, everyone. As Tom mentioned, we saw continued progress during the second quarter with SURFAXIN. Sales through our specialty distributor were $114,000 compared to a de minimis amount in the first quarter.

And demand sales or sale through the hospital to meet the needs of infants with RDS were $72,000 compared to $12,000 in the first quarter.

As a reminder, we use the sell-through method of revenue recognition, which means sales through our specialty distributor are deferred until the distributor sells product through to the hospital and all other revenue recognition criteria have been met. Based on this policy, we recognized $42,000 of SURFAXIN revenue in the second quarter.

In addition to our product revenue, we received $1.1 million of a $1.9 million NIH grant supporting our AEROSURF Phase IIa clinical trial. We expect the remaining $800,000 available under this grant to be received by the end of 2014. Operating expenses for the second quarter were $12 million compared to $11 million for the comparable period in 2013.

Let me begin with 2013.

Operating expenses in 2013 included investments to support the initiation of the AEROSURF Phase II program, including the technology transfer of the company's lyophilized KL4 surfactant manufacturing process through a CMO, and working along with the Battelle Memorial Institute, completing the design and development of the clinic-ready capillary aerosol generator device.

Both of these projects were successfully completed in 2013, and we are now realizing the benefit of these investments. We are currently in the clinic with the capillary aerosol generator and lyophilized KL4 surfactant, conducting our AEROSURF Phase IIa trial.

And as we announced in May, we have been issued new, very important patents related to both our lyophilized KL4 surfactant and our drug delivery technology platform.

The $12 million in 2014 operating expenses include continued investment in our AEROSURF development program, including costs associated with conducting the ongoing Phase IIa trial and initiating the manufacture of capillary aerosol generator devices for use in our anticipated Phase IIb program.

In addition, we increased our investment in medical affairs programs in order to communicate the key medical and scientific attributes of our KL4 technology to the neonatal community. From an overall operating standpoint, we reported an operating loss of $10.9 million for the quarter, compared to an operating loss of $10.8 million in 2013.

Interest expense for the second quarter of 2014 was $1.1 million and represents interest on our loan with Deerfield. Of the $1.1 million, $600,000 is related to cash interest expense and $500,000 represents noncash amortization of the debt discount.

Regarding our cash position, the second quarter operating cash burn was $10.4 million, and we ended the second quarter with approximately $66 million in cash and cash equivalents.

We continue to manage our operations with the objective of ensuring that our existing cash is sufficient to take us through to the end of the AEROSURF Phase IIb program, which, as Rusty mentioned, is expected to complete in the second half of 2015. For the third quarter of 2014, we're forecasting an operating cash burn of approximately $11 million.

And finally, regarding long-term debt, as I mentioned previously, we have $30 million outstanding in a secured loan with Deerfield. The loan is due in 3 equal annual installments beginning in February of 2017. As a reminder, the 2017 and 2018 installments can be deferred if we meet certain financial milestones.

So we believe we have flexibility regarding the repayment of this debt. With that, I will turn the call back over to John Cooper for closing comments..

Thank you, everyone. We're excited. We're really making good tangible progress. I know sometimes, it may feel as if it's slow, but I think it's very effective. We're doing the right things, that's the most important thing. We're in this to ultimately change the way infants are being treated with respiratory distress syndrome.

And I believe, we believe, I believe our stakeholders believe as well, that eventually, that time will come and that our technology will be the one that provides that.

So we will do everything we possibly can to make sure we're smart about our moves and that we are doing good science and we're building a good, strong relationship with the neonatal community. A lot of people to thank with respect to the work so far.

All of our stakeholders, our shareholders for your support, the neonatal community, Battelle, I will tell you that the work that we've done to have the capillary aerosol generator in the position that it's in today and being able to provide this very breakthrough technology and product -- or I should say, investigational product that we call AEROSURF has a lot to do with the relationships that we built with them.

They're one of the best in the world in the field of developing and ultimately registering medical devices. So we're really happy with what we've seen so far. With that said, let me turn the call back to the operator for Q&A..

[Operator Instructions] We have a question from David Amsellem from Piper Jaffray..

This is Traver Davis on for David. So just a couple on AEROSURF. What top line metrics from the Phase IIa study do you expect to disclose in -- now, the fourth quarter of 2014? And the second question is on SURFAXIN.

So can you just add a little bit more color around the formulary access that you guys have in place now? You mentioned that you have a total of about 15 in natal critical care facilities? So how many additional facilities are you targeting for formulary status as the months and quarters carry on? And where do we see this number evolve to by 2015?.

