Windtree Therapeutics, Inc. (referred to as “we,” “us,” or the “Company”) is a biotechnology company focused on developing novel KL4KL4 surfactant therapies for respiratory diseases and other potential applications. Surfactants are produced naturally in the lung and are essential for normal respiratory function and survival. Our proprietary technology platform includes a synthetic, peptide-containing surfactant (KL4(KL4 surfactant) that is structurally similar to endogenous pulmonary surfactant, and novel drug delivery technologies, including our proprietary aerosol delivery system (ADS), being developed to enable noninvasive administration of aerosolized KL4KL4 surfactant. We recently completed design verification for our new phase 3 ADS (which we previously referred to as the “NextGen ADS”), which we plan to use in our remaining AEROSURF® clinical development activities and, if approved, initial commercial activities. We believe that our proprietary technology platformtechnologies may make it possible to develop a pipeline of surfactant products to address a variety of respiratory diseases for which there are few or no approved therapies.

Our lead development program is AEROSURF® (lucinactant(lucinactant for inhalation), an investigational combination drug/device product that combines our KL4 surfactant with our novel aerosol delivery system (ADS). Wewe are developing AEROSURF to improve the management of respiratory distress syndrome (RDS) in premature infants. RDS is a serious respiratory condition caused by a deficiency of natural lunginfants who may require surfactant in lungs of premature infants, and the most prevalent respiratory diseasetherapy to sustain life. The currently-available surfactants in the neonatal intensive care unit. By enabling administration of aerosolized KL4 surfactant, AEROSURF may reduce or eliminate the need forUnited States (U.S.) are administered using invasive endotracheal intubation and mechanical ventilation, each of which currently are required to administer life-saving surfactant therapy, but which are associated withmay result in serious respiratory conditions and other complications. To avoid thethese risks, of surfactant administration, many neonatologists initially delay surfactant therapy and treat premature infants are initially treated with noninvasive respiratory support (suchsuch as nasal continuous positive airway pressure (nCPAP). Because nCPAP does not address the underlying surfactant deficiency, many premature infants respond poorly to nCPAP alone (typically within the first 72 hours of life) and may require delayed surfactant therapy administered with invasive intubation (an outcome referred to as “nCPAP failure”). If surfactant therapy could be administered noninvasively, neonatologists would be able to provide surfactant therapy to premature infants earlier in their course of treatment and without exposing them to the risks associated with invasive endotracheal intubation and mechanical ventilation.

AEROSURF is designed to potentially meaningfully reduce the use of invasive endotracheal intubation and mechanical ventilation by delivering aerosolized KL4 surfactant noninvasively. We believe that AEROSURF, if approved, will allow for earlier treatment of premature infants who currently receive delayed surfactant therapy, decrease the morbidities and complications currently associated with surfactant administration, and reduce the number of premature infants who are subjected to invasive intubation and delayed surfactant therapy following nCPAP failure. We also believe that AEROSURF has the potential to address a serious unmet medical need by enabling earlier KL4 surfactant therapy for infants receiving nCPAP alone, reducing the number of premature infants who are subjected to invasive surfactant administration, and potentially providingprovide transformative clinical and pharmacoeconomic benefits.

In June 2017, we announced that we had completed an AEROSURF phase 2b clinical trial that was designed to evaluate aerosolized KL4 surfactant administered to premature infants 28 to 32 week gestational age receiving nCPAP, in two dose groups (25 and 50 minutes) with up to two potential repeat doses, compared to infants receiving nCPAP alone. This trial was conducted in approximately 50 clinical sites in the U.S., Canada, the European Union and Latin America.  Based on the planned top-line results, data show that AEROSURF did not meet the primary endpoint of a reduction in nCPAP failure at 72 hours, which we believe was due in large part to an unexpected rate of treatment interruptions.  Such interruptions occurred in about 24% of active enrollments, predominantly in the 50 minute dose group, and we believe  were primarily related to specific lots of disposable cartridge filters with a higher tendency to clog.  After excluding the patients whose dose was interrupted in the 50 minute dose group, the data show an nCPAP failure rate of 32% compared to 44% in the control group which is a 12% absolute reduction or a 27% relative reduction in nCPAP failure compared to control. These data suggest a meaningful treatment effect in line Consistent with our targeted outcome.

We are currently focused onbelief, the U.S. Food and Drug Administration (FDA) has granted Fast Track designation for our project with Battelle Memorial Institute (Battelle)KL4 surfactant (including AEROSURF) to complete development of our next generation aerosol delivery device (NextGen ADS), which is intended to replace the prototype device used in our phase 2 clinical trials. The NextGen ADS combines the same aerosolization technology used during the phase 2 clinical program, but with improved ergonomics, interface, controls, and dose monitoring in a modular design. Design verification and validation are underway. Within this process, we are assessing whether the design of the NextGen ADS successfully mitigates the risk of clogging and related treatment interruptions that occurred during the Phase 2b clinical trial. To verify the design and confirm the performance of the NextGen ADS, including with respect to device-related treatment interruptions experienced with the phase 2 prototype ADS, we are planning to conduct a device bridging and confirmation clinical study (i) to gain experience with the next generation ADS (NextGen ADS), (ii) to confirm whether our development objectives have been met and (iii) to generate additional higher dose treatment data to augment the higher dose data obtained in the phase 2b clinical trial, which was adversely affected by treatment interruptions.  We currently are assessing the potential design and requirements for this trial.treat RDS.

In addition in June 2017,to advancing AEROSURF, we and a Hong Kong company, Lee’s Pharmaceutical (HK), Ltd. (Lee’s (HK)), entered intoare assessing potential development pathways to potentially gain marketing approval for lyophilized KL4 surfactant as an exclusive license and collaboration agreement (License Agreement)intratracheal instillate for the treatment and/or prevention of RDS. Lyophilized KL4 surfactant may potentially provide benefits related to use, including longer shelf life, reduced cold-chain requirements and lower viscosity. We have discussed with the FDA a potential development plan, trial design and commercializationregulatory plan for approval. If we can define an acceptable development program that is achievable from a cost, timing and resource perspective, we might seek approval to treat premature infants who, because they are unable to breathe on their own or other reason, cannot benefit from AEROSURF.

We also believe that our KL4 surfactant technology may potentially support a product pipeline to address a broad range of KL4 surfactant productsserious respiratory conditions in China, Hong Kongchildren and adults. We have received support, and plan to seek additional support, from the National Institutes of Health (NIH) and other select Asian markets, withgovernment funding sources to explore the utility of our KL4 surfactant to address a future optionvariety of such respiratory conditions as acute lung injury (ALI), including acute radiation exposure to potentially add Japan. The agreement includes AEROSURFthe lung (acute pneumonitis and delayed lung injury), chemical-induced ALI, and influenza-induced ALI; as well as the non-aerosol products, SURFAXIN® (approvedchronic rhinosinusitis, complications of certain major surgeries, mechanical ventilator-induced lung injury (often referred to as VILI), pneumonia, and diseases involving mucociliary clearance disorders, such as chronic obstructive pulmonary disease (COPD) and cystic fibrosis (CF). Although there can be no assurance, we may in the U.S. in 2012)future support development activities to establish a proof-of-concept and, SURFAXIN LS™ (an improved lyophilized formulationif successful, thereafter determine whether to seek strategic alliances or collaboration arrangements or pursue other financial alternatives to fund further development and, if approved, commercialization of SURFAXIN)additional KL4 surfactant indications.

