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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
COMMISSION FILE NUMBER 0-11550
PHARMOS CORPORATION
-------------------
(Exact name of registrant as specified in its charter)
NEVADA 36-3207413
------ ----------
(State or other jurisdiction of (IRS Employer Id. No.)
incorporation or organization)
99 WOOD AVENUE SOUTH, SUITE 311
ISELIN, NJ 08830
(Address of principal executive offices)
Registrant's telephone number, including area code: (732) 452-9556
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes __ No X.
As of November 12, 2003 the Registrant had outstanding 73,963,541 shares of its
$.03 par value Common Stock.
PART I. FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
PHARMOS CORPORATION
(UNAUDITED)
CONSOLIDATED BALANCE SHEETS
========================================================================================
SEPTEMBER 30, DECEMBER 31,
2003 2002
============= =============
ASSETS
Cash and cash equivalents $ 16,447,392 $ 19,579,287
Other receivables 505,099 698,800
Restricted cash 9,692,308 2,199,999
Debt issuance costs 1,219,623 -
Prepaid expenses and other current assets 327,943 323,991
------------- -------------
TOTAL CURRENT ASSETS 28,192,365 22,802,077
Fixed assets, net 1,343,534 1,792,322
Restricted cash 11,367,692 60,000
Debt issuance costs 142,925 -
Other assets 42,533 32,283
------------- -------------
TOTAL ASSETS $ 41,089,049 $ 24,686,682
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable $ 2,414,594 $ 3,742,460
Accrued expenses 3,409,158 3,241,581
Warrant Liability 1,576,590 -
Accrued wages and other compensation 1,004,228 999,647
Convertible debentures, net 14,985,775 3,446,658
------------- -------------
TOTAL CURRENT LIABILITIES 23,390,345 11,430,346
Other liability 10,000 10,000
Convertible debentures, net 2,543,383 -
------------- -------------
TOTAL LIABILITIES 25,943,728 11,440,346
------------- -------------
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock, $.03 par value,
1,250,000 shares authorized,
none issued and outstanding
Common stock, $.03 par value;
110,000,000 shares authorized,
71,372,231 and 56,574,849 issued and outstanding
in 2003 and 2002, respectively 2,141,168 1,697,246
Deferred compensation (79,992) (119,988)
Paid in capital 128,604,965 114,187,558
Accumulated deficit (115,520,394) (102,518,054)
Treasury stock, 14,189 shares held in 2003 and 2002 (426) (426)
------------- -------------
TOTAL SHAREHOLDERS' EQUITY 15,145,321 13,246,336
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 41,089,049 $ 24,686,682
============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
2
PHARMOS CORPORATION
(UNAUDITED)
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30,
2003 2002
------------ ------------
REVENUES - -
EXPENSES
Research and development, net $2,598,758 $4,148,848
Selling, general and administrative 931,066 1,076,057
Depreciation and amortization 165,293 170,063
------------ ------------
TOTAL OPERATING EXPENSES 3,695,117 5,394,968
------------ ------------
LOSS FROM OPERATIONS (3,695,117) (5,394,968)
OTHER INCOME (EXPENSE)
Interest income 52,629 127,496
Other (expense) income, net (19,625) 5,346
Derivative loss (457,090) -
Interest expense (69,813) (186,438)
------------ ------------
OTHER EXPENSE, NET (493,899) (53,596)
------------ ------------
NET LOSS ($4,189,016) ($5,448,564)
============ ============
NET LOSS PER SHARE
- BASIC AND DILUTED ($.06) ($.10)
============ ============
Weighted average shares outstanding - basic and diluted 71,083,346 56,583,958
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
3
PHARMOS CORPORATION
(UNAUDITED)
CONSOLIDATED STATEMENTS OF OPERATIONS
- -------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
------------ ------------
REVENUES - -
EXPENSES
Research and development, net $8,955,387 $10,016,149
Selling, general and administrative 2,535,997 2,907,645
Depreciation and amortization 505,486 516,787
------------ ------------
TOTAL OPERATING EXPENSES 11,996,870 13,440,581
------------ ------------
LOSS FROM OPERATIONS (11,996,870) (13,440,581)
OTHER INCOME (EXPENSE)
Interest income 948,045 442,276
Other (expense) income, net (44,346) 3,148
Derivative loss (1,529,636) -
Interest expense (379,533) (772,499)
------------ ------------
OTHER EXPENSE, NET (1,005,470) (327,075)
------------ ------------
NET LOSS ($13,002,340) ($13,767,656)
============ ============
NET LOSS PER SHARE
- BASIC AND DILUTED ($.20) ($.24)
============ ============
Weighted average shares outstanding - basic and diluted 64,789,797 56,534,870
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
4
PHARMOS CORPORATION
(UNAUDITED)
CONSOLIDATED STATEMENTS OF CASH FLOWS
- ---------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30,
2003 2002
------------ ------------
Cash flows from operating activities
Net loss ($13,002,340) ($13,767,656)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization 505,486 516,787
Reversal of beneficial conversion feature (786,000) -
Change in the value of warrants 1,529,636 -
Amortization of debt discount and issuance costs 111,929 285,721
Amortization of fair value of change in convertible debt 68,808 317,006
Amortization of stock options issuances below fair market value 39,996 39,649
Non-cash compensation charge - consultant compensation 32,472 63,537
Changes in operating assets and liabilities
Other receivables 193,701 (45,685)
Prepaid expenses and other current assets (3,952) 600,809
Other assets (10,250) (10,250)
Accounts payable (1,327,866) (657,826)
Accrued expenses 167,577 390,439
Accrued wages and other compensation 4,581 (208,746)
Other liability - 10,000
------------ ------------
Net cash flows used in operating activities (12,476,222) (12,466,215)
------------ ------------
Cash flows from investing activities
Purchases of fixed assets (56,698) (502,537)
(Increase) decrease in restricted cash (18,800,001) 3,543,299
------------ ------------
Net cash flows used in investing activities (18,856,699) 3,040,762
------------ ------------
Cash flows from financing activities
Proceeds from issuance of common stock and exercise of
warrants, net 12,080,090 18,104
Fees related to refinancing convertible debt - (163,000)
Proceeds from issuance of convertible debentures
and warrants, net 19,620,936 -
Repayment of convertible debentures, net (3,500,000) (2,000,000)
------------ ------------
Net cash provided by financing activities 28,201,026 1,398,403
------------ ------------
Net decrease in cash and cash equivalents (3,131,895) (11,570,349)
Cash and cash equivalents at beginning of year 19,579,287 35,269,114
------------ ------------
Cash and cash equivalents at end of period $16,447,392 $23,698,765
============ ============
Supplemental information:
Interest paid $525,448 $175,165
Supplemental disclosure of non-cash financing activities:
Conversion of convertible debt and interest to equity - $2,617,593
Issuance of warrants in connection with the private placement $393,707 -
The accompanying notes are an integral part of these consolidated
financial statements.
5
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. INTERIM FINANCIAL STATEMENTS
The interim Financial Statements of Pharmos Corporation (the "Company" or
"Pharmos") have been prepared in accordance with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
information and disclosures necessary for a presentation of the Company's
financial position, results of operations, and cash flows in conformity
with generally accepted accounting principles. In the opinion of
management, these financials statements reflect all adjustments, consisting
only of normal recurring accruals, necessary for a fair presentation of the
Company's financial position, results of operations, and cash flows for
such periods. The results of operations for any interim periods are not
necessarily indicative of the results for the full year. The December 31,
2002 Balance Sheet data was derived from audited financial statements, but
does not include all disclosures required by generally accepted accounting
principles. These financial statements should be read in conjunction with
the financial statements and notes thereto contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 2002.
Certain reclassifications have been made to the financial statements for
the three and nine months ended September 30, 2002 to conform with the
current period's presentation.