Okay. Sure, Traver. This is Rusty Clayton. So I'll take the AEROSURF question first, and then I'll turn it over to Tom Miller for the SURFAXIN question. So as I mentioned several times, this is a safety and tolerability study.

So what we're measuring currently is we're looking at physiologic measurements, such as the amount of oxygen the baby needs, the amount of CPAP pressure support that the baby needs, other therapeutic interventions that the baby needs.

We're looking at vital signs, we're looking at adverse experiences that are common in the NICU population and making sure that those experiences are not more frequent in the treated population.

So when we complete the study, we're going to put a lens in front of our eyes that looks for differences in the safety and tolerability between the treated group and the control group.

And we're going to be looking very carefully at all of the things I just mentioned to make sure that the treatment group is not faring the worse for wear after treatment compared to the control group. After we're thorough -- we're through with that thorough evaluation, we're then going to put a different lens in front of our eyes.

And that eyes -- that lens is going to help us look for any potential signs that we might see that would suggest that there is a potential benefit -- therapeutic benefit to the aerosol drug product. Now having said that, keep in mind that this is a very small study.

And with this small study, sometimes, it's hard to tease out the therapeutic beneficial differences. And even if you do see a difference, because of the small numbers in the study, it's very difficult, in fact impossible, to say that these results may not be due to chance alone. But I wanted to try to answer your questions thoroughly as possible.

So to recap, we're going to be looking at both clinical outcomes, as well as physiologic effects, but primarily to assess the safety and tolerability. So with that, if you need to follow-up after Tom answers his question, we're welcome to do so. But with that, I'll turn it over to Tom..

Thanks, Rusty, and thanks for your question, Traver. So maybe to -- a little bit of a step back and to remind even the listening audience that for commercial products, there's essentially 2 paths into the institution.

The most traditional one is to have the P&T committee convene and add the product to the hospital formulary, which is the allowable list of therapeutic products that can be prescribed at the discretion of the treatment team in the NICU.

An alternative approach is what's referred to as restricted use non-formulary allowance, which essentially means that the institution is going to bring the product in to try the product for an evaluation period, perhaps with a limit around the number of physicians that might choose to utilize the product, so perhaps with a utilization protocol in a subset of potentially eligible infants.

We've had experiences with both so far. While I haven't broken them down, I can tell you that the majority of our experience so far has been just a flat out add to formulary. With respect to where do we go from here, I've indicated a couple of things.

Number one, when we get to the P&T decision, I've been very pleased -- we've been very pleased with the observation that we've been successful with a favorable decision, the overwhelming majority of time.

The challenge that we've had, and I suspect for the immediate short term we will continue to have, is the shifting change [ph] of the winds of a P&T meeting. Typically, these meetings require a vote and quorum.

And if one individual is not present for reason A, B or C, it's very likely that, that will get pushed to the subsequent meeting, which may be a month later or a quarter later, depending upon the institution, everyone can be a little different.

So in facilities where we've converted to exclusive use, utilization is very straightforward to forecast because we understand exactly what their historical trends are.

But until we get a little bit more of the sample size of institutions regarding add frequency to formulary and throughput rate to formulary, we won't be providing any quantitative guidance with respect to formulary and/or revenue expectations..

Our next question is from Scott Henry from Roth Capital..

I guess, starting on AEROSURF, the IIa program, given that it's open label, you should have a lot of information.

Approximately how many patients are you evaluating at this point in time? Or are you getting kind of a running information report on?.

Well, Scott, in total, as we've said earlier and as we've indicated in the press release, the IIa program will evaluate a total of 42 patients. Where we are right now, we're not providing that detail. I don't want to get into a patient-by-patient, enrollment-by-enrollment situation until we're done.

But in total, we're going to be looking at 42 patients. There's one other thing that I wanted to mention as well to kind of put AEROSURF and what this IIa program is in some type of perspective. Remember this, that you've got a community that is truly, truly praying that one day, that an aerosolized surfactant could be used for babies.

And what this IIa study represents, showing safety and tolerability is a huge step forward. And having a device that can deliver a surfactant on a -- I'll say in a routine way, you're talking about a viscous material that is not easy to aerosolize. And having that ability, quite honestly, I think that's just a huge step forward.

So the ability to show that is, I think, a tremendous risk reduction going forward. Here's is the next step around the IIa. Most people, including us, investor community, the strategic community, everybody wants to see efficacy, everybody wants to see how are we performing versus control. And you know what, that will come out in the Phase IIb data.