To leverage our capabilities, maximize the use of our resources and potentially reduce our dependency on a single product candidate, we also seek to enter into strategic alliances, collaboration agreements and other strategic transactions (including without limitation, by merger, acquisition or other corporate transaction). We also granted Lee’s (HK) an exclusive licenseare pursuing a potential strategic transaction that could diversify our assets and bring in additional capital. There can be no assurance, however, that we will be able to manufacture KL4 surfactant in China for use in non-aerosol surfactant productsreach agreement on terms and within the time frame acceptable to all parties. Moreover, even if we reach agreement and complete a transaction, there can be no assurance that we will have sufficient resources to fund the continued development of AEROSURF or any other product candidates, that any of our development efforts would be successful, or that we would obtain regulatory approvals needed to commercialize our product candidates in the licensed territory and a future option to manufacture the device in the licensed territory.  In connection with the August 2017 Loan Agreement with Lee's (HK) (see, “– Note 7 – Loan Payable”), we amended the License Agreement to expand certain of Lee’s (HK) rights, including by immediately adding Japan to the licensed territory, accelerating the right to manufacture the ADS in and for the licensed territory, reducing or eliminating certain of the milestone and royalty payments and adding an affiliate of Lee’s (HK) as a party to the License Agreement.  We are presently engaged in a technology transfer of our KL4 surfactant manufacturing process to Lee’s (HK).  world’s markets.

As of September 30, 2017,2018, we had cash and cash equivalents of $1.8$0.6 million and current liabilities of $29.5$18.1 million, (including $12.5including $4.3 million in loans payable (see Note 8 – Loan Payable) and $1.0 million of long-term debt, current portion) and $12.5 millionconvertible note payable, net of long-term debt, non-current portion.  Total long-term debt of $25 million was with affiliates of Deerfield Management, L.P. (Deerfield), who held a security interest in substantially all ofdiscount (see Note 9 – Convertible Note Payable). As we remain focused on completing the potential strategic transaction that could diversify our assets (Deerfield Loan). 

On November 1,and bring in additional capital to fund our activities, we announced that we had completed a series of transactions to generate short-term cash and potentially enable future capital transactions. Effective October 27, 2017, LPH Investments Limited (LPH), a wholly-owned subsidiary ofare dependent upon Lee’s Pharmaceutical Holdings Limited (Lee’s) acquired $10 million of newly issued shares, the majority holder of our common stock, representing a controlling interestto provide us financial support. Since August 2018, Lee’s has provided $2.7 million in our Company. Atfinancial support in the sameform of loans (see, Note 8 – Loan Payable and Note 13 – Subsequent Event); however, since we have not executed agreements for any additional advances at this time, we reached an agreement with Deerfield to restructure and retire the outstanding $25 million long-term debt, and entered into a nonbinding memorandum of understanding with Battelle (Battelle MOU) outlining potential terms to restructure certain accounts payable related to our device development activities with Battelle.there can be no assurance that additional support will be forthcoming. In addition, in connection with the Battelle MOU, Battelle executedpotential strategic transaction, we are incurring and delivered a waiverwill continue to incur potentially significant legal, accounting, and other professional fees that in any event will represent an additional financial burden for which we will require additional capital. As of its rights to receive payments under a liquidation preference pursuant to Series A Convertible Preferred Stock held by BattelleNovember 2, 2018, and the related Certificate of Designation of Preferences, Rights and Limitations effective February 15, 2017 (the foregoing transactions with LPH, Deerfield and Battelle are collectively referred to in this Quarterly Report on Form 10-Q as the November 2017 Restructuring). See, “– Note 10 – Subsequent Events.”

Althoughbefore any additional financings, we believe that the November 2017 Restructuring has improvedwe will have sufficient cash resources available to support our financial position and better positions us to raise the capital needed to fund on-going operations and development plans, wethrough mid-November 2018.

We expect to continue to incur continuing significant losses and will require significant additional capital to furthersupport our operations, advance our AEROSURF clinical development program, and satisfy our currentexisting obligations, and support our operations for the next several years. Moreover, we do not currently have sufficient existing cash and cash equivalents for at least the next year following the date that thesethe financial statements are issued. These conditions raise substantial doubt about our ability to continue as a going concern within one year after the date that thesethe financial statements are issued.

To potentially alleviate the conditions that raise substantial doubt about our ability to continue as a going concern, management plans to seekraise additional capital through the following: (i) all or a combination ofpotential strategic transactions,transaction on which we are currently focused, which would provide access to additional products to diversify our offerings and other potential alliancesadditional capital to fund our operations.  Although we are currently actively engaged in diligence and collaborations focused on markets outside the U.S., as well as potential combinations (including by merger or acquisition) or other corporate transactions; and (ii) through public or private equity offerings. Therediscussions to complete this strategic transaction, there can be no assurance that these alternativeswe will be available, or if available,able to complete it within an acceptable time and on terms that are favorable to us.  If for any reason we are unable to complete the strategic transaction as planned, it is unlikely that we willwould be able to identify and enter into another suitable opportunity on acceptable terms and within a time for which we may have adequate funding. In that event, we would not have sufficient cash resources and liquidity to fund our development activities and business operations for at least the next year following the date that thesethe financial statements are issued. Accordingly, management has concluded that substantial doubt exists with respect to our ability to continue as a going concern through one year after the issuance of thesethe accompanying financial statements.

As of November 1, 2017, after closing the November 2017 Restructuring, we had cash and cash equivalents of $5.4 million. While we seek the additional capital that we require, we are working with our vendors and service providers to extend payment terms of certain obligations and our available cash. We believe that, before any additional financings, we will have sufficient cash resources to partially satisfy our existing obligations and fund our operations into January 2018. 

TheseThe accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business, and do not include any adjustments relating to recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.

Our ability to secure the capital that we will require through equity financings and other similar transactions is subject to regulatory and other constraints, including: (i)  our common stock is currently quoted on the OTCQB® Market (OTCQB), which is operated by OTC Markets Group Inc., under the symbol WINT and may experience periods of illiquidity; (ii) our common stock is currently considered a “penny stock,” such that brokers are required to adhere to more stringent market rules, which could result in reduced trading activity and trading levels in our common stock and limited or no analyst coverage; (iii) because we are no longer listed on a national securities exchange, we are not eligible to file a Form S-3 registration statement and our recent Form S-3 has expired; (iv) without a Form S-3, we are not able to use our ATM Program; (v) our controlling stockholder may not approve management proposals to increase the number of shares of common stock authorized under our Amended and Restated Certificate of Incorporation, as amended, which could impair our ability to conduct equity financings or enter into certain strategic transactions (mergers and acquisitions) that require stockholder approval under Delaware law; (vi) our capital structure, which currently consists of common stock, convertible preferred stock, pre-funded warrants and warrants to purchase common stock may make it difficult to conduct equity-based financings; and (vii) negative conditions in the broader financial and geopolitical markets.  In light of the foregoing, we expect that we will more likely conduct securities offerings as private placements with registration rights, which we would register under a registration statement on Form S-1, or other transactions, any of which could result in substantial equity dilution of stockholders’ interests.