2. THE COMPANY
Pharmos Corporation (the "Company" or "Pharmos") is a bio-pharmaceutical
company that discovers and develops new drugs to treat a range of
inflammatory, pain and neurological disorders. Although Pharmos does not
currently have any approved products, the Company has a portfolio of drug
candidates under development, as well as discovery, preclinical and
clinical capabilities. The Company has executive offices in Iselin, New
Jersey and conducts research and development through its wholly owned
subsidiary, Pharmos, Ltd., in Rehovot, Israel.
3. LIQUIDITY AND BUSINESS RISKS
The Company incurred operating losses since its inception through the year
ended December 31, 2000 and was not profitable in 2002 and the first three
quarters of 2003. During 2001, the Company recorded net income due to the
nonrecurring sale of its ophthalmic product line. At September 30, 2003,
the Company has an accumulated deficit of $115.5 million. Such losses have
resulted principally from costs incurred in research and development and
from general and administrative expenses. The Company has funded its
operations through the use of cash obtained principally from third party
financing. Management believes that cash and cash equivalents of $16.4
million and restricted cash of $5.0 million (released from restricted cash
in October 2003) as of September 30, 2003, will be sufficient to support
the Company's continuing operations into the fourth quarter 2004.
The Company is continuing to actively pursue various funding options,
including additional equity offerings, strategic corporate alliances,
business combinations and the establishment of product related research and
development limited partnerships, to obtain additional financing to
continue the development of its products and bring them to commercial
markets. Should the Company be unable to raise adequate financing in the
future, long-term operations will need to be scaled back or discontinued.
4. SIGNIFICANT ACCOUNTING POLICIES
REVENUE RECOGNITION
The Company earns license fees from the transfer of drug technology and the
related preclinical research data. License fee revenue is recognized when
all performance obligations are completed and the amounts are considered
collectible. The Company had no product sale revenues for the three and
nine month periods ending September 30, 2003 and 2002 due to the sale of
its ophthalmic product line in October 2001 and does not expect product
sale revenues for the next few years. Further product sales revenue may
never materialize if products currently under development fail to be
ultimately approved or commercialized.
6
EQUITY BASED COMPENSATION
The Company accounts for its employee stock option plans in accordance with
the provisions of Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees", and related interpretations. As such,
compensation expense related to employee stock options is recorded if, on
the date of grant, the fair value of the underlying stock equals or exceeds
the option exercise price. The Company adopted the disclosure-only
requirements of SFAS No. 123, " Accounting for Stock-Based Compensation",
which allows entities to continue to apply the provisions of APB Opinion
No. 25 for transactions with employees and provide pro forma operating
results and pro forma per share disclosures for employee stock grants as if
the fair-value-based method of accounting in SFAS No. 123 has been applied
to these transactions. Options issued to non-employees are valued using the
fair value methodology under SFAS 123.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, Accounting for Stock-Based Compensation, Transition and
Disclosure, an amendment of FASB Statement No. 123 (SFAS 148). This
statement provides alternative methods of transition for an entity that
voluntarily changes to the fair value based method of accounting for stock
based compensation. It also amends the disclosure provisions of SFAS 123 to
require prominent disclosure about the effects on reported net loss of an
entity's accounting policy decisions with respect to stock-based employee
compensation. Further, SFAS 148 amends Accounting Principles Board Opinion
No. 28, Interim Financial Reporting, to require disclosure about those
effects in interim financial information.
The following table illustrates the effect on loss from continuing
operations and loss per share if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based employee
compensation. The estimated fair value of each option is calculated using
the Black-Scholes option-pricing model.
Three months ended Nine months ended
September 30, September 30,
2003 2002 2003 2002
---- ---- ---- ----
Net (loss) as reported ($4,189,016) ($5,448,564) ($13,002,340) ($13,767,656)
Add: Stock-based employee
compensation expense included in 13,332 13,343 39,996 39,649
reported net income
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards (260,027) (293,060) (758,429) (823,044)
------------ ------------ ------------- -------------
Pro forma net (loss) ($4,435,711) ($5,728,281) ($13,720,773) ($14,551,051)
============ ============ ============= =============
Earnings per share:
Basic and diluted - as reported ($.06) ($.10) ($.20) ($.24)
Basic and diluted - pro forma ($.06) ($.10) ($.21) ($.26)
For disclosure purposes under SFAS No. 123, the fair value of each option
grant was estimated on the date of grant using the Black-Scholes option
valuation model with the following weighted-average assumption:
Three months ended Nine months ended
September 30 September 30
2003 2002 2003 2002
---- ---- ---- ----
Risk-interest rate 3.15 % 4.39 % 2.88 - 3.15% 4.34 - 4.39%
Expected lives (in years) 5 5 5 5
Dividend yield 0 % 0 % 0 % 0 %
Expected volatility 75 % 75 % 75 % 75 %
7
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In May 2003, the Financial Accounting Standards Board issued Statement No.
150 ("FAS 150"), Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity. FAS 150 specifies that
instruments within its scope embody obligations of the issuer and that the
issuer must classify them as liabilities. SFAS 150 requires issuers to
classify as liabilities the following three types of freestanding financial
instruments: (1) mandatorily redeemable financial instruments; (2)
obligations to repurchase the issuer's equity shares by transferring assets
and (3) certain obligations to issue a variable number of shares. SFAS 150
defines a "freestanding financial instrument" as a financial instrument
that (1) is entered into separately and apart from any of the entity's
other financial instruments or equity transactions or (2) is entered into
in conjunction with some other transaction and can be legally detached and
exercised on a separate basis. For all financial instruments entered into
or modified after May 31, 2003, SFAS 150 is effective immediately. For all
other instruments of public companies, SFAS 150 went into effect at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have a material impact on the Company's
financial statements for the third quarter of 2003. The Financial
Accounting Standards Board is expected to defer the effective date for
selected provisions of SFAS No. 150, limited to mandatorily redeemable
non-controlling interests associated with finite-lived subsidiaries. The
deferral of those selected provisions is not expected to have a material
impact on the Company's financial statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities ("SFAS No. 149"). SFAS No.
149 clarifies under what circumstances a contract with an initial net
investment meets the characteristics of a derivative as discussed in
Statement No. 133. It also specifies when a derivative contains a financing
component that warrants special reporting in the Consolidated Statement of
Cash Flows. SFAS No. 149 amends certain other existing pronouncements in
order to improve consistency in reporting these types of transactions. The
new guidance is effective for contracts entered into or modified after June
30, 2003, and for hedging relationships designated after June 30, 2003.
This standard did not have a material impact on the Company's consolidated
financial statements.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51". FIN 46 requires an
investor to consolidate a variable interest entity if it is determined that
the investor is a primary beneficiary of that entity, subject to the
criteria set forth in FIN 46. Assets, liabilities, and non-controlling
interests of newly consolidated variable interest entities will be
initially measured at fair value. After initial measurement, the
consolidated variable interest entity will be accounted for under the
guidance provided by Accounting Research Bulletin No. 51, "Consolidated
Financial Statements." FIN 46 is effective for variable interest entities
created or entered into after January 31, 2003. For variable interest
entities created or acquired before February 1, 2003, FIN 46 applies in the
first fiscal year or interim period beginning after December 15, 2003. The
Company does not believe that the adoption of this standard will have a
material impact on its consolidated financial statements.
In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (`FIN 45"), which clarifies disclosure
and recognition/measurement requirements related to certain guarantees. The
disclosure requirements are effective for financial statements issued after
December 15, 2002 and the recognition/measurement requirements are
effective on a prospective basis for guarantees issued or modified after
December 31, 2002. The Company typically grants its customers a warranty,
which guarantees that the Company's products will substantially conform to
the Company's current specifications for ninety days from the delivery date
as well as indemnification for customers from third party claims. This
standard did not have a material impact on the Company's consolidated
financial statements.
5. NET LOSS PER COMMON SHARE
Basic and diluted net loss per common share was computed by dividing the
net loss for the period by the weighted average number of shares of common
stock issued and outstanding. In accordance with the requirements of
Statement of Financial Accounting Standards No. 128, common stock
equivalents have been excluded from the calculation of diluted net loss per
common share, as their inclusion would be antidilutive.
8
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarized the equivalent number of common shares
assuming the related securities that were outstanding as of September 30,
2003 and 2002 had been converted.
2003 2002
---------- ----------
Stock options 3,960,955 3,104,030
Warrants 11,254,529 2,297,277
Shares issuable upon exercise of convertible debt 5,198,023 1,373,243
---------- ----------
Total potential dilutive securities assuming the
Company was in an income position 20,413,507 6,774,550
========== ==========
6. COLLABORATIVE AGREEMENTS
In June 1995, the Company entered into a marketing agreement (the
"Marketing Agreement") with Bausch & Lomb Pharmaceuticals, Inc. ("Bausch &
Lomb"), a shareholder of the Company, to market Lotemax(R) and Alrex(R), on
an exclusive basis in the United States following receipt of FDA approval.
The Marketing Agreement also covered the Company's other loteprednol
etabonate based product, LE-T. Under the Marketing Agreement, Bausch & Lomb
purchased the active drug substance (loteprednol etabonate) from the
Company. A second agreement, covering Europe, Canada and other selected
countries, was signed in December 1996 ("the New Territories Agreement").
In October 2001, the Company sold its ophthalmic product line, including
the Company's rights under the above agreements to Bausch & Lomb.
SALE OF OPHTHALMIC PRODUCT LINE
In October 2001, Bausch & Lomb purchased all rights to the Company's
loteprednol etabonate (LE) ophthalmic product line for cash and assumption
of certain ongoing obligations. The Company received gross proceeds of
approximately $25 million in cash for its rights to Lotemax(R) and
Alrex(R), prescription products that were manufactured and marketed by
Bausch & Lomb under the 1995 Marketing Agreement with the Company. Bausch &
Lomb also acquired future extensions of LE formulations including LE-T, a
product candidate that has completed a Phase III clinical trial. Bausch &
Lomb will pay the Company additional fees depending on the date of FDA
marketing approval as follows: If the earlier of (a) commercial launch or
(b) 6 months after FDA approval of LE-T (the "Triggering Event") occurred
before January 1, 2002 the Company was initially to receive $15.4 million.
That amount has been reducing by $90,000 for each month of 2002 and 2003 to
a minimum amount of $13.3 million (if the Triggering Event occurs on
December 31, 2003). If the Triggering Event occurs after December 31, 2003,
then the Company and Bausch & Lomb will negotiate in good faith to agree
upon the amount of additional consideration that Bausch & Lomb will pay the
Company but not to exceed $13.3 million. The patent owner of LE-T is
entitled to 11% of the additional fees that the Company receives as a
result of the contingent payment. The Triggering Event has not yet
occurred, and there is no assurance that FDA approval will be obtained.
Upon FDA approval, Pharmos will receive an additional fee of up to $10
million if the following occurs: (a) net sales of LE-T in the first 12
months after commercial launch are at least $7.5 million and (b) net sales
of LE-T in the second twelve consecutive months after commercial launch (i)
exceed $15.0 million and (ii) are greater than net sales in (a) above.
Future payments will be included in the Company's income when all
contingencies are resolved. The patent owner is also entitled to 14.3% of
the additional fees that the Company receives as a result of these
contingent payments. The Company's only future obligation to Bausch & Lomb
after the sale is to pay up to $3.75 million in research and development
cost relating to LE-T, of which $600,000 was withheld from the sales
proceeds. The entire $3.75 million was netted against the gain on sale
recorded. The Company has a passive role as a member of a joint committee
overseeing the development of LE-T. In July 2003, the Company paid Bausch &
Lomb $1.5 million of its liability for LE-T development. As of September
30, 2003, Pharmos owes an additional $1.6 million as its share of these
research and development related LE-T expenses. This amount is included as
part of accounts payable at September 30, 2003.
9
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As a result of this transaction, the Company recorded a gain of $16.3
million in the fourth quarter of 2001. The Company incurred transaction and
royalty costs of approximately $2 million. The Company also compensated the
LE patent owner approximately $2.7 million ($1.5 million paid upon closing
and $1.2 million was paid in October 2002) from the proceeds of the sale of
Lotemax and Alrex in return for his consent to the Company's assignment of
its rights under the license agreement to Bausch & Lomb.
7. COMMON STOCK TRANSACTIONS
On May 30, 2003, the Company completed a private placement to sell common
shares and warrants to ten investors, generating total gross proceeds of
$8.0 million. The Company filed a registration statement with the
Securities and Exchange Commission to permit resales of the common stock by
the investors. The private placement offering was completed by issuing
9,411,765 shares of common stock at a price of $0.85 per share
(representing an approximate 20% discount to a ten-day trailing average of
the closing price of the stock ending May 28, 2003) and 3,573,529 warrants
at an exercise price of $1.40 per share, which includes 441,177 placement
agent warrants. Issuance costs of approximately $525,000 in cash and
$240,000 for the value of the placement agent warrants were recorded as a
debit to additional paid in capital. The Company calculated the value of
the warrants, including the placement agent warrants, being approximately
$1,773,000 under the Black-Scholes option pricing method (assumption:
volatility 75%, risk free rate 3.15% and zero dividend yield). As of
September 30, 2003, one of the twelve (ten investors and two placement
agent) warrant holders have exercised their warrants totaling approximately
$124,000.
On March 4, 2003, the Company completed a private placement to sell common
shares and warrants to eight investors, generating total gross proceeds of
$4.3 million under a shelf registration. The private placement offering was
completed by issuing 5,058,827 shares of common stock at a price of $0.85
per share (the fair market value on March 4, 2003) and 1,141,182 warrants
at an exercise price of $1.25 per share, which includes 129,412 placement
agent warrants. Issuance costs of approximately $150,000 in cash and
$45,000 for the value of the placement agent warrants were recorded as a
debit to additional paid in capital. As of September 30, 2003, two of the
nine (eight investors and one placement agent) warrant holders have
exercised their warrants totaling approximately $265,000.
According to EITF 00-19, the issued warrants meet the requirements of and
will be accounted for as a liability since registered shares must be
delivered upon settlement. The Company calculated the value of the warrants
at the date of the transaction, including the placement agent warrants,
being approximately $394,000 under the Black-Scholes option-pricing method
(assumption: volatility 75%, risk free rate 2.88% and zero dividend yield).
The value of the warrants is being marked to market each reporting period
until exercised or expiration and has a value of $1,576,590 at September
30, 2003.
During 2003, the Company issued 26,789 shares of common stock with gross
proceeds of $33,133 pursuant to the Pharmos Corporation 2001 Employee Stock
Purchase Plan.
8. PRIVATE PLACEMENT
On September 26, 2003, Pharmos completed a $21.0 million convertible debt
financing with six investors. $5.0 million of the proceeds will be used for
working capital purposes, and $16.0 million will be available to fund
acquisitions upon the approval of the investors. Pharmos also issued
warrants exercisable into shares of common stock as part of the
transaction.
The acquisition facility may be used to assist Pharmos' ongoing efforts to
expand its pipeline beyond its existing product in late-stage development.
The financing also addresses a possible concern Nasdaq recently raised
informally relating to a violation of one of Nasdaq's corporate governance
rules. Specifically, Nasdaq expressed a concern that the May 2003 private
placement, when aggregated with Pharmos' March 2003 registered private
placement, would have resulted in the possible issuance of more than 20% of
Pharmos' outstanding securities at a price less than the applicable fair
market value for such shares. Completion of the $21.0 million convertible
debt financing had the effect of resolving any such Nasdaq concerns.
10
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The convertible debentures are convertible into common stock of the Company
at a fixed price of $4.04, 205% above the closing bid price of the stock
for the five days preceding the closing date. The debentures, which bear an
interest rate of 4%, will be redeemed in 13 substantially equal monthly
increments beginning March 31, 2004. Amounts converted into shares of
Pharmos common stock will reduce the monthly redemption amount in inverse
order of maturity. The $16.0 million earmarked for acquisition activity
will be held in escrow until used or repaid. At September 30, 2003, $5.0
million was held in escrow, which was released to the Company in October
2003. In connection with the financing, the Company also issued 5,514,705
three-year warrants (including 514,705 placement agent warrants) to
purchase shares of common stock at an exercise price of $2.04 per share.
The issuance costs related to the convertible debentures of approximately
$1,017,000 in cash and $485,000 for the value of the placement agent
warrants were capitalized and are being amortized over the life of the
debt. The Company calculated the value of the warrants at the date of the
transaction, including the placement agent warrants, being approximately
$4,652,877 under the Black-Scholes option-pricing method (assumption:
volatility 75%, risk free rate 1.59% and zero dividend yield). The Company
allocated the $21.0 million in gross proceeds between the convertible
debentures and the warrants based on their fair values. The Company is
reporting the debt discount as a direct reduction to the face amount of the
debt in accordance with APB 21. The discount will accrete over the life of
the outstanding debentures. The issuance costs allocated to the convertible
debentures are being deferred and amortized to interest expense over the
life of the debt. APB 21 also requires the Company to allocate the warrant
costs between the convertible debentures and the transaction warrants. The
issuance costs allocated to the warrants were recorded as a debit to
additional paid in capital.
If after the effective date, November 4, 2003, the closing prices for ten
out of any twenty consecutive trading days exceeds $5.50, subject to
adjustment for reverse and forward stock splits, stock dividends, stock
combinations and other similar transactions of the Common Stock that occur
after the original issue date, the Company may on one occasion, within
three trading days of any such period, deliver notice to the holder to
cause the holder to immediately convert all or part of up to 50% of the
original aggregate principal amount of the debenture.. If the Company
elects to exercise its right to a $5.50 forced conversion, it shall
exercise such right ratably among all holders of debentures. In addition,
if after the effective date, November 4, 2003, the closing prices for ten
out of any twenty consecutive trading days exceeds $6.50, the Company may
deliver notice to the holder to immediately convert all or part of up to
the remaining 50% of the original aggregate principal amount of the
debentures.
In September 2000, the Company completed a private placement of Convertible
Debentures, common stock and warrants to purchase shares of common stock
with institutional investors, generating gross proceeds of $11 million. The
Convertible Debentures, which generated gross proceeds of $8 million, were
due in February 2002 and carried a 6% interest payable semiannually in cash
or common stock. In connection with the Convertible Debenture, the
institutional investors also received warrants for the purchase of 276,259
common shares with a relative fair value of $725,000. The Convertible
Debentures were convertible into common shares of the Company at the
conversion price of $3.83 per share (or 2,088,775 common shares) and were
convertible beginning October 31, 2000. Under certain limited anti-dilutive
conditions, the conversion price could change. Until converted into common
stock or the outstanding principal is repaid, the terms of the Convertible
Debentures required the Company to deposit $4 million in an escrow account.
The escrowed capital is shown as Restricted Cash on the Company's balance
sheet and was released to the Company in proportion to the amount of
Convertible Debentures converted into common shares or upon the repayment
of the debt. The issuance costs related to the Private Placement of
approximately $1.4 million were capitalized and amortized over the life of
the debt.
The holders of the Convertible Debentures and the Company agreed to modify
the repayment and conversion terms in December 2001. The holders of $5.8
million convertible debt (book value on December 31, 2001, including
accrued interest) extended the maturity date to June 30, 2003 in exchange
for a reduction in the conversion price from $3.83 to $2.63 for half of the
outstanding balance and $ 2.15 for the other half of the outstanding
balance. The convertible debt with a maturity date of June 2003 is
convertible beginning December 31, 2001. The holder of the remaining
outstanding debt of $1.9 million (including accrued interest) changed the
maturity date from February 28, 2002 to January 31, 2002 in exchange for
lowering the conversion price for the other holders. As the modification
was not significant in accordance with EITF 96-19 the change in the fair
value between the original convertible debt and the modified convertible
debt was be accreted over the remaining term of the convertible debt with a
corresponding charge interest expense. During the first quarter of 2002,
the Company issued 1,217,485 shares of its common stock upon the conversion
of $2.5 million principal of the 2000 Convertible Debenture offering and
repaid $2 million of the Convertible Debentures. During the first quarter
11
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of 2003, the remaining balance of the $3.5 million was redeemed for
approximately $4.0 million, which included accrued interest.
Emerging Issues Task Force Issue No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios, required the Company to compute the Beneficial
Conversion Feature ("BCF") of the convertible debt from the private
placement of September 2000. The BCF must be capitalized and amortized from
the closing date until the earliest date that the investors have the right
to convert the debt into common shares. The BCF in 2000 was computed at
approximately $1.8 million, all of which has been amortized and included as
interest expense in the year ending December 31, 2000. Two of the eight
investors of the March 2003 private placement were also holders of the
remaining $3.5 million September 2000 Convertible Debenture offering, which
was ultimately redeemed for approximately $4.0 million, which includes
accrued interest. The Convertible Debenture holders chose not to convert
the existing debt to common equity. Instead, the Convertible Debenture
holders opted to be repaid early and participate in a new round of
financing. For the two investors, the sale of the common stock and warrants
reduced the conversion price of the outstanding debt, which resulted in an
additional BCF charge of approximately $2.7 million during the first
quarter ending March 31, 2003. The total related BCF charge since inception
of the debt of $3.5 million was redeemed this quarter as a result of the
debt being repaid. The impact of the reversal of the total BCF charge since
inception of the debt resulted in a net credit of $786,000 recorded as
interest income during the first quarter ending March 31, 2003. This
accounting treatment is in accordance with EITF 00-27.
9. SEGMENT AND GEOGRAPHIC INFORMATION
The Company is active in one business segment: designing, developing,
selling and marketing pharmaceutical products. The Company maintains
development operations in the United States and Israel. The Company's
selling operations are maintained in the United States.
Geographic information for the three and nine months ending September 30,
2003 and 2002 are as follows:
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
---- ---- ---- ----
NET LOSS
United States ($ 4,051,336) ($ 4,762,042) ($ 12,581,944) ($ 12,779,033)
Israel (137,680) (686,522) (420,396) (988,623)
------------- ------------- -------------- --------------
($ 4,189,016) ($ 5,448,564) ($ 13,002,340) ($ 13,767,656)
============= ============= ============== ==============
10. SUBSEQUENT EVENT
On November 5, 2003, Bausch & Lomb and Pharmos jointly announced that the
FDA accepted for review the New Drug Application for LE-T. In 2001, Bausch
& Lomb acquired the rights to the loteprednol etabonate ophthalmic business
of Pharmos. As part of the acquisition, Bausch & Lomb agreed to make future
payments to Pharmos for certain future extensions of the loteprednol
etabonate formulation, with the payments based on the date of market
introduction. Pending FDA approval, Bausch & Lomb expects to introduce the
new combination medication in 2004.
On November 6, 2003, the Company terminated its listing on the NASDAQ
Europe market. The request to delist was prompted by the decision by NASDAQ
Europe shareholders at an extraordinary shareholders' meeting on June 26,
2003 to close the markets operated by NASDAQ Europe.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion and analysis of our financial condition and results of
operations contains forward-looking statements that involve risks and
uncertainties. We have based these forward-looking statements on our current
expectations and projections of future events. Such statements reflect our
current views with respect to future events and are subject to unknown risks,
uncertainty and other factors that may cause results to differ materially from
those contemplated in such forward looking statements. In addition, the
following discussion should be read in conjunction with the consolidated
financial statements and the related notes thereto included elsewhere in this
report.
Through the end of the third quarter of 2001, the Company generated revenues
from product sales but continues to be dependent upon external financing,
interest income, and research and development contracts to pursue its intended
business activities. The Company had not been profitable from inception through
2000, was not profitable in 2002 and the first three quarters of 2003, and has
incurred a cumulative net loss of $115.5 million through September 30, 2003. In
2001, the Company recorded a profit due the sale of the ophthalmic product line
to Bausch & Lomb. Losses have resulted principally from costs incurred in
research and development activities aimed at identifying and developing the
Company's product candidates, clinical research studies, the write-off of
purchased research and development, and general and administrative expenses. The
Company expects to incur additional losses over the next several years as the
Company's research and development and clinical trial programs continue. The
Company's ability to achieve profitability, if ever, is dependent on its ability
to develop and obtain regulatory approvals for its product candidates, to enter
into agreements for product development and commercialization with strategic
corporate partners and contract to develop or acquire the capacity to
manufacture and sell its products. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources."
RESULTS OF OPERATIONS
QUARTERS ENDED SEPTEMBER 30, 2003 AND 2002
Total operating expenses decreased $1,699,851 or 32%, from $5,394,968 in 2002 to
$3,695,117 in 2003. Last year at this time the Company was preparing its
Investigational New Drug (IND) submission to the FDA to commence its study of
dexanabinol as a treatment for traumatic brain injury, which submission required
significant outside help from consultants and other experts. The Company's
operating expenses also decreased due to the implementation of the company wide
cost cutting program. The decrease offset the rising costs of the Phase III
clinical trial of dexanabinol for severe traumatic brain injury due to the
increasing number of centers and patients involved.
The company considers major research & development projects to be those projects
that have reached at least Phase II level of clinical development. The Company's
major projects are the development of dexanabinol for the treatment of traumatic
brain injury, which is currently involved in Phase III testing in the U.S.,
Europe, Australia and Israel, and the cognitive impairment that can result from
coronary surgery under cardiopulmonary bypass operations. During the third
quarter of 2003, the gross cost of the traumatic brain injury project was $2.5
million. Total gross costs since the traumatic brain injury project entered
Phase II development in 1996 through September 30, 2003 are $33.0 million.
Enrollment in the current Phase III trial is expected to continue until the
first quarter of 2004. Fifteen U.S. trauma centers have joined the 65 centers in
Europe, Israel and Australia already participating in the study. The principal
costs of completing the project include patient enrollment, collection and
evaluation of the data, production of the drug substance and drug product,
commercial scale-up, and management of the project. The primary uncertainties in
the completion of the project are the time required to enroll sufficient numbers
of patients in the study, the results of the study upon its conclusion, and the
Company's ability to produce or secure production of finished drug product under
current Good Manufacturing Practice conditions for sale in countries in which
marketing approval has been obtained, as well as the resources required to
generate sales in such countries. Should the uncertainties delay completion of
the project on the current timetable, the Company may experience additional
costs that cannot be accurately estimated. If the Phase III trial of dexanabinol
13
for the treatment of traumatic brain injury is successfully completed, the
Company may begin to earn revenues upon marketing approval as early as 2005;
however, should our product candidate experience setbacks or should a product
fail to achieve FDA or other regulatory approvals, or fail to generate
commercial sales, it would have a material adverse affect on our business.
In addition, a Phase IIa trial of dexanabinol as a preventive agent against the
cognitive impairment that can follow coronary surgery under cardiopulmonary
bypass (CS-CPB) operations is currently underway by the Company. The
exploratory, Phase IIa trial will enroll up to 200 patients undergoing CS-CPB.
Gross expenses directly related to this project were $241,798 in the quarter.
Gross expenses for other research & development projects in earlier stages of
development for the third quarters of 2003 and 2002 were $308,755 and $364,086,
respectively. Total net research and development expenses for the third quarters
of 2003 and 2002 were $2,598,758 and $4,148,846, respectively. The Company
received from the Office of the Chief Scientist of Israel's Ministry of Industry
and Trade grant money of $866,986 and $843,049 during the third quarters of 2003
and 2002, respectively, which reduced the gross research and development
expenses.
Selling, general and administrative expenses decreased by $144,991 or 13%, from
$1,076,057 in 2002 to $931,066 in 2003. Beginning in 2003, the Company increased
its resources to research and development and therefore, a greater portion of
shared costs was allocated to research and development compared to selling,
general and administrative expenses for facilities related expenses. As a
result, salaries, insurance, and office expenses decreased by $24,419, $2,742,
and $9,708, respectively, in the third quarter compared to the same period in
2002. As part of the cost cutting measures enacted by the Company during the
first quarter of 2003, consultants and investor relations decreased by $23,791,
and $78,818, respectively in the third quarter compared to the same period in
2002. Professional fees decreased by $16,522 in the third quarter of 2003 due to
a reduced need for legal and accounting services.
Depreciation and amortization expenses decreased by $4,770, or 3%, from $170,063
in 2002 to $165,293 in 2003. The decrease is due to some fixed assets becoming
fully depreciated.
Other expense, net, increased by $440,303 to $493,899 in 2003 from $53,596 in
2002. The warrants issued in the March 2003 private placement offering are
subject to the requirements under EITF 00-19 and are currently being accounted
for as a liability. The value of the warrants are being marked to market each
reporting period until exercised or expiration. The charge associated with these
warrants amounted to approximately $457,000 during the quarter. Interest expense
decreased by $116,625 in the third quarter of 2003 due to the early redemption
of the September 2000 Convertible Debentures. The lower average cash balance
during the third quarter of 2003 than in 2002 resulted in a decrease in interest
income of $74,867.
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Total operating expenses decreased $1,443,711 or 11%, from $13,440,581 in 2002
to $11,996,870 in 2003. The decrease was primarily due to the lower consultant
and professional fees. Last year at this time the Company was preparing its IND
submission to the FDA to commence its study of dexanabinol as a treatment for
traumatic brain injury in the U.S., which submission required significant
outside help from consultants and other experts.
The company considers major research & development projects to be those projects
that have reached at least Phase II level of clinical development. The Company's
major projects are the development of dexanabinol for the treatment of traumatic
brain injury, which is currently involved in Phase III testing in the U.S.,
Europe, Australia and Israel, and the cognitive impairment that can follow
coronary surgery under cardiopulmonary bypass operations. During the nine months
of 2003, the gross cost of the traumatic brain injury project was $8.1 million.
14
Total gross costs since the traumatic brain injury project entered Phase II
development in 1996 through September 30, 2003 are $33.0 million. Enrollment in
the current Phase III trial is expected to continue until the first quarter of
2004. The principal costs of completing the project include patient enrollment,
collection and evaluation of the data, production of the drug substance and drug
product, commercial scale-up, and management of the project. The primary
uncertainties in the completion of the project are the time required to enroll
sufficient numbers of patients in the study, the results of the study upon its
conclusion, and the Company's ability to produce or secure production of
finished drug product under current Good Manufacturing Practice conditions for
sale in countries in which marketing approval has been obtained, as well as the
resources required to generate sales in such countries. Should the uncertainties
delay completion of the project on the current timetable, the Company may
experience additional costs that cannot be accurately estimated. If the Phase
III trial of dexanabinol for the treatment of traumatic brain injury is
successfully completed, the Company may begin to earn revenues upon marketing
approval as early as 2005; however, should our product candidate experience
setbacks or should a product fail to achieve FDA or other regulatory approvals,
or fail to generate commercial sales, it would have a material adverse affect on
our business.
In addition, a Phase IIa trial of dexanabinol as a preventive agent against the
cognitive impairment that can follow coronary surgery under cardiopulmonary
bypass (CS-CPB) operations is currently underway by the Company. The
exploratory, Phase IIa trial will enroll up to 200 patients undergoing CS-CPB.
Gross expenses directly related to this project were $571,820 during the first
nine months of 2003.
Gross expenses for other research & development projects in earlier stages of
development for the first nine months of 2003 and 2002 were $1,174,558 and
$1,352,955, respectively. Total net research and development expenses for the
first nine months of 2003 and 2002 were $8,955,387 and $10,016,149,
respectively. The Company received from the Office of the Chief Scientist of
Israel's Ministry of Industry and Trade grant money of $2,271,838 and $2,031,891
during the first nine months of 2003 and 2002, respectively, which reduced the
gross research and development expenses.
Selling, general and administrative expenses decreased by $371,648 or 13%, from
$2,907,645 in 2002 to $2,535,997 in 2003. Beginning in 2003, the Company
increased its resources to research and development and therefore, a greater
portion of shared costs was allocated to research and development compared to
selling, general and administrative expenses for facilities related expenses. As
a result, salaries, insurance, and office expenses decreased by $94,853,
$23,492, and $33,028, respectively, in the first nine months compared to the
same period in 2002. As part of the cost cutting measures enacted by the Company
during the first quarter of 2003, consultants and investor relations decreased
by $62,039, and $123,796, respectively compared to the same period in 2002.
Professional fees declined by $96,292 due to a reduced need for legal and
accounting services.
Depreciation and amortization expenses decreased by $11,301, or 2%, from
$516,787 in 2002 to $505,486 in 2003. The decrease is due to some fixed assets
becoming fully depreciated.
Other expense, net, increased by $678,395 from $327,075 in 2002 to $1,005,470 in
2003. The warrants issued in the March 2003 private placement offering are
subject to the requirements under EITF 00-19 and thus are currently being
accounted for as a liability. The value of the warrants are being marked to
market each reporting period until exercised or expiration. The charge
associated with these warrants amounted to approximately $1.5 million. In
accordance with Emerging Issues Task Force Issue No. 98-5, Accounting for
Convertible Securities with Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios ("BCF"), the Company recorded a charge of $1.8
million which was fully amortized at December 31, 2000 in connection with the
issuance of convertible debt with a favorable conversion feature. In accordance
with EITF 00-27, a net credit of $786,000 was recorded as interest income during
the first quarter to reverse the BCF previously recorded which was associated
with the remaining balance of the September 2000 Convertible Debenture offering
with a face amount of $3.5 million which was not converted. During the first
nine months of 2003, the Company recognized royalties of a non-material amount
per the licensing agreement with Herbamed, Ltd, a company controlled by Dr. Haim
Aviv, the Company's CEO. The lower average cash balance during the first nine
15
months of 2003 than in 2002 resulted in a decrease in interest income of
$280,231. Interest expense decreased by $392,966 due to the early redemption of
the September 2000 Convertible Debentures.
LIQUIDITY AND CAPITAL RESOURCES
While the Company received revenues from 1998 until the third quarter of 2001
from the sale of its approved products, it has incurred cumulative operating
losses since its inception and had an accumulated deficit of $115.5 million at
September 30, 2003. The Company has financed its operations with private
offerings of its securities, advances and other funding pursuant to a marketing
agreement with Bausch & Lomb, research contracts, license fees, royalties and
sales, the sale of a portion of our New Jersey State Net Operating Loss
carryforwards, and interest income. Should the Company be unable to raise
adequate financing in the future, operations will need to be scaled back or
discontinued.
The Company had working capital of $4.8 million as of September 30, 2003.
Included in the current assets of $28.2 million is $16.4 million in cash and
cash equivalents, and $9.7 million in restricted cash. As of September, the
Company also had $21.0 million of restricted cash held in escrow. As part of the
September 2003 financing, $5.0 million of the $21.0 million was released to the
Company during October 2003 for working capital purposes. The remaining $16.0
million will remain in escrow until either the Company's convertible debentures
are converted into common shares of the Company by the investor or by the
Company, or such funds are repaid by the Company or such funds are used to fund
acquisition(s) with approval by the investors.
In September 2000, the Company completed a private placement of Convertible
Debentures, common stock and warrants to purchase shares of common stock with
institutional investors, generating gross proceeds of $11 million. The
Convertible Debentures, which generated gross proceeds of $8.0 million, were due
in February 2002 and carried a 6% interest payable semiannually in cash or
common stock. In connection with the Convertible Debenture, the institutional
investors also received warrants for the purchase of 276,259 common shares with
a relative fair value of $725,000. The Convertible Debentures were convertible
into common shares of the Company at the conversion price of $3.83 per share (or
2,088,775 common shares) and were convertible beginning October 31, 2000. Under
certain limited anti-dilutive conditions, the conversion price could change.
Until converted into common stock or the outstanding principal is repaid, the
terms of the Convertible Debentures require the Company to deposit $4 million in
an escrow account. The escrowed capital is shown as Restricted Cash on the
Company's balance sheet and was released to the Company in proportion to the
amount of Convertible Debentures converted into common shares or upon the
repayment of the debt. The issuance costs related to the private placement of
approximately $1.4 million were capitalized and amortized over the life of the
debt.
The holders of the Convertible Debentures and the Company agreed to modify the
repayment and conversion terms in December 2001. The holders of $5.8 million
convertible debt (book value on December 31, 2001, including accrued interest)
extended the maturity date to June 2003 in exchange for a reduction in the
conversion price from $3.83 to $2.63 for half of the outstanding balance and $
2.15 for the other half of the outstanding balance. The convertible debt with a
maturity date of June 2003 was convertible beginning December 31, 2001. The
holder of the remaining outstanding debt of $1.9 million (including accrued
interest) changed the maturity date from February 28, 2002 to January 31, 2002
in exchange for lowering the conversion price for the other holders. As the
modification was not significant in accordance with EITF 96-19 the change in the
fair value between the original convertible debt and the modified convertible
debt was accreted over the remaining term of the convertible debt with a
corresponding charge into interest expense.
In October 2001, Bausch & Lomb purchased all rights to the Company's loteprednol
etabonate ophthalmic product line for cash and assumption of certain ongoing
obligations. The Company received gross proceeds of approximately $25 million in
cash for its rights to Lotemax(R) and Alrex(R), prescription products that are
made and marketed by Bausch & Lomb under a 1995 Marketing Agreement with the
Company; in addition, Bausch & Lomb acquired future extensions of loteprednol
16
etabonate formulations including LE-T, a product currently in Phase III clinical
trial. The Company has had no product sales beginning in the fourth quarter of
2001. Upon FDA approval, Bausch & Lomb will pay the Company up to an additional
maximum gross proceeds of $12 million, with the actual payment price based on
the date of the earlier of commercial launch or the six month anniversary of FDA
approval of this new combination therapy. If the earlier of (a) commercial
launch or (b) the Triggering Event occurred before January 1, 2002, the Company
would have received $15.4 million. This amount is being reduced by $90,000 for
each month thereafter to a minimum amount of $13.3 million (if the Triggering
Event occurs on December 31, 2003). If the Triggering Event occurs after
December 31, 2003, then the Company and Bausch & Lomb will negotiate in good
faith to agree upon the amount of additional consideration that Bausch & Lomb
will pay the Company but not to exceed $13.3 million. An additional milestone
payment of up to $10 million could be paid to the Company to the extent sales of
the new product exceed an agreed-upon forecast in the first two years. The
Company has a passive role as a member of a joint committee overseeing the
development of LE-T and has an obligation to Bausch & Lomb to fund up to a
maximum of $3.75 million, of which $600,000 was deducted from the purchase price
paid by Bausch & Lomb to Pharmos in October 2001, of the LE-T development cost.
As a result of this transaction, the Company recorded a net gain of $16.3
million during the fourth quarter of 2001. In July 2003, the Company paid Bausch
& Lomb $1.5 million of its liability for LE-T development. As of September 30,
2003, Pharmos owes an additional $1.6 million as its share of these research and
development related LE-T expenses. This amount is included as part of accounts
payable at September 30, 2003. The Company incurred transaction and royalty
costs of approximately $2 million. The Company also compensated the LE patent
owner approximately $2.7 million ($1.5 million paid upon closing and $1.2
million of this amount was paid in October 2002) from the proceeds of the sale
of Lotemax and Alrex in return for his consent to the Company's assignment of
its rights under the license agreement to Bausch & Lomb. Additionally, the
patent owner will receive 11% of the proceeds payable to the Company following
FDA approval of LE-T, as well as 14.3% of its milestone payment, if any.
On March 4, 2003, the Company completed a private placement to sell common
shares and warrants to eight investors, generating total gross proceeds of $4.3
million under a shelf registration. The private placement offering was completed
by issuing 5,058,827 shares of common stock at a price of $0.85 per share (the
fair market value on March 4, 2003) and 1,141,182 warrants at an exercise price
of $1.25 per share, which includes 129,412 placement agent warrants. Issuance
costs of approximately $150,000 in cash and $45,000 for the value of the
placement agent warrants were recorded as a debit to additional paid in capital.
According to EITF 00-19, the issued warrants meet the requirements of and are
being accounted for as a liability since registered shares must be delivered
upon settlement. The Company calculated the value of the warrants, including the
placement agent warrants, being approximately $394,000 under the Black-Scholes
option-pricing method (assumption: volatility 75%, risk free rate 2.88% and zero
dividend yield). The value of the warrants is being marked to market each
reporting period until exercised or expiration and has a value of $1,576,590 at
September 30, 2003.
On May 30, 2003, the Company completed a private placement to sell common shares
and warrants to ten investors, generating total gross proceeds of $8.0 million.
The Company filed a registration statement with the Securities and Exchange
Commission to permit resales of the common stock issued. The private placement
offering was completed by issuing 9,411,765 shares of common stock at a price of
$0.85 per share (representing an approximate 20% discount to a ten-day trailing
average of the closing price of the stock ending May 28, 2003) and 3,573,529
warrants at an exercise price of $1.40 per share, which includes 441,177
placement agent warrants. Issuance costs of approximately $525,000 in cash and
$240,000 for the value of the placement agent warrants were recorded as a debit
to additional paid in capital.
On September 26, 2003, the Company completed a private placement of convertible
debentures and warrants to six institutional investors, generating total gross
proceeds of $21.0 million. $5.0 million of the proceeds will be used for working
capital purposes, and $16.0 million will be available to fund acquisitions upon
the approval of the investors. The convertible debentures are convertible into
common stock of the Company at a fixed price of $4.04, 205% above the closing
17
bid price of the stock for the five days preceding the closing date. The
debentures, which bear an interest rate of 4%, will be redeemed in 13
substantially equal monthly increments beginning March 31, 2004. Amounts
converted into shares of Pharmos common stock will reduce the monthly redemption
amount in inverse order of maturity. The $16.0 million earmarked for acquisition
activity will be held in escrow until used or repaid. At September 30, 2003,
$5.0 million was held in escrow, which was released to the Company in October
2003. In connection with the financing, the Company also issued 5,514,705
three-year warrants (including 514,705 placement agent warrants) to purchase
5,514,705 shares of common stock at an exercise price of $2.04 per share. The
issuance costs related to the convertible debentures of approximately $1,017,000
in cash and $485,000 for the value of the placement agent warrants were
capitalized and are being amortized over the life of the debt. The Company
calculated the value of the warrants at the date of the transaction, including
the placement agent warrants, being approximately $4,652,877 under the
Black-Scholes option-pricing method (assumption: volatility 75%, risk free rate
1.59% and zero dividend yield). The Company allocated the $21.0 million in gross
proceeds between the convertible debentures and the warrants based on their fair
values. The Company is reporting the debt discount as a direct reduction to the
face amount of the debt in accordance with APB 21. The discount will accrete
over the life of the outstanding debentures. The issuance costs allocated to the
convertible debentures are being deferred and amortized to interest expense over
the life of the debt. . APB 21 also requires the Company to allocate the warrant
costs between the convertible debentures and the transaction warrants. The
issuance costs allocated to the warrants were recorded as a debit to additional
paid in capital.
As of September 30, 2003, we had the following commitments and long-term
obligations:
Last three
months of
2003 2004 2005 2006 Thereafter Total
---- ---- ---- ---- ---------- -----
Operating Leases $ 402,389 $ 377,736 $ 81,375 $ 57,978 $ 12,212 $ 931,690
Convertible debentures,
excluding interest 16,153,846 4,846,154 21,000,000
R&D commitments 835,743 866,202 1,701,945
------------- --------------- ------------ ------------ ------------ ------------
Grand total $ 1,238,132 $ 17,397,784 $4,927,529 $ 57,978 $ 12,212 $ 23,633,635
The R&D commitments represent scheduled professional fee payments for clinical
services relating to the Phase III clinical study of dexanabinol for traumatic
brain injury. One of the clinical service based agreements, if fully executed,
currently totals $8.8 million. The contract may be terminated at any time on
thirty days' advance notice. As of September 30, 2003, the Company has
recognized $8.2 million as an expense.
Management believes that cash and cash equivalents of $16.5 million and the
total restricted balance of $5.0 million (released from restricted cash in
October 2003) as of September 30, 2003, will be sufficient to support the
Company's continuing operations into the fourth quarter of 2004. The Company is
continuing to actively pursue various funding options, including additional
equity offerings, strategic corporate alliances, business combinations and the
establishment of product related research and development limited partnerships,
to obtain additional financing to continue the development of its products and
bring them to commercial markets.
We have assessed our vulnerability to certain market risks, including interest
rate risk associated with financial instruments included in cash and cash
equivalents, our convertible debentures and the fair market value of the warrant
liability. Due to the relatively short-term nature of these investments we have
determined that the risks associated with interest rate fluctuations related to
these financial instruments do not pose a material risk to us.
Statements made in this document related to the development, commercialization
and market expectations of the Company's drug candidates, to the establishment
of corporate collaborations, and to the Company's operational projections are
forward-looking and are made pursuant to the safe harbor provisions of the
Securities Litigation Reform Act of 1995. Such statements involve risks and
uncertainties which may cause results to differ materially from those set forth
in these statements. Among the factors that could result in a materially
18
different outcome are the inherent uncertainties accompanying new product
development, action of regulatory authorities and the results of further trials.
Additional economic, competitive, governmental, technological, marketing and
other factors identified in Pharmos' filings with the Securities and Exchange
Commission could affect such results.
In May 2003, the Financial Accounting Standards Board issued Statement No. 150
("FAS 150"), Accounting for Certain Financial Instruments with Characteristics
of Both Liabilities and Equity. FAS 150 specifies that instruments within its
scope embody obligations of the issuer and that the issuer must classify them as
liabilities. SFAS 150 requires issuers to classify as liabilities the following
three types of freestanding financial instruments: (1) mandatorily redeemable
financial instruments; (2) obligations to repurchase the issuer's equity shares
by transferring assets and (3) certain obligations to issue a variable number of
shares. SFAS 150 defines a "freestanding financial instrument" as a financial
instrument that (1) is entered into separately and apart from any of the
entity's other financial instruments or equity transactions or (2) is entered
into in conjunction with some other transaction and can be legally detached and
exercised on a separate basis. For all financial instruments entered into or
modified after May 31, 2003, SFAS 150 is effective immediately. For all other
instruments of public companies, SFAS 150 went into effect at the beginning of
the first interim period beginning after June 15, 2003. The adoption of SFAS No.
150 did not have a material impact on the Company's financial statements for the
third quarter of 2003. The Financial Accounting Standards Board is expected to
defer the effective date for selected provisions of SFAS No. 150, limited to
mandatorily redeemable nonctrolling interests associated with finite-lived
subsidiaries. The deferral of those selected provisions is not expected to have
a material impact on the Company's financial statements.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities ("SFAS No. 149"). SFAS No. 149
clarifies under what circumstances a contract with an initial net investment
meets the characteristics of a derivative as discussed in Statement No. 133. It
also specifies when a derivative contains a financing component that warrants
special reporting in the Consolidated Statement of Cash Flows. SFAS No. 149
amends certain other existing pronouncements in order to improve consistency in
reporting these types of transactions. The new guidance is effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. This standard does not have a
material impact on the Company's consolidated financial statements.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51". FIN 46 requires an investor to
consolidate a variable interest entity if it is determined that the investor is
a primary beneficiary of that entity, subject to the criteria set forth in FIN
46. Assets, liabilities, and non-controlling interests of newly consolidated
variable interest entities will be initially measured at fair value. After
initial measurement, the consolidated variable interest entity will be accounted
for under the guidance provided by Accounting Research Bulletin No. 51,
"Consolidated Financial Statements." FIN 46 is effective for variable interest
entities created or entered into after January 31, 2003. For variable interest
entities created or acquired before February 1, 2003, FIN 46 applies in the
first fiscal year or interim period beginning after December 15, 2003. The
Company does not believe that the adoption of this standard will have a material
impact on its consolidated financial statements.
In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (`FIN 45"), which clarifies disclosure and
recognition/measurement requirements related to certain guarantees. The
disclosure requirements are effective for financial statements issued after
December 15, 2002 and the recognition/measurement requirements are effective on
a prospective basis for guarantees issued or modified after December 31, 2002.
The Company typically grants its customers a warranty, which guarantees that the
Company's products will substantially conform to the Company's current
specifications for ninety days from the delivery date as well as indemnification
for customers from third party claims. This standard does not have a material
impact on the Company's consolidated financial statements.
19
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Please refer to the second to last paragraph in the foregoing section,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of
Pharmos' disclosure controls and procedures (as defined in
section13(a) - 14(c) of the Securities Exchange Act of 1934 (the
"Act")) was carried out under the supervision and with the
participation of Pharmos' Chief Executive Officer and Chief Financial
Officer and several other members of Pharmos' senior management at the
end of the period. Pharmos' Chief Executive Officer and Chief
Financial Officer concluded that Pharmos' disclosure controls and
procedures as currently in effect are effective in ensuring that the
information required to be disclosed by Pharmos in the reports it
files or submits under the Act is (i) accumulated and communicated to
Pharmos' management (including the Chief Executive Officer and Chief
Financial Officer) in a timely manner, and (ii) recorded, processed,
summarized and reported within the time periods specified in the SEC's
rules and forms.
(b) Changes in Internal Controls: There were no significant changes in
Pharmos' internal controls or in other factors that could
significantly affect those controls subsequent to the date of their
most recent evaluation.
20
PART II
OTHER INFORMATION
Item 1 Legal Proceedings NONE
Item 2 Changes in Securities
On September 26, 2003, the Company completed a private placement under
Rule 506 of Regulation D of convertible debentures and warrants to six
institutional investors, generating total gross proceeds of $21 million. $5
million of the proceeds will be used for working capital purposes, and $16
million will be available to fund acquisitions upon the approval of the
investors. The convertible debentures are convertible into common stock of the
Company at a fixed price of $4.04, 205% above the closing price of the stock for
the five days preceding the closing date. The debentures, which bear an interest
rate of 4%, will be redeemed in 13 substantially equal monthly increments
beginning March 31, 2004. Pharmos also issued 5,514,705 in warrants (including
placement agent warrants) at an exercise price of $2.04 per share. On October
24, 2003, the Company filed a registration statement with the Securities and
Exchange Commission ("SEC") to permit resales of the common stock by the
investors in this September 2003 private placement (and of the shares of common
stock issuable upon exercise of the warrants), which registration statement was
declared effective by the SEC on November 4, 2003.
Item 3 Defaults upon Senior Securities NONE
Item 4 Submissions of Matters to Vote of Security Holders
At the Corporation's Annual Meeting of Stockholders held on July 30,
2003, the stockholders of the Corporation elected the following persons
as directors of the Corporation. In October 2002, the Company's Board of
Directors amended the Company's by-laws to provide for a classified
Board of Directors. The amended by-laws now provide for three classes of
directors, with the initial term of the Class I directors to expire at
the 2004 annual meeting, the initial term of the Class II directors to
expire at the 2005 annual meeting, and the initial term of the Class III
directors to expire at the 2006 annual meeting. Following the expiration
of the initial term for each class, all subsequent terms will be for
three-year periods.
The following persons have been elected to serve as directors in the
following classes:
Name Class Term Expiring
---- ----- -------------
Haim Aviv III 2006
Elkan R. Gamzu III 2006
David Schlachet II 2005
Mony Ben Dor II 2005
Georges Anthony Marcel I 2004
Lawrence F. Marshall I 2004
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The results of the voting were as follows:
VOTES FOR VOTES WITHHELD
--------- --------------
Haim Aviv 47,266,679 388,434
Elkan R. Gamzu 47,398,152 256,961
Mony Ben Dor 47,395,622 259,491
David Schlachet 47,364,477 290,636
Georges Anthony Marcel 47,373,097 282,016
Lawrence F. Marshall 47,380,117 274,996
Further, the stockholders ratified the Board's selection of
PricewaterhouseCoopers LLP as the Corporation's independent auditors for
the fiscal year ending December 31, 2003, with 47,483,169 votes for
ratification, 116,893 votes against ratification, and 55,050
abstentions.
Item 5 Other Information
In August 2003, Pharmos was informally notified by the NASDAQ Stock Market, Inc.
("Nasdaq") of a possible violation relating to Nasdaq's "20% Rule". Based upon
Nasdaq's preliminary analysis of Pharmos' February 2003 registered placement
transaction and the May 2003 private placement transaction, Nasdaq expressed a
concern that such transactions, when aggregated together, would have first
required shareholder approval based upon the issuance of securities representing
more than 20% of Pharmos' outstanding securities at a price at less than market
value. The completion of the September 2003 convertible debt financing had the
effect of eliminating any concerns Nasdaq may have had relating to a possible
violation by Pharmos of such corporate governance rules.
Item 6 Exhibits and Reports on Form 8-K
Number Exhibit
-------- --------
31.1 Certification of Chief Executive Officer
pursuant to Exchange Act Rules 13a-14(a) and
15(d)-14(a), adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer
pursuant to Exchange Act Rules 13a-14(a) and
15(d)-14(a), adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer
pursuant to 18 U.S.C. Section 1350, adopted
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certification of Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, adopted
pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K
Current Report filed on September 30, 2003; Item 5 was
reported
22
SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHARMOS CORPORATION
DATED: NOVEMBER 13, 2003
by: /s/ Robert W. Cook
-----------------------
Robert W. Cook
Executive Vice President and
Chief Financial Officer
(Principal Accounting and
Financial Officer)
23