When we get that up and running and we have a whole host of sites that are now participating, and now you're talking about the number of patients that exceed 100, now you have a good sample size to begin to tease out efficacy signals.

But in order to even get to that point, so the next piece is, if you think about it just logically is, is the aerosol that we're delivering and as we're so excited about the generator that's delivering that aerosol, can we have evidence of some sort that the drug is now getting into the lungs of a child? And that's where Dr.

Clayton mentioned earlier about physiological effects. So to us, that's what this IIa represents. And so Scott, I know I rambled on here for a minute, but with respect to how many patients, we're not giving that information.

We are well on our way in the clinical program, and we're very excited and our institutions that we're working with are very excited about where we are today and the experience so far..

Another question, obviously, if you expand the trial to include 33 and 34 weeks gestational age, that is a slightly different patient population.

How do you feel about those older infants, and how may that impact the data?.

Well, Scott, let me take that a step back. This is Rusty. Yes, so our initial expectation when we did a lot of our prestudy research was that this was a population that would not likely contribute to our clinical program.

And the reason for that is, is that our prestudy research had suggested that, even though this is a very large group, we thought that a very small proportion of those babies would have enough disease to benefit from aerosolized surfactant therapy.

Then when we actually got into the sites and are able to manage and look at real data in real time and take a look at these populations, we're pleasantly surprised to find that these babies had disease that were every bit as severe as the lower gestational age babies.

And one could then imagine that they would benefit as much with the aerosolized surfactant therapy. So we were actually quite excited with that finding for a couple of reasons. First of all, now we have an additional number of patients that we -- that are eligible for recruitment into the study. And this is going to help move the study faster.

Not just the Phase IIa trial, but also the Phase IIb study as well. Secondarily, if things work out well for us in terms of the clinical program, this is an opportunity that we're going to have to kind of reevaluate what this finding has on the market potential of the product. So this is another interesting finding for us.

But getting back to the Phase IIa study, because we've changed enrollment criteria, that is, we've increased the gestational age of the babies, the only impact of the study itself is that we're going to have to expand the control group to make sure that we continue to have an apples-to-apples comparison between controls and treatment.

Otherwise, we don't expect the study to have any further impact with regard to the addition of these babies, other than potentially enrolling a little bit faster. Certainly, increase -- adding this population does not increase the risk profile of the study.

So we're very excited to have this finding and remember that we're looking at safety and tolerability here with the goal towards moving the program forward once we assess that safety and tolerability..

Okay.

And well, the IIb trial, should that start in fourth quarter of 2014?.

Our goal is to be prepared to do exactly that. That's correct..

Okay. And then, shifting gears to SURFAXIN, you mentioned that you're exclusive in 4 of 30 facilities.

What were those facilities doing before they had you? Were they using another product or were they not carrying any surfactant at all?.

Yes. Scott, this is Tom. Essentially, all the facilities that we are targeting out of the data [ph] are currently using some surfactant, one of the 3 currently available animal-derived surfactants.

So when we highlight conversion to exclusivity, it means they, at least for the definable future, decide to use SURFAXIN and no longer use the product that they were using previously. This is really the basis for our overall thesis with SURFAXIN. We think we have a very compelling package from a data -- clinical and preclinical data perspective.

We've decided to -- we're not going to compete on price as we've indicated, but we're not going to let price get in the way.

And the goal is to recognize that these facilities, once they transition, and to John's earlier point in the prepared comments, very deliberately focus on making sure that we do everything we can to have a good experience, we believe that the likelihood of going back to utilizing an animal-derived surfactant is very low.

So the idea is to recognize that this is going to take time for all the reasons that we've discussed, but with good initial experiences, we can convert those facilities to exclusive use, and that's the overarching goal for the program. And I've been very pleased to see that we've had some immediate success in the short term with these 4 facilities..

And I guess the final question is, the company has some partnership opportunities, whether it be outside of the U.S. for SURFAXIN or -- as well for AEROSURF partnering really worldwide.

When should we think about a partnership on any front? What sort of timeline would you want us to expect?.

Scott, this is John. Here's what I'd say about that.

First of all, regarding SURFAXIN, I mean, we are receiving inquiries and we are having discussions with companies that have capabilities to basically commercialize and manage a hospital-based product like SURFAXIN in areas of the world outside of the United States where we can leverage what we've accomplished with SURFAXIN and the FDA.