In the eventJune 2018, we entered into a Guaranty and Replenishment Agreement with Lee’s pursuant to which Lee’s agreed to replenish up to $1 million expended by us that reduce our cash resources below our planned minimum cash (the amount that would otherwise be required to cover estimated wind-down costs should we cannot raise sufficient capital, we may be forced to consider transactions on less-than-favorable terms, or limit or cease our development activities. If we are unable to raise the required capital, we may be forced to curtail all of our activities and, ultimately, cease operations. Even if we are able to raise sufficient capital, such financings may only be available on unattractive terms, or result in significant dilution of stockholders’ interests and, in such event, the market price of our common stock may decline.

We have fromat any time to time collaborated with research organizationscontinue as a going concern). To secure its obligation to us, Lee’s delivered an Irrevocable Stand-by Letter of Credit (the Letter of Credit) in the amount of $1 million and universities to assess the potential utilitydrawn in our favor, which, following a recent extension, now expires on December 28, 2018. As of our KL4 surfactant in studies funded in part through non-dilutive grants issued by U.S. Government-sponsored drug development programs, including grants in support of initiatives related to our AEROSURF clinical development program. In late May 2017, we announced thatNovember 2, 2018, we have been awarded $0.9 million under a previously announced Phase II Small Business Innovation Research Grant (SBIR) valued at up to $2.6 million fromnot drawn on the National Heart, Lung, and Blood Institute (NHLBI)Letter of the National Institutes of Health (NIH) to support the AEROSURF phase 2b clinical trial.  We currently are determining whether, as a subsidiary of Lee’s, we continue to be eligible for SBIR grants.  We also have received from time to time grants that support medical and biodefense-related initiatives under programs that encourage private sector development of medical countermeasures against chemical, biological, radiological and nuclear terrorism threat agents, and pandemic influenza, and provide a mechanism for federal acquisition of such countermeasures. Although there can be no assurance, we expect to pursue potential additional funding opportunities as they arise and expect that we may qualify for similar programs in the future.Credit.

As of September 30, 2017, and November 8, 2017, we had outstanding 0.9 million pre-funded warrants issued in a July 2015 public offering, of which the entire exercise price was prepaid upon issuance, and 3,203 convertible preferred shares issued in the February 2017 private placement offering.  Each preferred share is convertible into 1,000 shares of common stock. Upon exercise of the pre-funded warrants and conversion of the convertible preferred shares, we would issue common shares to the holders and receive no additional proceeds.  

In addition, as of September 30, 2017,2, 2018, there were 120 million shares of common stock and 5 million shares of preferred stock authorized under our Amended and Restated Certificate of Incorporation, as amended, and approximately 85.0113.3 million shares of common stock and approximately 55.0 million shares of preferred stock available for issuance and not otherwise reserved.

TheseThese interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the U.S. (U.S. GAAP) for interim financial information in accordance with the instructions to Form 10-Q.  Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete consolidated financial statements.  In the opinion of management, all adjustments (consisting of normally recurring accruals) considered for fair presentation have been included.  Operating results for the three and nine months ended September 30, 20172018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.2018. There have been no changes to our critical accounting policies since December 31, 2016.2017. For a discussion of our accounting policies, see, “– Note 54 – Summary of Significant Accounting Policies” in this Quarterly Report on Form 10-Q, and, in the Notes to Consolidated Financial Statements in our 2017 Form 10-K, “– Note 4 – Accounting Policies and Recent Accounting Pronouncements” in the Notes to Consolidated Financial Statements in our 2016 Form 10-K.Pronouncements.”  Readers are encouraged to review those disclosures in conjunction with this Quarterly Report on Form 10-Q.

February 2017 Private Placement

On February 15, 2017, we completed a private placement offering of 7,049 Series A Convertible Preferred Stock units at a price per unit of $1,495, for an aggregate purchase price of approximately $10.5 million, including $1.6 million of non-cash consideration representing a reduction in amounts due and accrued as of December 31, 2016 for current development services that otherwise would have become payable in cash in the first and second quarters of 2017. Each unit consists of: (i) one share of Series A Convertible Preferred Stock, par value $0.001 per share (Preferred Shares); and (ii) 1,000 Series A-1 Warrants (Warrants) to purchase one share of common stock at an exercise price equal to $1.37 per share. Each Preferred Share may be converted at the holder's option at any time into 1,000 shares of common stock at a conversion price of $1.37 per share. The Warrants may be exercised beginning August 15, 2017 and through February 15, 2024. The Preferred Shares and the Warrants may not be converted or exercised to the extent that the holder would, following such exercise or conversion, beneficially own more than 9.99% (or other lesser percent as designated by each holder) of our outstanding shares of common stock. In the event of a liquidation, including without limitation, the sale of substantially all of our assets and certain mergers and other corporate transactions (as defined in the Certificate of Designation of Preferences, Rights and Limitations relating to the Preferred Shares), the holder of Preferred Shares will have a liquidation preference that could result in the holder receiving a return of its initial investment before any payments are made to holders of common stock, and then participating with other equity holders until it has received in the aggregate up to three times its original investment.  In addition to the offering, the securities purchase agreement also provides that, until February 13, 2018, the investors are entitled to participate in subsequent bona fide capital raising transactions that we may conduct.

As of November 8, 2017, 3,846 Preferred Shares have been converted into 3,846,000 shares of common stock and 3,203 Preferred Shares remain outstanding.

At-the-Market (ATM) Program

During the nine months ended September 30, 2017, we completed offerings of our common stock under our ATM Program of 847,147 shares. This resulted in an aggregate purchase price of approximately $1,082,000 ($1,036,000 net) for the nine month period ended September 30, 2017. During the three and nine months ended September 30, 2016, we completed offerings of our common stock under our ATM Program of 159,051 shares and 187,022 shares, respectively. This resulted in an aggregate purchase price of approximately $432,000 ($402,000 net) and $503,000 ($471,000 net), respectively, for the three and nine month periods ended September 30, 2016.

Effective May 5, 2017, we were no longer able to make use of our ATM Program (see, “– Note 2 – Liquidity Risks and Management’s Plans”).