Specifically, those areas are Latin America and the Middle East, Northern African countries. And Latin America is really interesting. As we dig into our homework and the likelihood of finding all of this in IMS studies is very low. So we've done a lot of homework and a lot of information has been provided to us by those who are talking to us.

You've got a market in Latin America that is equal to or possibly larger than what is in the United States currently. So that's an attractive opportunity. From a timing perspective, I'm not going to get into the timing.

The only thing I will tell you is that, it's on our radar and we have intentions of hopefully again being smart about that and making SURFAXIN available outside of the United States where appropriate.

With respect to AEROSURF, same thing about timing, I'm not going to give a time frame, but I will tell you that, in the past, literally, over the last 2 years, there are a number of companies that we've been talking to with respect to AEROSURF.

We have told anybody in our discussions that we fully intend to maintain AEROSURF for the United States market. I mean, if you think about what we're doing with SURFAXIN, SURFAXIN, in so many ways, is building a relationship with the neonatal community in the United States.

So that ultimately -- should AEROSURF be approved and be available on the market, that those relationships are well established and we can transition accordingly. So partnership opportunities for us have always been focused on going then taking AEROSURF outside of the United States where we do not have a lot of experiences.

And quite frankly, we could use every bit of help from a regulatory, as well as a commercial capability outside of the United States. Those companies that we're talking to is -- of course, in the end, they want to see data.

Now, whether the IIa data is going to be sufficient for them, whether IIb data is going to be sufficient, we can't get into their heads and make their calls, everybody has a risk profile that is up to them. Again, the only thing I can tell you that we're doing is we're staying active. We talked to these companies, and we'll continue to do that.

Should the AEROSURF program generate the data and the success that we are all really excited about and hoping for, I would tend to think that there's a good likelihood that a partner will be available and can help us financially and can also help us with development outside of the United States..

And our next question is from Tom Schrader from Stifel..

I wanted to go back to the exclusive comment.

Should we think about this that most hospitals carry only a single surfactant so that you really only need to detail at the formulary level? Or once you're on formulary, are you actually competing within the formulary and having to detail individual doctors?.

Tom, this is Tom Miller. Thanks for the question. So here's how we think about it. When you look across institutions in the country, it really is a mixed bag. And we have the ability to see with various data feeds down to the institution level, what products they currently have the access to within their facility.

And as our folks go into those facilities, we prepare them accordingly. The way the -- each facility chooses to use an animal-derived surfactant. Again, there are 3 that are available in the United States for slightly different reasons. So let's try to put our best foot forward from a data package perspective to be competitive.

Most facilities in this country carry only one surfactant. And the reason that they do that, is because there's a price advantage typically, given the amount of business that gets converted in the facility. And each of the products are prepared and dosed a little bit differently.

So having more than one product on that at a given time adds some degree of risk that has to be managed by the medical teams.

So our strategy recognizing this, of course, while we want the exclusive in all facilities as a long-term goal, our initial ask is, once you understand the data package, would you be willing to just try the product for a defined period of time, and then get to a more comprehensive decision regarding long term and continuity use of the product.

Some of the thought leading institutions in the United States are just simply more familiar with the product, given the experience that they've had with Discovery Labs over time. And we're willing to make that commitment in the immediate short term. I don't expect that to be the case with all facilities, but that is the longer-term goals..

But it's been interesting because, those who -- that do carry one, we've been finding a willingness to add another. To think about again the evolution of any product, whether it be medicine or otherwise, you now come to the -- you come to the market with a synthetic, a peptide-containing synthetic product.

Why not, if you're an institution, why not consider having the animal-derived product on, and as Tom said, bring the synthetic on and begin to gain an experience with the synthetic product? Hence, why we're so measured. Hence, why the in-servicing process and the relationship with the hospital is so important.

It's -- we want to make sure that they're applying the proper -- the product properly. This is a scientifically developed product. In terms of the volume that's required, the way it's administered, all of those things. So we're teaching the institution how to use the product properly.

And should that be a positive experience, the goal is for them, at one point in time, is to say, "All right. Well, let's move forward, let's advance." And that's been shown a lot of times in a lot of other therapeutic areas, and that's where we're focused..

So I mean, along those lines, I find it amazing that 4 sites right of the bat said we're going to use only this -- only your material.

Are those trial sites or what? Why are they so familiar?.

Yes. We won't be specific with the centers, Tom, obviously, for competitive reasons, but they tend to be centers that are more familiar with the totality of our data package..

Okay. And just one quick question on AEROSURF. So you're paving the way with SURFAXIN in these hospitals.

Is the target audience the same for AEROSURF or is it bigger? Do more people do CPAP, then would do administration of animal or your SURFAXIN?.

Yes. Tom, this is Tom again. So maybe I could -- I'll start off and try to give you some perspective from a market orientation. And maybe Rusty can provide a little bit color about what -- how that works in the institution. So the short answer to your question is yes.

There are many, many more children in this country and throughout the developed world that have the diagnosis of respiratory distress syndrome or RDS, which, by definition, means surfactant deficiency.

That's the root cause of the problem, but don't actually receive the therapeutic solution, which is a -- currently an animal-derived surfactant today, or in our case, of course, SURFAXIN.

And the reason is, is that there's a -- it's very well established that the very act of intubation or inserting an endotracheal tube into the airway of the child, in and of itself, can be problematic.

So there's a risk-benefit situation where not all kids that have the problem of respiratory distress syndrome receive the solution of therapeutic surfactant administration because of the intrinsic invasiveness that's required today.

Our thesis that centers around the AEROSURF project is to be able to get the surfactant into the lung without the need for invasive and mechanical ventilation. And by doing so, potentially significantly expand an eligible patient population.

As we've discussed previously, as we've done this walk through from an epidemiologic perspective in this country, there's about 45,000 or so babies that receive first-line surfactant therapy today. These are babies that are intubated immediately, very oftentimes right in the delivery room, as soon as they are born, and get a dose of surfactant.

But there's a secondary population that's approximately of equal size, about another 45,000 babies, that are trialed initially on CPAP and ultimately fail, meaning -- failure meaning a need for rescue intubation, mechanical ventilation and very likely, surfactant therapy.

But now that surfactant, in that circumstance, is being administered well outside of the optimal therapeutic window, and you only wish -- the medical teams only wish that there was a way to predict who was going to be successful on CPAP and who's not going to be successful on CPAP, but no such predicted demography exists.

That's really the fundamental dilemma that the neonatology community has today, and the problem that we hope to solve with AEROSURF. So we see a patient population that is larger -- an eligible patient population that is larger for a potential AEROSURF application in the order of magnitude of about 160,000 or so children in the United States.

And that's larger than the entire surfactant-treated population today. I don't know if, Rusty, you have any additional clinical color or commentary..

No, I think that you've covered it pretty well, Tom. The one thing I might add is that when a neonatologist is standing at the bed side, they really have an important choice to make within the first few minutes of this baby's life after birth.

And I think that some neonatologists are going to tend to be a little bit more towards the utilization of CPAP. But with that said, with the availability of the aerosolized surfactant, they're going to go right there -- right to there to mitigate the risk.

We also have to keep in mind that there are some babies that neonatologists would tend to intubate, that otherwise, we might -- they might consider using CPAP if there was a way of noninvasively delivering surfactant as well.

So overall, Tom, I think the answer to your question is, is that we're going to have 2 technologies that, I think, answer the sum total of solutions facing the neonatologist with regard to RDS.

We're going to have the solution for the babies that require endotracheal intubation for other reasons, and we're going to have the solution for the babies receiving nasal CPAP, and that will definitely expand our reach within the neonatal care space..

And Tom, if I were -- if I was understanding your question correctly, it's the same number of hospitals though. SURFAXIN is paving the way, we're not going to be going after more hospitals because AEROSURF is available. It's the same number of hospitals..

[Operator Instructions] Our next question is from Larry Smith from SmithOnStocks.com..

Rusty, I have a question for you. It's kind of a multi-faceted question, so I apologize if it doesn't come across clearly.

But in the Phase IIa trial, could you tell us how long the babies are being maintained on the aerosol? And could you compare that to what an actual clinical practice -- would it be the same, or a greater period of time? And then, could you make some kind of comment on whether you've seen any change in the characteristics of the aerosol? For example, is -- on the particle size, is there any clumping over time? Have there been any situations where the generator has clogged up and they've had to make some kind of an adjustment? And I'm sure you can embellish on that, but I think you know the point I'm getting at -- is that -- are you maintaining pretty much the same type of flow over the life of -- over the time that you're giving the aerosol? And how does that relate to actual clinical practice?.

Okay. Sure, Larry. Thanks. I'm going to take those questions in the order that you asked. So first, with regard to the duration of the aerosol, I think, we mentioned the last time we're on the conference call that we're controlling those not by changing the concentration of the drug in the aerosol, but by increasing the exposure time to the aerosol.