Use of Estimates

The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Severance

Effective February 1, 2016,Restructured debt liability – contingent milestone payment

In conjunction with the November 2017 restructuring and retirement of long-term debt (See, "– Note 10 – Restructured debt liability"), we terminatedestablished a $15 million long-term liability for contingent AEROSURF regulatory and commercial milestone payments, beginning with the Employmentfiling for marketing approval in the United States, potentially due under the Exchange and Termination Agreement dated as of October 27, 2017 (Exchange and Termination Agreement), between ourselves and our then-President and Chief Executive Officer (Former CEO)affiliates of Deerfield Management Company L.P. (Deerfield). During the first quarter of 2016, we incurred a severance charge of $1.2 million in general and administrative expense under the termsThe liability has been recorded at full value of the Former CEO’s employment agreement, including $0.2 million relatedcontingent milestones and will continue to stock option expense for certain options that continued to vest through August 1, 2017. Ofbe carried at full value until the $1.0 million in severancemilestones are achieved and paid or milestones are not related to stock-based compensation, $0.9 million was paidachieved and the liability is written off as of September 30, 2017.a gain on debt restructuring.

During the second quarter of 2016, we incurred a severance charge of $0.4 million related to a May 2016 workforce reduction that was a component of a broader effort to initiate cash conservation and other cost reduction measures.Deferred revenue

On July 13, 2017, we implemented a reduction in workforce by 20 employees, representing approximately 42% of our total workforce, from 48 to 28 employees. The reduction was across all functions of the Company and affected employees were eligible for certain severance and other benefits resulting in a severance charge of $0.2 million in the third quarter of 2017.

Deferred Revenue

Deferred revenue represents amounts collected butreceived prior to satisfying the revenue recognition criteria (see, Revenue recognition) and are recognized as deferred revenue in our balance sheet.  Amounts expected to be recognized as revenue within the 12 months following the balance sheet date are classified as Deferred revenue – current portion.  Amounts not yet earned and includes $1.0 millionexpected to be recognized as revenue within the 12 months following the balance sheet date are classified as Deferred revenue – non-current portion.

Deferred revenue primarily consists of amounts related to an upfront license fee received in July 2017 for an upfront license fee in connection with the License Agreement with Lee’s. The License Agreement constitutes a multiple-element arrangement and revenue will be recognized as deliverablesour performance obligations under the contract are completedmet (see, Note 12 – Out-Licensing Agreement).

Revenue recognition

Effective January 1, 2018, we adopted Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers, using the modified retrospective transition method. Under this method, we recognize the cumulative effect of initially adopting ASC Topic 606, if any, as an adjustment to the opening balance of retained earnings.  Additionally, under this method of adoption, we apply the guidance to all incomplete contracts in scope as of the date of initial application. This standard applies to all contracts with customers, except for contracts that are within the scope of other standards, such as leases, insurance, collaboration arrangements and allfinancial instruments.

In accordance with ASC Topic 606, we recognize revenue when the customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services. To determine revenue recognition criteriafor arrangements that we determine are within the scope of ASC Topic 606, we perform the following five steps:

We only apply the five-step model to contracts when we determine that it is probable that we will collect the consideration we are entitled to in exchange for the goods or services we transfer to the customer. At contract inception, once the contract is determined to be within the scope of ASC Topic 606, we assess the goods or services promised within a contract and determine those that are performance obligations, and assesses whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

We have concluded that our government grants are not within the scope of ASC Topic 606 as they do not meet the definition of a contract with a customer.  We have concluded that the grants meet the definition of a contribution and are non-reciprocal transactions, and have also concluded that Subtopic 958-605, Not-for-Profit-Entities-Revenue Recognition does not apply, as we are a business entity and the grants are with governmental agencies.

In the absence of applicable guidance under U.S. GAAP, effective January 1, 2018, we developed a policy for the recognition of grant revenue when the related costs are incurred and the right to payment is realized.

We believe this policy is consistent with the overarching premise in ASC Topic 606, to ensure that revenue recognition reflects the transfer of promised goods or services to customers in an amount that reflects the consideration that we expect to be entitled to in exchange for those goods or services, even though there is no exchange as defined in ASC Topic 606. We believe the recognition of revenue as costs are incurred and amounts become realizable is analogous to the concept of transfer of control of a service over time under ASC Topic 606.

Prior to January 1, 2018, we recognized revenue as related costs were incurred under the grants given that persuasive evidence of an arrangement exists, delivery has occurred or services have been met.rendered, the price is fixed and determinable, and collectability is reasonably assured. Recognized amounts reflected our performance under the grants and equal direct and indirect costs incurred. Revenue and expenses under these arrangements were presented gross. Revenue recognition under this new policy is not materially different than would have been calculated under the old guidance. As a result of the adoption of this policy, there was no change to the amounts we have historically recorded in our financial statements.

Research and Development Expensedevelopment

We account for research and development expense by the following categories: (a) product development and manufacturing, (b) clinical medical and regulatory operations, and (c) direct preclinical and clinical development programs. Research and development expense includes personnel, facilities, manufacturing and quality operations, pharmaceutical and device development, research, clinical, regulatory, other preclinical and clinical activities and medical affairs. Research and development costs are charged to operations as incurred.incurred in accordance with ASC Topic 730, Research and Development.

Net Loss perper Common Share

Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted net loss per common share is computed by giving effect to all potentially dilutive securities outstanding for the period.

As of September 30, 20172018 and 2016,2017, the number of shares of common stock potentially issuable upon the conversion of preferred stock or exercise of certain stock options and warrants was 18.21.3 million and 9.40.9 million shares, respectively. For the three and nine months ended September 30, 20172018 and 2016,2017, all potentially dilutive securities were anti-dilutive and therefore have been excluded from the computation of diluted net loss per share.

In accordance with Accounting Standards Codification Topic 260, Earnings per Share, when calculating diluted netNet loss per common share a gain associated with the decrease in the fair value of warrants classified as derivative liabilities results in an adjustment to the net loss;– basic and the dilutive impact of the assumed exercise of these warrants results in an adjustment to thediluted and weighted average number of common shares outstanding. We utilize the treasury stock method to calculate the dilutive impact of the assumed exercise of warrants classified as derivative liabilities. Foroutstanding for the three and nine months ended September 30, 2017 and 2016,have been corrected for immaterial calculation errors related to the effectconversion of the adjustments for warrants classified as derivative liabilities was anti-dilutive.preferred stock to common stock during those periods.

We do not have any components of other comprehensive income (loss).

Beneficial Conversion Feature

The issuance of our Preferred Shares in the first quarter of 2017 (see, “– Note 4 – Stockholders’ Equity”) resulted in aA beneficial conversion feature which arises when a debt or equity security is issued with an embedded conversion option that is beneficial to the investor (or in the money) at inception due to the conversion option having an effective conversion price that is less than the fair value of the underlying stock at the commitment date.

Preferred Stock

The issuance of Series A Convertible Preferred Stock (Preferred Shares) in the first quarter of 2017 (see, “– Note 5 – Stockholders’ Equity”) resulted in a beneficial conversion feature. We recognized this feature by allocating the intrinsic value of the beneficial conversion feature, by allocating the relative fair value of the conversion option, which is the number of shares of common stock available upon conversion multiplied by the difference between the effective conversion price per share and the fair value of common stock per share on the commitment date, to additional paid-in capital, resulting in a discount on the Preferred Shares. As the Preferred Shares are immediately convertible by the holders, the discount allocated to the beneficial conversion feature was immediately accreted and recognized as a $3.6 million one-time, non-cash deemed dividend to the preferred shareholders during the first quarter of 2017.

An additional discount to the Preferred Shares of $4.5 million was created due to the allocation of proceeds to the Warrants which were issued with the Preferred Shares. This discount is amortized proportionately as the Preferred Shares are converted. No Preferred Shares were converted during the three or nine months ended September 30, 2018. For the three and nine month periodsmonths ended September 30, 2017, we recognized a non-cash deemed dividend to the preferred shareholders of $1.9$2.2 million and $2.4$6.4 million, respectively, related to the Preferred Shares converted during the periods.

RecentlyConvertible Note 

The issuance on July 2, 2018 of a Secured Convertible Promissory Note (the Note) to Panacea Venture Management Company Ltd. (Panacea) with respect to a loan facility in the aggregate amount of $1.5 million resulted in a beneficial conversion feature. We recognized this feature by allocating the relative fair value of the conversion option, which is the number of shares of common stock available upon conversion multiplied by the difference between the effective conversion price per share and the fair value of common stock per share on the commitment date, resulting in a discount on the Note. We recorded the Note as current debt at its face value of $1.5 million less debt discount consisting of (i) $0.4 million related to the beneficial conversion feature and (ii) $0.4 million in fair value of the warrants issued in connection with the Note. The discount is being accreted to the $1.5 million loan over its term using the effective interest method.

Income taxes

We account for income taxes in accordance with ASC Topic 740, Accounting for Income Taxes, which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between financial statement carrying amounts and the tax basis of assets and liabilities.

We use a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Because we have never realized a profit, management has fully reserved the net deferred tax asset since realization is not assured.

On December 22, 2017, the U.S. government enacted the 2017 Tax Cuts and Jobs Act (the 2017 Tax Act), which significantly revises U.S. tax law by, among other provisions, lowering the U.S. federal statutory income tax rate to 21%, imposing a mandatory one-time transition tax on previously deferred foreign earnings, and eliminating or reducing certain income tax deductions. As of December 31, 2017, we recorded the provisional impact from the 2017 Tax Act in accordance with SAB 118. As of September 30, 2018, we have not adjusted any of our provisional amounts that were recorded as of December 31, 2017. We will finalize our adjustments during the fourth quarter of 2018.

Recently Adopted Accounting Standards

In AugustMay 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-15, Presentation of Financial Statements – Going Concern(Subtopic 205-40):Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern, which defines management's responsibility to evaluate whether there is substantial doubt about an organization's ability to continue as a going concern and to provide related footnote disclosures. Substantial doubt about an entity's ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued (or are available to be issued). We adopted ASU 2014-15 effective December 31, 2016. Management has concluded that substantial doubt exists with respect to our ability to continue as a going concern through one year after the issuance of these financial statements (see, “ – Note 2 – Liquidity Risks and Management's Plans”).

In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This update addresses the income tax effects of stock-based payments and eliminates the windfall pool concept, as all of the tax effects related to stock-based payments will now be recorded at settlement (or expiration) through the income statement. The new guidance also permits entities to make an accounting policy election for the impact of forfeitures on the recognition of expense for stock-based payment awards. Forfeitures can be estimated or recognized when they occur. We adopted ASU 2016-09 during the three months ended March 31, 2017 and will continue to recognize stock compensation expense with estimated forfeitures. The adoption did not have a material impact on our unaudited condensed consolidated financial statements and is not expected to have an impact on the annual 2017 financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The new standard requires that the statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Entities will also be required to reconcile such total to amounts on the balance sheet and disclose the nature of the restrictions. We adopted ASU 2016-18 on March 31, 2017 on a retrospective basis. As a result, beginning-of-period cash, cash equivalents and restricted cash in the statement of cash flows increased by $0.2 million for each of the nine-month periods ended September 30, 2017 and 2016.

Recent Accounting Pronouncements

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which requires an entitywas subsequently amended by several other ASUs related to recognize revenue at an amount that reflectsTopic 606 to, among other things, defer the consideration to which the entity expects to be entitled in exchange for transferring goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for the annual period ending December 31, 2018date and interim periods within that annual period. An entity can elect to apply the guidance under oneclarify various aspects of the following two methods: (i) retrospectively to each prior reporting period presented, referred to as the full retrospective method or (ii) retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application in retained earnings, referred to as the modified retrospective method. The Company has not yet completed its final review of the impact of thisnew revenue guidance including the new disclosure requirements,principal versus agent considerations, identifying performance obligations,  licensing, and other improvements and practical expedients. We adopted ASU 2014-09, as it is continuing to evaluate the impacts of adoption and the implementation approach to be used. The Company plans to adopt the new standardamended, effective January 1, 2018 using the modified retrospective transition method. In June 2017, we entered into a License Agreement with Lee’s (HK), granting Lee’s (HK) rights to develop and commercialize our products in a specific Asian territory. The consideration we are eligible to receive under this agreement includes an upfront payment, contingent revenues in the form of regulatory and commercial milestones, and sales-based milestone and royalty payments. We evaluated the License Agreement under ASU 2014-09 and determined that there was no material impact to revenues for any of the years presented upon adoption. Additionally, there were no revisions to any balance sheet components of revenues such as deferred revenues or beginning retained earnings as a result of using the modified retrospective method. The Company continuesprimary impact on our financial statements is related to monitorrevised or additional changes, modifications, clarifications or interpretations being undertaken by the FASB,disclosures with respect to revenues and cash flows arising from contracts with customers, which may impact its current conclusions.are included in Note 12 – Out-Licensing Agreement.

In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718):, Scope of Modification Accounting. This ASU clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. The ASU is effective prospectively for the annual period ending December 31, 2018 and interim periods within that annual period. We adopted ASU 2017-09 effective January 1, 2018 and the adoption did not have a material impact on our unaudited condensed consolidated financial statements and is not expected to have a material impact on the annual 2018 financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments. This ASU clarifies clarify how entities should classify certain cash receipts and cash payments related to eight specific cash flow issues, including debt prepayment or extinguishment costs, with the objective of reducing diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The ASU also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The ASU is effective retrospectively for the annual period ending December 31, 2018 and interim periods within that annual period. We adopted ASU 2016-15 effective January 1, 2018 and the adoption did not have a material impact on our unaudited condensed consolidated financial statements and is not expected to have a material impact on the annual 2018 financial statements.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU requires lessees to put most leases on their balance sheets but recognize expenses in the income statement in a manner similar to current accounting standards. The ASU is effective January 1, 2019. Early adoption is permitted. The standard requires a modified retrospective approach; however, the FASB recently added a transition option to the leases standard that allows entities to apply the new guidance in the year of transition rather than at the beginning of the earliest period presented. We have not elected to early adopt this standard.  We are currently evaluating the effect thatof ASU 2017-092016-02 and believe it may have a material impact on our consolidated financial statements and related disclosures.

On April 4, 2018, we completed a private placement offering pursuant to a Securities Purchase Agreement (SPA) and Registration Rights Agreement with LPH II Investments Limited (LPH II), a Cayman Islands company and wholly-owned subsidiary of Lee’s. Under this SPA, LPH II invested $2.6 million and acquired 541,667 shares of our common stock and warrants to purchase 135,417 shares of our common stock at an exercise price of $5.52 per share. The purchase price per share was $4.80. The warrants are exercisable after 6 months and through the seventh anniversary of the issue date. In addition, under the Registration Rights Agreement, we agreed to file an initial resale registration statement with the SEC to register for subsequent resale the shares and the warrant shares. We are required to seek registration of 25% of the shares and warrant shares on such initial resale registration statement. From time to time, following the 180th day from March 30, 2018, LPH II or a majority of the holders of the shares and warrant shares may require us to file additional registration statement(s) to register the resale of the balance of the shares and warrant shares, subject to certain limitations.

License revenue with affiliate for the three and nine months ended September 30, 2018 represents revenue from a License Agreement with Lee’s (HK) and constitutes a contract with a customer accounted for in accordance with ASC Topic 606, which we adopted effective January 1, 2018 (see, Note 4 – Summary of Significant Accounting Policies – Recently Adopted Accounting Standards and Note 12 – Out-Licensing Agreement). There was no impact to License revenue with affiliate previously recognized as a result of the adoption of ASC Topic 606.

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, as follows:

Fair Value on a Recurring Basis

The tables below categorize assets and liabilities measured at fair value on a recurring basis for the periods presented:

The following table summarizes changes in the fair value of common stock warrant liability measured on a recurring basis using Level 3 inputs for the nine months ended September 30, 2016 representing the write-off of the remaining liability upon expiration of the underlying warrants in February 2016.

Fair Value of Long-Term Debt

At September 30, 2017, the estimated fair value of the Deerfield Loan (see, “– Note 8 – Long-term Debt”) was $23.0 million, compared to a carrying value for current and non-current portions of $25.0 million. The estimated fair value of the Deerfield Loan is based on discounting the future contractual cash flows to the present value at the valuation date. This analysis utilizes certain Level 3 unobservable inputs, including current cost of capital. Considerable judgment is required to interpret market data and to develop estimates of fair value. The estimates presented are not necessarily indicative of amounts that could be realized in a current market exchange. The use of alternative market assumptions and estimation methodologies could have a material effect on these estimates of fair value. The methodology and assumptions do not take into consideration the restructuring and retirement of the Deerfield Loan effective November 1, 2017 (see, “– Note 10 – Subsequent Events”).

Loan Payable consists solely of amounts due under a loan agreement with Lee’s (HK).

On August 14, 2017, we entered into a loan agreement (Loan Agreement) with Lee’s (HK). Under the Loan Agreement, Lee’s (HK)In January 2018 and March 2018, LPH agreed to lend us up$1.5 million and $1.0 million, respectively, to $3.9 million (Loan), to be funded at Lee’s (HK)’s sole discretion in three equal installments on August 15, September 10 and October 10, 2017. The Loan was to be used to support our AEROSURF development activities and sustain our operations through October 31, 2017, while we seek to identify and Lee’s (HK) negotiatedadvance one or more potential strategic initiatives as defined in the SPA and related agreements.loan agreements (Funding Event). The Loan accruedloans accrue interest at a rate of 12%6% per annum. We receivedannum and mature upon the three installmentsearlier of $1.3 million from Lee's (HK)the closing date of the Funding Event or December 31, 2018. To secure our obligations under these loans, we granted LPH a security interest in accordancesubstantially all our assets pursuant to the terms of a Security Agreement with LPH dated March 1, 2018 (LPH Security Agreement).

In August 2018 and September 2018, LPH agreed to lend us funds to sustain our operations while we continued to work on a strategic transaction.  The initial loan was funded on August 14, 2018 in the schedule. As partial considerationamount of $300,000, and subsequent loans on the following dates and in the following amounts: August 29, 2018, in the amount of $480,000; September 12, 2018 in the amount of $500,000; and September 27, 2018 in the amount of $500,000.  The loans accrue interest at a rate of 6% per annum and mature upon the earlier of (i) the closing date for the SPA,strategic transaction (as defined in the outstanding principal balance of the Loan was applied in full satisfaction of a like amount of cash consideration payable by Lee’s (HK) at the closing of the SPA, and the Loan was discharged in full (seerelated loan agreements), “– Note 10 – Subsequent Events”). 

As of September 30, 2017, accrued interest on the Loan was $28,000.

As partial consideration for the Loan,provided that the Company and Lee’s (HK) also agreedis able to amend the License, Development and Commercialization Agreement dated asraise a minimum of June 12, 2017 between the parties (License Agreement) and have entered into Amendment No. 1$30 million in connection with such transaction, or (ii) March 31, 2019.  In each case, we granted to the License Agreement (the Amendment). UnderLPH a security interest in substantially all of our assets pursuant to the terms of the Amendment, reductions have been made to certain of the milestone and royalty payments. As a result, the Company may receive up to $35.8 million (previously, $37.5 million) in potential clinical, regulatory and commercial milestone payments. The options to add Japan to the Licensed Territory (as defined in the License Agreement) and to manufacture the Company’s aerosol delivery device in and for the Licensed Territory are made effective immediately. In addition, Zhaoke Pharmaceutical (Hefei) Co. Ltd. an affiliate of Lee’s (HK), has been made a party to the LicenseLPH Security Agreement. Except as set forth in the Amendment, all other terms and conditions of the License Agreement remain in full force and effect.

Long-term

On July 2, 2018, we issued to Panacea a Secured Convertible Promissory Note (the Note) with respect to a loan facility in the aggregate amount of up to $1.5 million, which was funded in two loans of, $1.0 million on the date of the Note and $500,000 on July 23, 2018. The Note has a maturity date of December 31, 2018 and bears interest at a rate of 15% per annum until the Note is paid in full or converted into shares of our common stock at a price per share of $4.00. In addition, in lieu of converting the Note, Panacea may deliver the Note into a private placement in which Panacea Venture Healthcare Fund I L.P., an affiliate of Panacea, may participate. There can be no assurance that such a private placement will be completed. In connection with these Loans, we granted to Panacea a security interest in substantially all our assets.

In connection with the Note, we issued to Panacea warrants (the “Series D Warrants”) to purchase 187,500 shares (the “Warrant Shares”) at an exercise price of $4.00 per Warrant Share (the “Exercise Price”). The Warrants may be exercised at any time beginning six months after the date of issuance and through the fifth anniversary of the date of issuance. The Warrants may not be exercised to the extent that the holder thereof would, following such exercise, beneficially own more than 9.99% of the Company’s outstanding shares of Common Stock, which percentage may be increased, decreased or waived by such holder upon sixty-one days’ notice to us. The Warrants also contain customary provisions that adjust the Exercise Price and the number of Warrant Shares in the event of a corporate transaction.

We recorded the Note as current debt consists solelyat its face value of amounts due under$1.5 million less debt discounts consisting of (i) $0.4 million fair value of the Deerfield Loanwarrants issued in connection with the Note and (ii) a $0.4 million beneficial conversion feature related to an embedded conversion option that had an effective conversion price that was less than the fair value of the underlying stock at the commitment date. The discount is being accreted to the $1.5 million loan over its term using the effective interest method. The Panacea Warrants are derivatives that qualify for the periods presented:

an exemption from liability accounting as provided for in ASC Topic 815, Derivatives and Hedging – Contracts in Entity’s Own Equity, and have been classified as equity.

The principal amountfair value at issuance of the loan is payablePanacea Warrants was determined using the Black-Scholes option-pricing model. The input assumptions used in two equal annual installmentsthe valuation are the historical volatility of $12.5 million, payableour common stock price, the expected term of the warrants, and the risk-free interest rate based on the five-year treasury bill rate in each of February 2018 and 2019. See, “Note 10 – Subsequent Events”.effect at the measurement date. 

The following amounts comprise the Deerfield Loan interest expense for the periods presented:

Amortization of prepaidThe following amounts comprise the convertible note interest expense represents non-cash amortization of $5 million of units purchased by Deerfield in our July 2015 public offering and accepted in satisfaction of $5 million of future interest payments calculated at an interest rate of 8.75% underfor the Deerfield Loan. Cash interest expense represents interest at an annual rate of 8.25% on the outstanding principal amount, paid in cash on a quarterly basis.periods presented:

On November 1, 2017, we and Deerfield entered into an Exchange and Termination Agreement pursuant to which (i) promissory notes evidencing a loan with affiliates of Deerfield Management Company L.P. (Deerfield Loan) in the aggregate principal amount of $25 million and (ii) warrants to purchase up to 25,000 shares of our common stock at an exercise price of $786.80 per share held by Deerfield were cancelled in consideration for (i) a cash payment in the aggregate amount of $2.5 million, (ii) 71,111 shares of common stock, representing 2% of fully-diluted shares outstanding (as defined in the Exchange and Termination Agreement) on the closing date, and (iii) the right to receive certain milestone payments based on achievement of specified AEROSURF development and commercial milestones, which, if achieved, could potentially total up to $15 million. In addition, a related security agreement, pursuant to which Deerfield held a security interest in substantially all of our assets, was terminated. We established a $15 million long-term liability for the contingent milestone payments potentially due to Deerfield under the Exchange and Termination Agreement (see, Note 4 – Summary of Significant Accounting Policies – Restructured debt liability – contingent milestone payment).

We recognize in our condensed consolidated financial statements all stock-based option awards to employees and non-employee directors based on their fair value on the date of grant, calculated using the Black-Scholes option-pricing model. Compensation expense related to stock-based option awards is recognized ratably over the vesting period, which for employees is typically three years.  We recognize restricted stock unit awards to employees and non-employee directors based on their fair value on the date of grant.  Compensation expense related to restricted stock unit awards is recognized ratably over the vesting period, which is typically between approximately six to 18 months.

A summary of activity under our long-term incentive plans is presented below:

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing formula based on the following weighted average assumptions:

The table below summarizes the total stock-based compensation expense included in the statements of operations for the periods presented:

Lee’s Pharmaceutical (HK) Ltd.

In June 2017, we entered into a License, Development and Commercialization Agreement (“License Agreement”) with Lee’s Pharmaceutical (HK) Ltd., a company organized under the laws of Hong Kong (“Lee’s (HK)") and an affiliate of Lee's. Under the License Agreement, we granted to Lee’s (HK) an exclusive license with a right to sublicense, (i) to develop and commercialize our KL4 surfactant products, including SURFAXIN®, which was approved by the U.S. Food and Drug Administration (“FDA”) in 2012 for the prevention of respiratory distress syndrome (“RDS”) in premature infants, SURFAXIN LS™, the lyophilized dosage form of SURFAXIN; and AEROSURF®, an investigative combination drug/device product that is designed to deliver aerosolized KL4 surfactant noninvasively, and (ii) to register and manufacture SURFAXIN and SURFAXIN LS for use in the Licensed Territory, which includes the People’s Republic of China (“PRC”), Hong Kong, Thailand, Taiwan and 12 other countries (the “Licensed Territory”). In addition, we granted Lee’s (HK) options to potentially add Japan to the Licensed Territory and to manufacture our ADS in the Licensed Territory, in each case subject to conditions set forth in the License Agreement.

Under the License Agreement, Lee’s (HK) made an upfront payment to us of $1 million. We also may receive up to $37.5 million in potential clinical, regulatory and commercial milestone payments and will share in any sublicense income Lee’s (HK) may receive at a rate equal to low double digits. In addition, Lee’s (HK) will be responsible for all costs and expenses in and for the Licensed Territory related to development activities, including a planned AEROSURF phase 3 clinical trial, regulatory activities, and commercialization activities.

In August 2017, we entered into a Loan Agreement, pursuant to which Lee’s (HK) agreed to lend us up to $3.9 million to support our activities through October 31, 2017, while we and Lee’s worked to complete a $10 million securities purchase agreement (Lee’s SPA) pursuant to which Lee’s acquired a controlling interest in our Company effective on November 1, 2017. In connection with the Loan Agreement, we amended the License Agreement (Amendment No. 1) to expand certain of Lee’s (HK) rights, by immediately adding Japan to the licensed territory, accelerating the right to manufacture the ADS in and for the licensed territory, reducing or eliminating certain of the milestone and royalty payments and adding an affiliate of Lee’s (HK) as a party to the License Agreement. As a result, the additional amounts for potential clinical, regulatory and commercial milestone payments were reduced to $35.8 million.

Accounting Analysis under ASC 606

In evaluating the License Agreement in accordance with ASC Topic 606, we concluded that the contract counterparty, Lee’s (HK), is a customer. We identified the following performance obligations: (i) a bundled performance obligation consisting of licensing rights to develop and commercialize our KL4 surfactant products and a technology transfer process for the manufacture of SURFAXIN and SURFAXIN LS; and (ii) a technology transfer process for the manufacture of our ADS. We determined that participation in the Joint Steering Committee (and other committees under its authority) and our ongoing product development, regulatory, and commercialization activities under the License Agreement were deemed immaterial in the context of the contract. Consistent with the guidance under ASC 606-10-25-16A, we disregarded immaterial promised goods and services when determining performance obligations.

We concluded that the licensing rights were not distinct within the context of the contract (i.e., separately identifiable) because the licensing rights do not have stand-alone value from other promised goods and services as Lee’s (HK) could not benefit from the licensing rights without the completion of the technology transfer process for the manufacture of SURFAXIN and SURFAXIN LS. The technology transfer process for the manufacture of our ADS is distinct within the context of the contract because it has stand-alone value from other promised goods and services as Lee’s (HK) could benefit from this right on a stand-alone basis. However, we determined that the ADS manufacturing right has a nominal stand-alone selling price at the time of Amendment No. 1 as the ADS is not yet verified and there is uncertainty with regard to the commercial value of the ADS given that the AEROSURF combination drug/device product is currently in clinical development.

With respect to Amendment No. 1, we elected to use the practical expedient for contract modifications that occur prior to the adoption of ASU 2014-09, and we determined that the impact was immaterial. Allocable arrangement consideration under the practical expedient comprised the upfront payment of $1 million and $0.3 million related to reductions in royalties and milestones in connection with Amendment No. 1. The $1.3 million was attributed in its entirety to the bundled performance obligation of licensing rights to develop and commercialize our KL4 surfactant products and a technology transfer process for the manufacture of SURFAXIN and SURFAXIN LS. Revenue associated with the bundled performance obligation was recognized beginning in November 2017 with the initiation of the technology transfer process for the manufacture of SURFAXIN and SURFAXIN LS and will be recognized over time as services are performed and based on the input method related to the level of effort expended. The expected completion date for the technology transfer is June 2019.

Regulatory and commercialization milestones were excluded from the transaction price, as all milestone amounts were fully constrained under the guidance. As part of our evaluation of the constraint, we considered a number of factors in determining whether there is significant uncertainty associated with the future events that would result in the milestone payments. Those factors include: our financial position; ongoing delays in our development activities and with initiating our phase 3 clinical trial; our limited experience with successful drug development; our limited experience with clinical trials; our recent failure to achieve primary endpoints in our phase 2b clinical trial; our limited experience with commercialization; our decision in 2015 to cease manufacturing and commercializing of SURFAXIN; and the fact that the uncertainty about the related consideration is not expected to be resolved for a long period of time (see, Item 1A – Risk Factors).

Consideration related to sales-based milestones and royalties will be recognized when the related sales occur, provided that the reported sales are reliably measurable and that we have no remaining performance obligations, as such sales were determined to relate predominantly to the license granted to Lee’s (HK) and therefore have also been excluded from the transaction price. We will re-evaluate the transaction price in each reporting period and as uncertain events are resolved or other changes in circumstances occur.

EffectiveOn October 27, 2017, 19, 2018 and November 2, 2018, we entered into the SPALoan Agreements (“Loan Agreements”) with LPH Investments Limited (LPH), a company incorporated in the Cayman Islands with limited liability.wherein LPH is a wholly-owned subsidiary of Lee’s. Under the SPA, LPH invested $10 million (the Investment) in our Company and acquired 46,232,085 shares of our common stock (the Shares), at a price of $0.2163 per share, which represents a 15% premium over the average of the daily volume-weighted average price per share (VWAP) over the 10-day trading period ending on and including the date of the SPA. Following the transactions described in the SPA, LPH beneficially owned 73% of our issued and outstanding shares of common stock. The Investment includes cancellation of $3.9 million in outstanding loans ($2.6 million of which was recorded as loan payable as of September 30, 2017) that we borrowed from Lee’s (HK) under the Loan Agreement, effective August 14, 2017, between ourselves and Lee's (HK). Pursuant to the SPA, we granted LPH the right to appoint up to two individuals to serve on our Board of Directors, and LPH may designate such individuals on or prior to the 30th day following the closing of the transactions contemplated by the SPA (the Closing). In addition, the SPA also amends the executive employment agreement of each of our President and Chief Executive Officer (Craig Fraser), Senior Vice President and Chief Financial Officer (John A. Tattory) and Senior Vice President and Chief Medical Officer (Steven G. Simonson, M.D.), such that in lieu of the Annual Bonuses (as defined in each executive's employment agreement) that would have been payable to the executives during the 24-month period following the Closing, the executives are entitled to an award of equity under our 2011 Long-Term Incentive Plan, as amended, having a value when issued equal to the combined total value of the 2017 and 2018 Target Bonus Amounts (as defined in each executive's employment agreement) and vesting in two equal installments on March 15, 2018 and March 15, 2019. Under the terms of the SPA, we also granted to LPH a preemptive right to purchase in future offerings of equity securities up to that number of shares of the Company's equity securities needed to maintain LPH's percentage of beneficial ownership of the Company's outstanding voting stock immediately prior to each such offering, subject to certain limitations and exclusions.

Contemporaneously with the execution of the SPA, we and LPH entered into a registration rights agreement pursuant to which we agreed to provide certain registration rights with respectlend us $430,000 and $500,000 (together the “Loans”) to the Shares under the SPA, which rights are limitedsupport our operations while we seek to registration of up to 25% of the Shares during the initial 18-month period following the closing of the SPA. We issued the Shares to LPH pursuant to Rule 506(b) of Regulation D and Regulation S under, and Section 4(a)(2) of, the Securities Act of 1933.

Contemporaneously with the execution of the SPA, we and Deerfield entered into an Exchange and Termination Agreement (the Exchange and Termination Agreement). Under the Exchange and Termination Agreement, (i) promissory notes evidencing an aggregate principal amount of $25 million that we owed to Deerfield undercomplete a Facility Agreement dated as of February 13, 2013 (Facility Agreement), as amended from time to time, and (ii) warrants to purchase up to 500,000 shares of our common stock at an exercise price of $39.34 per share held by Deerfield (the Deerfield Warrants) were cancelled in consideration for (i) a cash payment in the aggregate amount of $2.5 million, (ii) an aggregate of 1,422,250 shares of common stock and (iii) the right to receive certain milestone payments (Milestone Payments) based on achievement of specified development and commercial milestones related to the Company's AEROSURF® development program, which, if achieved, could potentially total up to $15 million.

Contemporaneously with the execution of the Exchange and Termination Agreement, we and Deerfield entered into a registration rights agreement pursuant to which we agreed to provide certain registration rights with respect to the shares of common stock issued to Deerfield under the Exchange and Termination Agreement. We issued the shares of common stock to Deerfield pursuant to Rule 506(b) of Regulation D under, and Section 4(a)(2) of, the Securities Act of 1933.

On November 1, 2017 (the Closing Date), we, Lee's and Deerfield consummated the transactions contemplated by the SPA and the Exchange and Termination Agreement. Effective upon the Closing Date, (i) the Facility Agreement, including the outstanding promissory notes thereunder, and (ii) that certain Security Agreement, dated as of February 13, 2013, among Deerfield and us were cancelled and terminated.

To facilitate consummation of the SPA, effective upon the Closing, Battelle, holder of an aggregate of 1,095 shares of Series A Convertible Preferred Stock, par value $0.001 per share, of the Company (Preferred Shares), executed a waiver wherein Battelle waived its right to the Liquidity Preferencestrategic transaction (as defined in the DesignationLoan Agreements, the “Strategic Transaction”). The Loans, which were funded on October 19, 2018 and November 2, 2018, each accrue interest at a rate of Preferences, Rights6% per annum and Limitationsmature upon the earlier of (i) the closing date for the Preferred Shares)Strategic Transaction, provided that the Company is able to raise a minimum of $30 million in connection with respect to their Preferred Shares.such transaction, or (ii) March 31, 2019. In addition,each case, we and Battelle entered intogranted LPH a non-binding memorandum of understanding outliningsecurity interest in substantially all our assets under the key terms for a potential restructuring of the amounts due to Battelle under development and collaboration agreements between ourselves and Battelle.LPH Security Agreement.