And that's how we're moving through our escalating dose. So the first cohort exposed to a relatively short period of time, and then we increase that time as we go forward. All of the exposure times are less than 1 hour.

And we're going to have stay deliberately vague with regard to the precise times for now because there are other people that are interested in trying to aerosolized surfactants, and we're not really prepared to unveil our dosing strategy just yet.

But I will say that, thus far, this period of time that we're delivering the aerosol sitting very well within the practice of the NICU, and the babies seem to be tolerating the exposure to the aerosol quite well.

With regard to your second question, in our in vitro testing of the capillary aerosol generator, we have been able to run the capillary aerosol generator for several hours without any change whatsoever in its operational characteristics. The particle size remains extremely constant.

It's within a narrow band within the respirable range of the particles that we'd want to deliver. Remember, these babies have very small airways, so we don't want to deliver particles that are too large.

We don't want to deliver particles that are too small, but I think that we found the Goldilocks solution here in terms of delivering them within the respirable range. And that is absolutely maintained. It does not get, as you say, chunky.

As it goes forward, it delivers the same amount of drug, whether I'm measuring it at minute 1 or let's say minute 60 or minute 120 or minute 360. So it's an incredibly dependable workhorse type of aerosolization technology there.

And that's in contrast to some of the other aerosol generators that we've looked at in our laboratories, and I can't go into specifics with regard to the brands.

But other aerosol generators, and I think you know this, related to your question, as time goes by, as you're trying to aerosolize surfactants with these aerosol generators, we tend to see the changes in particle sizes and a fall off from the emitted dose.

So I think we have quite a novel and innovative device here with our capillary aerosol generator..

Rusty, if I could just ask a follow-up on that.

So in clinical practice, you would think -- would it be your opinion that physicians would deliver an -- with a nasal CPAP dosage, AEROSURF for perhaps an hour rather than continuous? I guess, what I'm trying to ask, will you pulse the usage of AEROSURF or will you give it continuously over several days?.

I see what you're saying. So the treatment is designed to be a discrete dose. And so there's going to be a period of time, and obviously, we want to try to get the surfactant in as early as possible because the data clearly demonstrates that early surfactant therapy is the most beneficial.

So we're going to try to get that dose on board as quickly as possible, and we're going to provide a single dose. So it'll be, as you mentioned, a pulse dose and rather than a continuous dose over several days. The reason for that is, there's a couple of reasons.

First of all, you don't want the staff to have to maintain an aerosol generator that's constantly running over a matter of hours or days. It's -- that's pretty labor-intensive to do that. And secondly, with the output of our aerosol generator, there's no need to do so.

We believe that we're going to be able to deliver a sufficient quantity of the surfactant within what our neonatology colleagues have told us to be a reasonable period of time..

Larry, this is Tom Miller. And so while Rusty and the team is working through the optimized dosing exercise and assessment, as we speak, in the Phase II program, maybe an interesting observation to contemplate here is that, in our own hands, in the SURFAXIN experience, more than 70% of babies received only a single dose.

And while we can't say today whether or not that's going to be true for AEROSURF in general, certainly within the RDS [ph] spectrum, surfactants are acute therapeutics, and we have every reason to believe that, that will likely be the case for AEROSURF as well..

Would -- could you make a guess as to whether 1 hour will be the probable -- or close to the period of time that you'll need to deliver a therapeutic dose?.

We'll let the clinical trials dictate that, Larry.

And Larry, if I could just add one thing to it, the beauty behind the aerosol generator also then is, remember, surfactants have, we believe, an application to other respiratory diseases where you'd want to deliver an aerosolized surfactant to the patient, whether that be a child or eventually an adult.

So one of the things that John Tattory covered earlier in the financial section is the investment that we made in this capability a year ago, that is now beginning to show itself. So we will not be touting or getting into what a pipeline could look like until we have our happiness in the AEROSURF world, however that's defined.

But I could tell you that we're excited to begin that process. So more on that for the future..

And ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to management for any closing remarks..

Thank you, everybody. This is John. Thank you so much for your time. This call has been a little over an hour. So I know your time is precious, but we really appreciate your interest.

And we look forward to another update, probably towards the end of October, early November, around our third quarter call or of course, unless there's an opportunity around our business to provide information prior to that. So with that said, thanks, again, and we'll talk soon..

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines..