SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the Fiscal Year Ended Commission File No. 0-11550
December 31, 2002
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) (zip code)
Registrant's telephone number, including area code: (732) 452-9556
Securities registered pursuant to Section 12(b) of the Act:
None
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.03 par value
(Title of Class)
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes |_| No |X|.
The aggregate market value of the registrant's Common Stock at March 18,
2003 held by those persons deemed to be non-affiliates was approximately
$48,776,672.
As of March 15, 2003, the Registrant had outstanding 61,619,487 shares of
its $.03 par value Common Stock.
PART I
Item 1. Business
Introduction
Pharmos Corporation ("Pharmos") is a bio-pharmaceutical company that discovers
and develops new drugs to treat a range of inflammatory, pain and neurological
disorders. Although we do not currently have any approved products, we have an
extensive portfolio of drug candidates under development, as well as discovery,
preclinical and clinical capabilities. Prior to the sale of our existing
ophthalmic product line to Bausch & Lomb Incorporated in October of 2001, we had
two successful ophthalmic products on the market. To date, our principal sources
of cash have been the sale of our existing ophthalmic business, revenues from
our ophthalmic product line, public and private financings and research grants.
Dexanabinol, Pharmos' lead central nervous system product, is currently
undergoing a pivotal Phase III clinical trial for severe traumatic brain injury
in Europe, Australia, and Israel. In February 2003, the FDA accepted the
Company's Investigational New Drug (IND) application. With the accepted IND
application by the FDA, the Company is now able to begin U.S. patient enrollment
into this trial. The Company estimates a total of up to 20 U.S. trauma centers
will join the 60 centers in Europe, Israel and Australia already participating
in the study. The study is expected to enroll a total of 860 patients, including
patients in the U.S.. The Phase II studies, completed in early 2000, revealed
that the drug inhibited the increase in intracranial pressure above 25mmHg, the
level of pressure above which is considered to be a prognostic indicator of poor
outcome. This result was statistically significant. The study also showed a
trend of efficacy in the drug treated groups versus the placebo group and,
within the most severely injured patients, a more than two-fold increase in the
percentage of those achieving good recovery (28.0% in the dexanabinol group vs.
11.7% in the placebo group) was demonstrated. In addition, neurological recovery
appeared to be accelerated in the dexanabinol treated group, such that the
percentage of dexanabinol patients achieving good recovery at one month after
injury was significantly higher than in the placebo group.
In addition, the Company has received approval from Israel's Ministry of Health
to commence a Phase IIa trial of dexanabinol as a preventive agent against the
mild cognitive impairment (MCI) that can follow coronary surgery under
cardiopulmonary bypass (CS-CPB) operations.
Pharmos has identified several promising new compounds based upon its program to
develop synthetic relatives of the active ingredient in cannabis. Preclinical
investigations are underway for compounds to treat stroke, pain, and multiple
sclerosis.
On October 9, 2001, Pharmos sold all of its rights to its existing ophthalmic
product line to Bausch & Lomb for cash and assumption of certain ongoing
obligations. The disposition had two parts, one for its two products already on
the market, Lotemax(R) and Alrex(R), and the second part for a medication now in
Phase III clinical trials, a product known as LE-T, involving a combination of
loteprednol etabonate and the antibiotic tobramycin. Based on meeting certain
new product milestones for LE-T in the future, the gross proceeds of the total
disposition may reach $47 million. Certain rights to the formulation patents of
these ophthalmic products in Japan, Korea, and Australia were conveyed to Senju
Pharmaceutical Co., Ltd.
Pharmos received gross proceeds of approximately $25 million in cash for the
rights to Lotemax(R) and Alrex(R), prescription anti-inflammation and allergy
products that are manufactured and marketed by Bausch & Lomb Incorporated under
a 1995 Marketing Agreement with Pharmos, and for the rights to any future
extensions of the active ingredient, loteprednol etabonate. Additionally,
Pharmos may receive up to an additional $12 million in gross proceeds, adjusted
based on the date of FDA approval of LE-T. An additional milestone payment of up
to $10 million could be paid to Pharmos to the extent certain sales levels are
exceeded in the first two years following commencement of sales of LE-T in the
U.S. Pharmos paid Dr. Nicholas Bodor, the loteprednol etabonate patent owner and
licensor, who is also a former director of and consultant to Pharmos, a total of
approximately $2.7 million from the initial proceeds of the sale of
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Lotemax(R) and Alrex(R) in return for his consent to Pharmos' assignment of its
rights under the license agreement to Bausch & Lomb Incorporated. Pharmos will
also pay Dr. Bodor 11% of our LE-T proceeds due upon FDA approval and 14.3% of
any LE-T milestone payment as described above. Pharmos agreed to pay up to $3.75
million of the costs of developing LE-T based on the arrangement with Bausch &
Lomb Incorporated, of which $600,000 was deducted from the purchase price paid
by Bausch & Lomb to Pharmos in October 2001. As of December 31, 2002, Pharmos'
share of these research and development related LE-T expenses was approximately
$1.6 million.
Strategy
Pharmos' business is the discovery and development of new drugs to treat a range
of inflammatory and neurological disorders such as traumatic brain injury,
stroke and pain. We seek to enter into collaborative relationships with
established pharmaceutical companies to complete development and
commercialization of our products.
Pharmos is applying its experience in rational drug design, novel drug delivery
technology and high through put screening procedures that facilitate the rapid
testing of compounds to develop products directed at several fields, including
neuroprotective compounds for traumatic brain injury and stroke, and synthetic,
non-psychotropic compounds related to cannabis for neurological, vascular and
other conditions involving inflammatory processes.
Products
Platform Technologies
Pharmos is developing two families of compounds based on scientific knowledge of
the medicinal activities of cannabis. Since these compounds are chemically
similar in several ways to the main active component of cannabis, they are
referred to as cannabinoids. The company utilizes state-of-the-art technologies
to synthesize, evaluate and develop new cannabinoid molecules that exhibit
enhanced therapeutic benefit but do not display the undesirable, psychotropic
effects seen with cannabis. Pharmos continues to expand its library of compounds
through a hybrid methodology combining the rational design of compounds based on
knowledge of detailed molecular requirements for drug activity with
combinatorial chemistry, a technique that utilizes randomized chemical reactions
to synthesize large numbers of different molecules. In contrast to the
conventional random methods of combinatorial chemistry, this hybrid approach
leads to a larger percentage of synthesized compounds that demonstrate activity
in screening assays and increases the potential of developing potent and
selective drug candidates.
Pharmos' chemical library consists of two chemically distinct cannabinoid
platforms, tricyclic dextrocannabinoids and bicyclic cannabinoids. The two
classes of synthetic cannabinoids have different mechanisms of action, but there
is considerable overlap in their therapeutic potential for treating
neurological, cardiovascular, autoimmune and inflammatory disorders.
Tricyclic dextrocannabinoids
The tricyclic dextrocannabinoids, for which dexanabinol is the prototype, do not
bind appreciably to either of the two known classes of cannabinoid receptors.
Therefore, this family of compounds does not show the psychotropic and other
negative side effects seen with naturally occurring cannabinoids. Drug
candidates in this family display biological activity by blocking the activation
of specific channels in nerve cells and/or inhibiting several major inflammatory
mechanisms. Both activities may reduce the amount of sudden and programmed cell
death caused by certain disorders.
Dexanabinol is currently undergoing a Phase III clinical study for the treatment
of severe head injury, and we will be commencing a Phase IIa trial for
dexanabinol as a preventive agent against the mild cognitive impairment (MCI)
that can follow coronary surgery under cardiopulmonary bypass (CS-CPB)
operations.
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Other tricyclic dextrocannabinoids are under evaluation in preclinical models
for stroke; neuropathic pain, which results from nerve damage or dysfunction;
nociceptive pain, which is caused by activation of nerve sensors as a result of
acute tissue damage; and autoimmune disorders such as multiple sclerosis.
Dexanabinol
Dexanabinol is Pharmos' lead central nervous system product aimed at treating
severe head trauma. It is a member of the tricyclic family of compounds,
therefore it is similar in structure to the active ingredient in cannabis but is
designed to avoid the unwanted psychotropic and sedative effects while retaining
properties of medicinal value as an agent to reduce inflammation..
In 1996, a Phase I study conducted in England of rising dose tolerance in
healthy volunteers (50 subjects) showed dexanabinol to be safe and well
tolerated at doses up to and including the expected therapeutic doses. An
additional Phase I study was conducted in Germany in 2002. In late 1996, Pharmos
commenced a Phase II study conducted at six medical centers in Israel on
patients with severe head injury. This trial was reviewed and approved by the
American Brain Injury Consortium and the European Brain Injury Consortium.
In 1998, Pharmos announced the results of a Phase II Clinical Study involving 67
patients. The study tested three doses of dexanabinol in three groups, also
known as cohorts, of patients, and Pharmos' announcement related to the first
two cohorts of the three cohort study. These studies established an excellent
safety profile of the drug in the treated patients. There were no unexpected
adverse experiences reported for either the drug treated or placebo group.
Intracranial pressure above a threshold of 25 mmHg, an important risk factor and
a predictor of poor neurological outcome, was significantly reduced in the
drug-treated patients through the third day of treatment, without a concomitant
reduction in systolic blood pressure. The mortality rate of 10% (3/30) in the
dexanabinol group compared favorably with a 13.5% rate in the placebo group
(5/37). The investigators concluded that dexanabinol was shown to be safe and
well tolerated in severe head trauma patients. Neurological outcomes in the
study, assessed periodically up to 6 months after injury, established a strong
trend of efficacy. The percentage of patients achieving Good Neurological
Outcome, the highest score on the five level Glasgow Outcome Score used to
assess the recovery of head trauma patients, was higher in the drug-treated
group at each measurement. Among the most severely injured patients in the
study, a better outcome was consistently observed among the drug treated group
than among the placebo treated group. Patients received an intravenous injection
of either dexanabinol or placebo within 6 hours of the injury. Demographically,
all 67 patients were fairly representative of the characteristics describing
severe head trauma.
In early 2000, Pharmos announced the results of the third cohort of the Phase II
Clinical Study. The study concluded that the Phase II goals of establishing the
safety of dexanabinol in traumatic brain injury and the dosing parameters for a
pivotal study were met. 101 patients in total were enrolled in the multi-center,
double-blind, randomized Phase II study, which was carried out in six trauma
centers in Israel affiliated with the American Brain Injury Consortium.
Fifty-two of the patients were treated with dexanabinol at three separate doses
and forty-nine received a placebo. In the third cohort, thirty-three patients
received an intravenous injection of either 200 mg. of dexanabinol (N=21) or
placebo (N=12) within six hours of injury. Demographically, these patients were
fairly representative of the traumatic brain injury population, comprising
mostly young men injured in motor vehicle accidents. However, the dexanabinol
and placebo groups differed with respect to several important baseline entry
parameters affecting the patients' prognosis; for example, injury severity as
determined by the Glasgow Coma Scale was significantly worse in the treated
group than in the placebo group. In addition, the patients' Computerized
Tomography classifications indicating the extent of the brain injury were worse
in the drug-treated group compared to placebo. Predictably, the strong trend for
better neurological outcome in comparison with placebo that was observed in the
first two cohorts (48mg. and 150mg. doses) was not repeated in this cohort.
Nevertheless, intracranial pressure above a threshold of 25mmHg, a major risk
factor affecting the prognosis of traumatic brain injury, was lower 40-70% of
the time during the first days after injury in the treated group vs. the placebo
group. This result was similar to those of the previous two cohorts (48mg. and
150mg. doses) reported in 1998.
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An analysis of patient performance on the Galveston Orientation and Amnesia Test
demonstrated significantly better results in the dexanabinol treated patients at
1, 3 and 6 months follow-up compared to placebo. The Galveston Orientation and
Amnesia Test is a neurological test that measures awareness of surroundings and
ability to remember. The 6 month outcome as measured by the Glasgow Outcome
Score was similar in the treated and placebo groups as a whole, a comparison of
outcome within the subgroup of very severe (Glasgow Coma Scale 4-6) patients
revealed a more than two-fold increase in the percentage of those achieving good
recovery (28.0% in the dexanabinol group vs. 11.7% in the placebo group). In
addition, neurological recovery appeared to be accelerated in the dexanabinol
treated group, such that the percentage of dexanabinol patients achieving good
recovery (measured by Glasgow Outcome Score) at 1 month was significantly higher
than in the placebo group (17% vs. 2%, p<0.02).
During January 2001, Pharmos announced that its international pivotal trial of
dexanabinol for severe traumatic brain injury commenced in Europe and Israel.
During February 2003, the FDA accepted the Company's IND application, which will
allow the Company to commence the trial in the U.S. The purpose of the Phase III
study is to determine the safety and efficacy of dexanabinol in severe traumatic
brain injury patients. The study is expected to enroll a total of 860 patients.
Over sixty centers are currently participating in the trial. Up to 80 centers in
Europe, U.S., Australia, and Israel are expected to participate in the study.
European countries participating in the study include Belgium, Finland, France,
Germany, Italy, the Netherlands, Spain, Switzerland, Turkey, and the U.K., along
with Israel and Australia. Pharmos is collaborating with the European Brain
Injury Consortium and the American Brain Injury Consortium in a number of areas,
including recruitment efforts with trauma centers.
Pharmos currently anticipates that it will complete enrollment of the 860
patients for the Phase III clinical trial by the end of 2003. Approximately six
months after the completion of enrollment, Pharmos anticipates completing the
clinical trial, since the trial protocol requires periodic examinations and
testing of patients enrolled in the trials during the six months following their
initial treatment.
Bicyclic cannabinoids
As with the tricyclic dextrocannabinoids, the bicyclic cannabinoids do not
display the unwanted psychotropic side effects seen with natural cannabinoids.
However, the molecular activity of the bicyclics is different from the
tricyclics in that the bicyclic cannabinoids bind with high affinity to
cannabinoid receptor located on immune and inflammatory cells. Such binding of
bicyclic cannabinoids to these receptors may help prevent certain cells from
activating inflammatory conditions.
Pharmaceuticals that activate these receptors may be important in treating
various autoimmune, inflammatory or degenerative disorders. Several candidates
from Pharmos' bicyclic cannabinoid library have shown promise in animal models
for autoimmune disorders such as multiple sclerosis, and for neuropathic and
nociceptive pain.
Loteprednol Etabonate
Loteprednol etabonate is a unique steroid, designed to act in the eye and
alleviate inflammatory and allergic conditions, and is quickly and predictably
reduced into inactive particles before it reaches the inner eye or systemic
circulation. This results in improved safety by avoiding the side effects
related to exposure to most ocular steroids. In the eye, the most unwanted side
effect of steroids is the elevation of intra-ocular pressure, which can be sight
threatening. While steroids, for lack of an alternative, are regularly used for
severe inflammatory conditions of the eye, milder conditions, such as allergies,
are preferentially treated with less effective non-steroidal agents.
LE-T, a loteprednol etabonate-based eye drug combined with the antibiotic
tobramycin that was sold to Bausch & Lomb as part of the ophthalmic business
disposition in October 2001, is undergoing a further clinical trial before
submitting the New Drug Application for FDA approval. Upon successful completion
of the clinical trial, Bausch & Lomb expects to file the New Drug Application
with the FDA.
5
In October 2001, Pharmos sold all of the assets of its existing ophthalmic
business in the U.S. and Europe to Bausch & Lomb. Pharmos retains no residual
rights to Lotemax(R) or Alrex(R), two commercially-available products which were
included in the assets sold to Bausch & Lomb, but may receive up to a maximum
gross $12 million based on the date of FDA approval of LE-T, and 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. In addition, Pharmos has agreed to pay for up to
$3.75 million of the clinical development costs of LE-T, depending upon the
total developmental costs for LE-T. There are several products currently on the
market against which LE-T would compete, with Alcon's Tobradex(R) being the
largest selling product in the category.
The first of the two contingent payments, tied to the date Bausch & Lomb
receives FDA approval for LE-T, was initially established at $15.4 million if
the FDA approval was obtained on or before January 2, 2002. That amount has been
decreasing by $90,000 per month for each month of 2002 and 2003. If the FDA
approval is obtained after December 2003, the parties have agreed to negotiate
in good faith an appropriate payment.
Competition
The pharmaceutical industry is highly competitive. Pharmos competes with a
number of pharmaceutical companies that have financial, technical and marketing
resources significantly greater than those of Pharmos. Some companies with
established positions in the pharmaceutical industry may be better equipped than
Pharmos to develop and market products in the markets Pharmos is seeking to
enter. A significant amount of pharmaceutical research is also being carried out
at universities and other not-for-profit research organizations. These
institutions are becoming increasingly aware of the commercial value of their
findings and are becoming more active in seeking patent protection and licensing
arrangements to collect royalties for the use of technology they have developed.
These institutions may also market competitive commercial products on their own
or through joint ventures and will compete with Pharmos in recruiting highly
qualified scientific personnel.
Pharmos is pursuing areas of product development in which there is a potential
for extensive technological innovation. Pharmos' competitors may succeed in
developing products that are more effective than those of Pharmos. Rapid
technological change or developments by others may result in Pharmos' potential
products becoming obsolete or non-competitive.
While there are currently no products either on the market or in clinical trials
of which we are aware that would compete with our lead central nervous systems
drug, there are products currently on the market which would compete with the
Bausch & Lomb ophtahalmic product in which we have a financial interest, LE-T,
including Tobradex(R) from Alcon, which is the largest selling product in the
category, as well as Pred Forte(R) from Allergan and Vexol(R) from Alcon.
Collaborative Relationships
Pharmos' commercial strategy is to develop products independently and, where
appropriate, in collaboration with established pharmaceutical companies and
institutions. Collaborative partners may provide financial resources, research
and manufacturing capabilities and marketing infrastructure to aid in the
commercialization of Pharmos' products in development and potential future
products. Depending on the availability of financial, marketing and scientific
resources, among other factors, Pharmos may license its technology or products
to others and retain profit sharing, royalty, manufacturing, co-marketing,
co-promotion or similar rights. Any such arrangements could limit Pharmos'
flexibility in pursuing alternatives for the commercialization of its products.
Due to the often unpredictable nature of the collaborative process, we cannot be
sure that we will be able to establish any additional collaborative arrangements
or that, if established, any such relationships will be successful.
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Bausch & Lomb
In October 2001, Pharmos sold to Bausch & Lomb all of its rights in the U.S. and
Europe to manufacture and market Lotemax(R) and Alrex(R) and the third
loteprednol etabonate-based product, LE-T, which continues to be developed by
Bausch & Lomb. As part of the sale agreement, upon FDA approval Pharmos will
receive up to an additional $12 million in gross proceeds, based upon the date
of FDA approval of the product, and a milestone payment of up to an additional
$10 million if actual sales during the first two years following
commercialization exceed agreed-upon forecasted amounts. Pharmos agreed to pay
up to $3.75 million of the costs of developing LE-T based on the arrangement
with Bausch & Lomb and will have a passive role as a member of a joint committee
overseeing the development of LE-T. As of December 31, 2002, Pharmos' share of
these research and development related LE-T expenses was approximately $1.6
million.
Pharmos paid Dr. Nicholas Bodor, the loteprednol etabonate patent owner and
licensor, who is also a former director of and consultant to Pharmos, a total of
approximately $2.7 million from the initial proceeds of the sale of Lotemax(R)
and Alrex(R) in return for his consent to Pharmos' assignment of its rights
under the license agreement to Bausch & Lomb ($1.5 million paid at closing and
$1.2 million paid in October 2002). Pharmos will also pay Dr. Bodor 11% of our
LE-T proceeds due upon FDA approval and 14.3% of the payment we will receive in
the event that certain sales levels are exceeded in the first two years
following commencement of sales in the U.S.
Patents, Proprietary Rights and Licenses
Patents and Proprietary Rights
Proprietary protection generally has been important in the pharmaceutical
industry, and the commercial success of products incorporating Pharmos'
technologies may depend, in part, upon the ability to obtain strong patent
protection.
Some of the technologies underlying Pharmos' potential products were invented or
are owned by various third parties, including the Hebrew University of
Jerusalem. Pharmos is the licensee of these technologies under patents held by
the applicable owner, through licenses that generally remain in effect for the
life of the applicable patent. Pharmos generally maintains, at its expense, U.S.
and foreign patent rights with respect to both the licensed and its own
technology and files and/or prosecutes the relevant patent applications in the
U.S. and foreign countries. Pharmos also relies upon trade secrets, know-how,
continuing technological innovations and licensing opportunities to develop its
competitive position. Pharmos' policy is to protect its technology by, among
other things, filing, or requiring the applicable licensor to file, patent
applications for technology that it considers important to the development of
its business. Pharmos intends to file additional patent applications, when
appropriate, relating to its technology, improvements to its technology and to
specific products it develops.
The patent positions of pharmaceutical firms, including Pharmos, are uncertain
and involve complex factual questions. In addition, the coverage claimed in a
patent application can be significantly reduced before or after the patent is
issued. Consequently, Pharmos does not know whether any of the pending patent
applications underlying the licensed technology will result in the issuance of
patents or, if any patents are issued, whether they will provide significant
proprietary protection or will be circumvented or invalidated. Since patent
applications in the U.S. and elsewhere publish only 18 months after priority
date, and since publication of discoveries in the scientific or patent
literature often lag behind actual discoveries, Pharmos cannot be certain that
it or its licensors, as the case may be, were the first creators of inventions
covered by pending and issued patents or that it or its licensors, as the case
may be, were the first to file patent applications for such inventions.
Moreover, Pharmos may have to participate in interference proceedings declared
by the U.S. Patent and Trademark Office to determine priority of invention,
which could result in substantial cost to Pharmos, even if the eventual outcome
is favorable to Pharmos. The results of the judicial process are often
uncertain, and we cannot therefore be sure that a court of competent
jurisdiction will uphold
7
the patents, if issued, relating to the licensed technology, or that a
competitor's product will be found to infringe such patents.
Other pharmaceutical and drug delivery companies and research and academic
institutions may have filed patent applications or received patents in Pharmos'
fields. If patents are issued to other companies that contain competitive or
conflicting claims and such claims are ultimately determined to be valid, it is
possible that Pharmos would not be able to obtain licenses to these patents at a
reasonable cost or be able to develop or obtain alternative technology.
Pharmos also relies upon trade secret protection for its confidential and
proprietary information. It is always possible that others will independently
develop substantially equivalent proprietary information and techniques or
otherwise gain access to Pharmos' trade secrets.
It is Pharmos' policy to require its employees, consultants, outside scientific
collaborators and sponsored researchers and other advisors to execute
confidentiality agreements upon the commencement of employment or consulting or
advisory relationships with Pharmos. These agreements generally provide that all
confidential information developed or made known to the individual during the
course of the individual's relationship with Pharmos is to be kept confidential
and not disclosed to third parties except in specific circumstances. In the case
of employees and certain consultants, the agreements provide that all inventions
conceived by the individual in the course of their employment or consulting
relationship shall be the exclusive property of Pharmos. Due to the vital nature
of trade secrets and the often uncertain results of the judicial process, we
cannot be sure, however, that these agreements will provide meaningful
protection or adequate remedies for Pharmos' trade secrets in the event of
unauthorized use or disclosure of such information. Pharmos' patents and
licenses underlying its potential products described herein are summarized
below.
Neuroprotective Agents. Pharmos has licensed from the Hebrew University of
Jerusalem, which is the academic affiliation of the inventor, Dr. Raphael
Mechoulam, patents covering new compounds that have demonstrated beneficial
activity which may prevent damage or death to nerve cells resulting from various
diseases and disorders of the nervous system while appearing to be devoid of
most of the deleterious side effects usually associated with this class of
compounds. Several patents have been designed to protect this family of
compounds and their uses devised by inventors at Pharmos and the inventors at
the Hebrew University. The earliest patent applications resulted in patents
issued in 1989, and the most recent patents date from 2002. These patents cover
dexanabinol, which is under development for the treatment of head trauma and
other conditions, and new molecules discovered by modifying the chemical
structure of dexanabinol.
Site-Specific Drugs. In the general category of site-specific drugs that are
active mainly in the eye and have limited systemic side effects, Pharmos
licensed several patents from Dr. Nicholas Bodor. It assigned its rights under
the Bodor license to Bausch & Lomb in October 2001 in connection with its sale
of its existing ophthalmic business. The earliest patents date from 1984 and the
most recent from 1996. Some of these patents cover loteprednol etabonate-based
products and its formulations.
Analgesic Agents. Pharmos has also licensed from the Hebrew University of
Jerusalem, patents for inventions of Dr. Mechoulam covering new compounds that
have demonstrated beneficial activity, which may be effective in treating not
only neurological disorders, but also inflammatory diseases and most importantly
pain. These bicyclic compounds do not cause most of the adverse deleterious side
effects usually associated with cannabinoids. Several patents have been designed
to protect this family of compounds and their uses devised by inventors at
Pharmos and the inventors at the Hebrew University. The earliest patent
applications resulted in patents issued in 1995, and the most recent patent
application dates from 2003. These patents cover HU-308 and related compounds
and new molecules from a different chemical structure.
Selective Estrogen Receptor Modulators (SERM). Pharmos has filed patent
applications in the U.S., Israel, Australia, Canada, Japan, Brazil, Korea and
the European Patent Office to protect certain derivatives of
8
tamoxifen, a drug approved by the FDA, and other molecules that enhance or
improve the actions of steroid hormones. In July 1997, the U.S. Patent and
Trademark Office issued a patent with claims covering the compounds themselves
and their use. A second patent issued in July 2000 claims the use of these
compounds as agents to inhibit growth of new blood vessels, a potential method
of treating various cancers. Pharmos believes that these derivatives are
superior to the parent compounds in that they are devoid of central nervous
system side effects.
Emulsion-based Drug Delivery Systems. In the general category of SubMicron
Emulsion technology, Pharmos holds a license to one family of patents from the
Hebrew University of Jerusalem and has filed ten independent patent families of
applications including more than ninety patent applications that are at
different stages of prosecution. These patents and patent applications have been
devised to protect a group of formulation technologies devised by Pharmos and
the inventors as they relate to pharmaceutical and medicinal products. The
earliest patent filings for SubMicron Emulsion technology date from 1993 and the
most recent from 1998. These patents cover a broad range of new formulations,
which improve the absorption of drugs that are poorly soluble in water.
Licenses
As discussed above, Pharmos licenses patents covering neuroprotective agents and
emulsion-based drug delivery systems from the Hebrew University of Jerusalem.
Pharmos assigned its rights as licensee of Dr. Bodor's loteprednol
etabonate-based ophthalmic compounds to Bausch & Lomb in October 2001.
Pharmos' subsidiary Pharmos Ltd. has licensed its patents related to the oral
delivery of lipophilic substances in the limited field of use of nutraceuticals
to Herbamed, Lt., a company in Israel controlled by the Chairman and Chief
Executive Officer of Pharmos. The terms of the license agreement are discussed
in "Item 13. Certain Relationships and Related Transactions."
Government Regulation
Regulation by governmental authorities in the U.S. and other countries is a
significant factor in our ongoing research and development activities and in the
production and marketing of our products. In order to undertake clinical tests,
to produce and market products for human therapeutic or diagnostic use,
mandatory procedures and safety standards established by the FDA in the U.S. and
comparable agencies in other countries must be followed.
The standard process required by the FDA before a pharmaceutical agent may be
marketed in the U.S. includes the following steps:
(i) Preclinical studies including laboratory evaluation and animal
studies to test for initial safety and efficacy;
(ii) Submission to the FDA of an Investigational New Drug Application,
which must become effective before human clinical trials may
commence;
(iii) Adequate and well-controlled human clinical trials to establish the
safety and efficacy of the drug in its intended application;
(iv) Submission to the FDA of a New Drug Application, which application
is not automatically accepted by the FDA for consideration; and
(v) FDA approval of the New Drug Application prior to any commercial
sale or shipment of the drug.
In addition to obtaining FDA approval for each product, each domestic
drug-manufacturing establishment must be registered or licensed by the FDA for
each product that is manufactured at that facility. U.S.
9
manufacturing establishments are subject to inspections by the FDA and by other
Federal, state and local agencies and must comply with current Good
Manufacturing Practices, requirements applicable to the production of
pharmaceutical drug products.
Preclinical studies include laboratory evaluation of product chemistry and
animal studies to assess the potential safety and efficacy of the product and
its formulation. The results of the preclinical studies are submitted to the FDA
as part of an Investigational New Drug Application, and unless the FDA objects,
the application will become effective 30 days following its receipt by the FDA.
Clinical trials involve the administration of the drug to healthy volunteers
and/or to patients under the supervision of a qualified principal investigator.
Clinical trials are conducted in accordance with protocols that detail the
objectives of the study, the parameters to be used to monitor safety and the
efficacy criteria to be evaluated. Each protocol is submitted to the FDA as part
of the application. Each clinical study is approved and monitored by an
independent Institutional Review Board or Ethics Committee at each clinical site
who will consider, among other things, ethical factors, informed consents, the
safety of human subjects and the possible liability of the institution
conducting a clinical study.
Clinical trials typically are conducted in three sequential phases, although the
phases may overlap. In Phase I, the initial introduction of the drug to humans,
the drug is tested for safety and clinical pharmacology such as metabolism.
Phase II involves detailed evaluation of safety and efficacy of the drug in
patients with the disease or condition being studied. Phase III trials consist
of larger scale evaluation of safety and efficacy and usually require greater
patient numbers and multiple clinical trial sites, depending on the clinical
indications for which marketing approval is sought.
The process of completing clinical testing and obtaining FDA approval for a new
product is likely to take a number of years and require the expenditure of
substantial resources. The FDA may grant an unconditional approval of a drug for
a particular indication or may grant approval conditioned on further
post-marketing testing. The FDA also may conclude that the submission is not
adequate to support an approval and may require further clinical and preclinical
testing, re-submission of the New Drug Application, and further review. Even
after initial FDA approval has been obtained, further studies may be required to
provide additional data on safety or to gain approval for the use of a product
for clinical indications other than those for which the product was approved
initially. Also, the FDA may require post-market testing and surveillance
programs to monitor the drug's efficacy and side effects.
Marketing of pharmaceutical products outside of the U.S. are subject to
regulatory requirements that vary widely from country to country. In the
European Union, the general trend has been towards coordination of the common
standards for clinical testing of new drugs. Centralized approval in the
European Union is coordinated through the European Medicines Evaluation Agency,
or EMEA.
The level of regulation outside of the U.S. varies widely. The time required to
obtain regulatory approval from comparable regulatory agencies in each country
may be longer or shorter than that required for FDA or EMEA approval. In
addition, in certain markets, reimbursement may be subject to governmentally
mandated prices.
Corporate History
Pharmos Corporation, a Nevada corporation, formerly known as Pharmatec, Inc.,
was incorporated under the laws of the State of Nevada on December 20, 1982. On
October 29, 1992, Pharmos, the Nevada Corporation, completed a merger with a
privately held New York corporation known as Pharmos Corporation, and in 1992
acquired all of the outstanding shares of Xenon Vision, Inc., a privately held
Delaware corporation.
10
Human Resources
As of January 1, 2003, Pharmos had 67 employees (61 full-time and 6 part-time),
including 14 in the U.S. (1 part-time) and 53 in Israel (5 part-time), of whom
approximately 23 hold doctorate or medical degrees.
During the first quarter of 2003, the Company implemented a company-wide cost
cutting program. Staff reductions of up to 20% will be concentrated in its
Discovery & Early Stage Research Group and in certain general and administrative
areas.
Pharmos' employees are not covered by a collective bargaining agreement. Pharmos
has never experienced employment-related work stoppages and considers its
employee relations to be excellent.
Public Funding and Grants
Pharmos' subsidiary, Pharmos Ltd., has received certain funding from the Chief
Scientist of the Israel Ministry of Industry and Trade (the Chief Scientist) for
research and development of dexanabinol, SubMicron Emulsion technology for
injection and nutrition as well as for research relating to pilocarpine,
dexamethasone and ophthalmic formulations for dry eyes. Pharmos has received an
aggregate of $5,893,889 under such agreements through December 31, 2002. Pharmos
will be required to pay royalties to the Chief Scientist ranging from 3% to 5%
of product sales, if any, as a result of the research activities conducted with
such funds. Aggregate royalty payments per product are limited to the amount of
funding received to develop that product. Additionally, funding by the Chief
Scientist places certain legal restrictions on the transfer of know-how and the
manufacture of resulting products outside of Israel. See "Conditions in Israel."
Pharmos received funding of $925,780 from the Israel-U.S. Binational Industrial
Research and Development Foundation to develop Lotemax(R) and LE-T. Pharmos was
required to pay royalties to this foundation on product sales, if any, of 2.5%,
through September 1999, then 5% thereafter, as a result of the research
activities conducted with such funds. Aggregate royalty payments are limited to
150% of the amount of such funding received, linked to the exchange rate of the
U.S. dollar and the New Israeli Shekel. During October 2001, in connection with
the sale of Pharmos's existing ophthalmic business, Pharmos paid the foundation
royalties of approximately $1.0 million for Lotemax(R) which concluded Pharmos'
obligation to pay royalties to the foundation with respect to Lotemax(R).
Pharmos retains its' obligation to repay that portion of funding it received
from the foundation with respect to LE-T of $302,438.
In April 1997, Pharmos signed an agreement with the Magnet consortium, operated
by the Office of the Chief Scientist, for developing generic technologies and
for the design and development of drug and diagnostic kits. Under such
agreement, Pharmos was entitled to a non-refundable grant amounting to
approximately 60% of the actual research and development and equipment
expenditures on approved projects. No royalty obligations were required within
the framework. As of December 31, 2002, Pharmos had received grants totaling
$1,627,680 pursuant to this agreement.
Conditions in Israel
A significant part of our operations is conducted in Israel through our wholly
owned subsidiary, Pharmos Ltd., and we are directly affected by economic,
political and military conditions there.
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, as well as
incidents of civil unrest. In addition, Israel and companies doing business with
Israel have, in the past, been the subject of an economic boycott. Although
Israel has entered into various agreements with certain Arab countries and the
Palestinian Authority, there has been an increase in the unrest and terrorist
activity that began in September 2000 and has continued with varying levels of
severity into 2003. We do not believe that the political and security situation
has had any material negative impact on our business to date; however, the
situation is volatile and we cannot be sure that security and political
conditions will have no such effect in the future.
11
Many of our employees in Israel are obligated to perform military reserve duty.
In the event of severe unrest or other conflict, individuals could be required
to serve in the military for extended periods of time. Our operations could be
disrupted by the absence for a significant period of time of some of our
employees due to military service.
In addition, since 1997 Pharmos Ltd. has received funding from the Office of the
Chief Scientist of the Israel Ministry of Industry and Trade relating to generic
technologies for the design and development of drugs and diagnostic kits.
Through 2002, we have received an aggregate of $1,627,680 from these grants, and
may receive future grants, the amounts of which would be determined at the time
of application. This funding prohibits the transfer or license of know-how and
the manufacture of resulting products outside of Israel without the permission
of the Chief Scientist. Although we believe that the Chief Scientist does not
unreasonably withhold this permission if the request is based upon commercially
justified circumstances and any royalty obligations to the Chief Scientist are
sufficiently assured, the matter is solely within his discretion and we cannot
be sure that such consent, if requested, would be granted upon terms
satisfactory to us or granted at all. Without such consent, we would be unable
to manufacture any products developed by this research outside of Israel, which
may greatly restrict any potential revenues from such products.
Availability of SEC Filings
All reports filed by the Company with the SEC are available free of charge via
EDGAR through the SEC website at www.sec.gov. In addition, the public may read
and copy materials filed by the Company with the SEC at the SEC's public
reference room located at 450 Fifth St., N.W., Washington, D.C., 20549. The
company also provides copies of its Forms 8-K, 10-K, 10-Q, Proxy and Annual
Report at no charge available through its website at www.pharmoscorp.com as soon
as reasonably practicable after filing electronically such material with the
SEC. Copies are also available, without charge, from Pharmos Corporation, 99
Wood Avenue South, Suite 311, Iselin, NJ, 08830.
Item 2. Properties
Pharmos is headquartered in Iselin, New Jersey where it leases its executive
offices and maintains clinical, regulatory and business development staff.
Pharmos also leases facilities used in the operation of its research,
development, pilot manufacturing and administrative activities in Rehovot,
Israel. These facilities have been improved to meet the special requirements
necessary for the operation of Pharmos' research and development activities. In
the opinion of the management these facilities are sufficient to meet the
current and anticipated future requirements of Pharmos. In addition, management
believes that it has sufficient ability to renew its present leases related to
these facilities or obtain suitable replacement facilities. The monthly lease
obligations for our office space in 2003 are $17,308 for Iselin, New Jersey and
$23,735 for Rehovot, Israel. The approximate square footage for Iselin, New
Jersey and Rehovot, Israel are 10,403 and 21,600, respectively.
Item 3. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
12
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
The Company's Common Stock is traded on the Nasdaq SmallCap Market under the
symbol "PARS." The following table sets forth the range of high and low bid
prices per share for the Common Stock as reported on the NASDAQ National Market
System and the Nasdaq SmallCap Market during the periods indicated.
Year ended December 31, 2002 HIGH LOW
- ---------------------------- ---- ----
1st Quarter ....................................... $2.55 $1.68
2nd Quarter ....................................... 1.73 0.89
3rd Quarter ....................................... 1.55 0.73
4th Quarter ....................................... 1.38 1.01
Year ended December 31, 2001 HIGH LOW
- ---------------------------- ---- ----
1st Quarter ....................................... $2.88 $1.50
2nd Quarter ....................................... 3.80 1.87
3rd Quarter ....................................... 3.85 1.84
4th Quarter ....................................... 2.76 1.97
The high and low bid prices for the Common Stock during the first quarter of
2003 (through March 18, 2003) were $1.25 and $0.77, respectively. The closing
price on March 18, 2003 was $0.82.
The foregoing represents inter-dealer prices, without retail mark-up, mark-down
or commission, and may not necessarily represent actual transactions.
On March 6, 2003, there were approximately 468 record holders of the Common
Stock of the Company and approximately 17,200 beneficial owners of the Common
Stock of the Company, based upon the number of shares of Common Stock held in
"street name".
The Company has paid no dividends on its Common Stock and does not expect to pay
cash dividends in the foreseeable future. The Company is not under any
contractual restriction as to its present or future ability to pay dividends.
The Company currently intends to retain any future earnings to finance the
growth and development of its business.
13
Item 6. Selected Financial Data
Year Ended December 31,
------------------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------- ------------- ------------- ------------- -------------
Revenues -- $ 4,298,441 $ 5,098,504 $ 3,279,397 $ 1,539,941
Gross Margin -- 3,029,852 3,222,549 2,284,780 1,102,228
Operating expenses ($ 16,858,414) (13,789,291) (9,969,879) (6,999,136) (6,109,809)
Income (Loss) Before Income
Taxes (17,284,823) 4,819,822* (7,984,202)* (4,618,1990) (4,663,347)
Net (Loss) Income (17,069,600) 5,045,855 (7,984,202) (4,618,190) (4,663,347)
Dividend embedded in
convertible preferred stock -- -- -- -- (642,648)
Preferred Stock dividends -- -- -- (22,253) (242,295)
------------- ------------- ------------- ------------- -------------
Net income (loss) applicable to
common shareholders ($ 17,069,600) $ 5,045,855* ($ 7,984,202)** ($ 4,640,443) ($ 5,548,290)
============= ============= ============= ============= =============
Net income (loss) per share applicable
to common shareholders -
basic & diluted ($ 0.30) $ 0.09 ($ 0.15) ($ 0.11) ($ 0.15)
============= ============= ============= ============= =============
Total assets $ 24,686,682 $ 44,262,991 $ 30,783,109 $ 7,791,294 $ 8,066,670
============= ============= ============= ============= =============
Long term obligations $ 10,000 $ 5,847,951 $ 7,680,872 $ 1,277,565 $ 2,691,023
============= ============= ============= ============= =============
Cash dividends declared -- -- -- -- --
Average shares outstanding - basic 56,520,041 54,678,932 52,109,589 42,725,157 37,277,186
Average shares outstanding - diluted 56,520,041 55,298,063 52,109,589 42,725,157 37,277,186
* includes a $16.3 million gain on sale of the ophthalmic product line in
October 2001
** includes a beneficial conversion charge of $1.8 million.
14
Item 7. 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 audited consolidated
financial statements and the related notes thereto included elsewhere in this
report.
During 2000 and 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 has incurred a
cumulative net loss of $102.5 million through December 31, 2002. In 2001, the
Company recorded a profit due the sale of its' ophthalmic product line to Bausch
& Lomb. Losses have resulted principally from costs incurred in research
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."
Critical Accounting Policies
The Company considers certain accounting policies related to the tax valuation
allowance and revenue recognition to be critical policies due to the estimation
process involved in each.
Revenue
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. Up-front license fees are deferred and recognized when all
performance obligations are completed. The Company had no product sales revenue
during 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 and may never have
such sales if products currently under development fail to be commercialized.
Tax Valuation Allowance
The Company has assessed the future taxable income and has determined that a
100% deferred tax valuation allowance is deemed necessary. In the event the
Company were to determine that it would be able to realize its deferred tax
asset, an adjustment to the deferred tax asset would increase income in the
period such determination is made.
15
Results of Operations
Years Ended December 31, 2002 and 2001
There were no product sales or cost of goods sold for the twelve months ended
December 31, 2002. Revenue totaled $4,298,441 and cost of goods sold totaled
$1,268,589 for the twelve months ended December 31, 2001. The decrease in both
product sales, license fee income, and cost of goods sold is due to the sale of
the Company's ophthalmic product line to Bausch & Lomb in October 2001. Bausch &
Lomb was the Company's marketing partner for its ophthalmic line.
Total operating expenses increased by $3,069,123 or 22%, from $13,789,291 in
2001 to $16,858,414 in 2002. The increase in operating expenses is primarily due
to increased research and development expenses as the Company increased
expenditures related to the development of dexanabinol for the treatment of
traumatic brain injury and to increased activity in the Company's cannabinoid
program to treat various central nervous system and inflammation-based
conditions.
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 product is the development of dexanabinol for the treatment of traumatic
brain injury, which is currently involved in Phase III testing in Europe,
Australia and Israel. During 2002, the gross cost of the project was $10.0
million. Total costs since the project entered Phase II development in 1996
through December 31, 2002 were $24.8 million. Enrollment in the current Phase
III trial is expected to continue until the end of 2003. The principal costs of
completing the project include patient enrollment, production of the drug
product, collection and evaluation of the data, 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 sufficient quantities
of drug product under current Good Manufacturing Practice conditions. 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 can expect to 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, during 2002, the Company received approval from Israel's Ministry
of Health to commence a Phase IIa trial of dexanabinol as a preventive agent
against the mild cognitive impairment (MCI) that can follow coronary surgery
under cardiopulmonary bypass (CS-CPB) operations. Enrollment of up to 200
patients with this trial is expected to occur by the end of 2003. Expenses
directly related to this project were not material for the twelve months ended
December 31, 2002.
Expenses for other research & development projects in earlier stages of
development for the twelve months of 2002 and 2001 were $3,324,882 and
$3,464,781, respectively. Research and development expenses, net of grants, for
2002 and 2001 were $12,337,840 and $9,349,025, respectively. The company
received from the Office of the Chief Scientist of Israel's Ministry of Industry
and Trade grant money of $2,755,882 and $1,336,566 during 2002 and 2001,
respectively, which reduced the research and development expenses.
Selling, general and administrative expenses increased by $162,457 or 4%, from
$3,666,293 in 2001 to $3,828,750 in 2002. The increase is due to higher
professional fees, consultants, and investor relations while offset by a
reduction in the overhead allocation.
Depreciation and amortization expenses decreased by $82,149, or 11%, from
$773,973 in 2001 to $691,824 in 2002. The decrease is primarily due to the
accelerated amortization of the intangible assets in 2001. This nets against an
increase in depreciation expense related to laboratory equipment purchases.
Other income (expense), net of interest and other expenses, decreased by
$16,005,670 from income of
16
$15,579,261 in 2001 to expense of $426,409 in 2002. The decrease is primarily
due to a gain of $16.3 million from the sale of the Company's ophthalmic product
line to Bausch & Lomb in October 2001. The reported gain includes charges of
$3.75 million representing the Company's maximum liability for the completion of
the clinical development of LE-T, the final product resulting from the
ophthalmic marketing relationship with Bausch & Lomb. Should LE-T gain FDA
approval, the Company will receive additional gross proceeds up to a maximum of
$12 million depending on the date of FDA approval and up to an additional $10
million based upon the achievement of certain sales goals. Also, the decrease
was attributable to the lower debt payable at December 31, 2002 resulting from
(i) the conversion from debt to equity in the first quarter of 2002 of $2.6
million of our Convertible Debentures issued in 2000, and (ii) the repayment of
$2 million of the Convertible Debentures in the first quarter of 2002. This
conversion and repayment resulted in lower interest expense. Interest income
decreased by $445,005 which was primarily due to a lower average cash balance in
2002 than in 2001 combined with the decrease in interest rates.
Years Ended December 31, 2001 and 2000
Revenues decreased $800,063 or 16%, from $5,098,504 in 2000 to $4,298,441 in
2001. The decrease is due to the sale of the Company's ophthalmic product line
to Bausch & Lomb in October 2001. Bausch & Lomb was the Company's marketing
partner for its ophthalmic product line. Product revenues for the year ended
December 31, 2000 included a full year of revenue, while the product revenues
for the year ended December 31, 2001 included revenues for only the first three
fiscal quarters. Additionally, License Fee revenues were $225,000 in 2000
compared to $80,000 in 2001.
Cost of goods sold decreased $607,366 or 32%, from $1,875,955 in 2000 to
$1,268,589 in 2001. The decrease reflects the decrease in product revenue due to
the sale of the Company's ophthalmic product line to Bausch & Lomb in October
2001. Cost of goods sold includes the cost of the active drug substance and
royalty payments to the licensor.
Total operating expenses increased $3,891,412 or 38%, from $9,969,879 in 2000 to
$13,789,291 in 2001. The increase in operating expenses is primarily due to
increased research and development expenses as the Company increased
expenditures related to the development of dexanabinol for the treatment of
traumatic brain injury and to increased activity in the Company's cannabinoid
program to treat various central nervous system and inflammation-based
conditions.
Net research and development expenses increased by $3,905,737 or 72%, from
$5,443,288 in 2000 to $9,349,025 in 2001. The increase in R&D expense is
primarily due to increased expenditures, including increased employee
headcounts, related to the development of dexanabinol for the treatment of
traumatic brain injury and to increased activity in the Company's cannabinoid
program to treat various central nervous system and inflammation-based
conditions.
Selling, general and administrative expenses decreased by $378,574 or 9%, from
$4,044,867 in 2000 to $3,666,293 in 2001. The decrease is primarily due to a
reallocation of employee resources to research and development from general and
administrative areas.
Depreciation and amortization expenses increased by $292,249, or 61%, from
$481,724 in 2000 to $773,973 in 2001, reflecting increased depreciation expense
related to laboratory equipment purchases.
Other income (expense), net of interest and other expenses, increased by
$16,816,133 from expense of $1,236,872 in 2000 to income of $15,579,261 in 2001.
The increase is primarily due to a gain of $16.3 million from the sale of the
Company's ophthalmic product line to Bausch & Lomb in October 2001. The reported
gain includes charges of $3.75 million representing the Company's maximum
liability for the completion of the clinical development of LE-T, the final
product resulting from the ophthalmic marketing relationship with Bausch & Lomb.
Should LE-T gain FDA approval, the Company will receive additional gross
proceeds up to a maximum of $12 million depending on the date of FDA approval
and up to an additional $10 million based upon the achievement of certain sales
goals. Also contributing to the increase in
17
other income was a lower level of interest expense primarily due to non-cash
charges related to the Company's convertible debt financing, completed in the
third quarter of 2000. Partially offsetting the increase in other income is
decreased interest income as a result of lower market interest rates on the
Company's cash balances in 2001.
Liquidity and Capital Resources
While the Company recorded revenues since 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 $102,518,056 at
December 31, 2002. The Company has financed its operations with public and
private offerings of 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
Losses carryforwards, and interest income. Should the Company be unable to raise
adequate financing in the future, long-term projects will need to be scaled
back or discontinued.
The Company had working capital of $11.4 million as of December 31, 2002.
Included in the current assets of $22.8 million is $19.6 million of cash and
cash equivalents.
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 are made and marketed by Bausch & Lomb under a 1995 Marketing Agreement
with the Company; in addition, Bausch & Lomb also acquired future extensions of
LE formulations including LE-T, a product currently in Phase III clinical trial.
The Company 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 FDA approval of this new combination therapy. 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 the LE-T development cost, of which $600,000 was deducted from the purchase
price paid by Bausch & Lomb to Pharmos in October 2001. As a result of this
transaction, the Company recorded a net gain of $16.3 million. The Company
recorded an accrual of $3.75 million representing the Company's maximum
obligation in the continuing clinical development of LE-T. 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 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.
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 may 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 will be 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.
18
In December 2001, the holders of the Convertible Debentures and the Company
agreed to modify the repayment and conversion terms. 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 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 will be accreted over the remaining term of the convertible debt with a
corresponding charge into interest expense.
In 2002, and 2001, the Company sold $5,561,838, and $9,060,168, respectively, of
our State Net Operating Loss carryforwards under the State of New Jersey's
Technology Business Tax Certificate Transfer Program (the "Program"). The
Program allows qualified technology and biotechnology businesses in New Jersey
to sell unused amounts of net operating loss carryforwards and defined research
and development tax credits for cash. The proceeds from the sale in 2002, and
2001 were $215,223 and $226,033, respectively and such amounts were recorded as
a tax benefit in the statements of operations. The State renews the Program
annually and limits the aggregate proceeds to $10,000,000. We cannot be certain
if we will be able to sell any of our remaining or future carryforwards under
the Program.
Emerging Issues Task Force Issue No. 98-5, Accounting for Convertible Securities
with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios, require 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 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.
Additionally, the discount on the Convertible Debenture of approximately
$800,000 was fully amortized by December 31, 2001.
During 2001, the Company paid $589,819 and issued 182,964 shares of the common
stock of the Company to the investors in the convertible debenture. The payment
of cash and stock were the option chosen by the Company and represent
adjustments to the pricing based upon the Company's stock price during the
adjustment period. Under the terms of the agreements, no further adjustments are
due.
One investor in the September 2000 private placement had an option, in the form
of a warrant, to purchase an additional $2 million of common shares for a period
of one year provided that the future purchase price is greater than the initial
closing price of $3.65 per share. During the third quarter of 2001, the investor
exercised this option and, accordingly, the Company issued 542,299 shares to the
investor. The Private Placement provided certain conditions under which the
number of shares issued for this option could be adjusted and, accordingly, the
Company issued 281,659 shares to the investor in the fourth quarter of 2001 as
an adjustment to the warrant.
On March 4, 2003, the Company raised $4.3 million from the placement of common
stock and warrants. The private placement offering was completed by issuing
5,058,827 shares of common stock at a price of $0.85 per share and approximately
1.1 million warrants at an exercise price of $1.25 per share. Additionally, the
remaining balance of the September 2000 Convertible Debenture offering was
redeemed for cash. The original face amount of $3.5 million was redeemed for
approximately $4.0 million, which included accrued and unpaid interest.
19
Commitments and Long Term Obligations
As of December 31, 2002, we had the following contractual commitments and long
term obligations:
2003 2004 2005 2006 Thereafter Total
---------- -------- ------- ------- ---------- ----------
Operating Leases $ 523,768 $377,736 $81,375 $57,978 $ 12,212 $1,053,069
Convertible debentures,
excluding interest 3,500,000 3,500,000
R&D commitments 190,437 190,437
---------- -------- ------- ------- ---------- ----------
Grand total $4,214,205 $377,736 $81,375 $57,978 $ 12,212 $4,743,506
On March 4, 2003, the Company redeemed two outstanding Convertible Debentures,
with an aggregate original face issue amount of $3.5 million, for approximately
$4.0 million which included accrued and unpaid interest. The Convertible
Debentures were due to mature in June 2003.
The R&D commitments represent scheduled professional fee payments for clinical
services relating to the European Phase III clinical study for dexanabinol. Upon
the completion of certain agreed upon milestones, additional fees will be paid.
The fees that Pharmos is obligated to pay upon the reaching of the agreed upon
milestones is not included in the above table due to uncertainties in timing.
The maximum amount that could be paid is approximately $7.8 million. As of
December 31, 2002, the Company has recorded $4.8 million as an expense and paid
$3.4 million.
The Company has entered into various employment agreements. The terms of these
employment agreements include one-year renewable terms and do not represent long
term commitments of the Company.
Management believes that cash and cash equivalents of $19.6 million and the
total restricted cash balance of $2.3 million as of December 31, 2002, will be
sufficient to support the Company's continuing operations through the first
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.
Item 7a. Quantitative and Qualitative Disclosure About Market Risk
We assessed our vulnerability to certain market risks, including interest rate
risk associated with financial instruments included in cash and cash
equivalents, restricted cash, and convertible debentures. Due to the short-term
nature of the cash and cash equivalent investments, restricted cash, and the
fixed interest rate on the convertible debt, we have determined that the risks
associated with interest rate fluctuations related to these financial
instruments do not pose a material risk to us.
Item 8. Financial Statements and Supplementary Data
The information called for by this Item 8 is included following the "Index to
Financial Statements" contained in this Annual Report on Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
20
PART III
Item 10. Directors and Executive Officers of the Registrant
The directors, officers and key employees of the Company are as follows:
Name Age Position
- ------------------------------------- --- ----------------------------------
Haim Aviv, Ph.D 63 Chairman, Chief Executive Officer,
Chief Scientist and Director
Gad Riesenfeld, Ph.D 59 President, Chief Operating Officer
Robert W. Cook 47 Executive Vice President and
Chief Financial Officer
David Schlachet 57 Director
Mony Ben Dor 57 Director
Georges Anthony Marcel, M.D., Ph.D 62 Director
Elkan R. Gamzu, Ph.D 60 Director
Lawrence F. Marshall, M.D. 59 Director
Haim Aviv, Ph.D., is Chairman, Chief Executive Officer, Chief Scientist and a
Director of the Company. In 1990, he co-founded Pharmos Corporation, a New York
corporation ("Old Pharmos"), which merged into the Company in October 1992 (the
"Merger"). Dr. Aviv also served as Chairman, Chief Executive Officer, Chief
Scientist and a Director of Old Pharmos prior to the Merger. Dr. Aviv was the
co-founder in 1980 of Bio-Technology General Corp. ("BTG"), a publicly-traded
company engaged in the development of products using recombinant DNA, its
General Manager and Chief Scientist from 1980 to 1985, and a Director and Senior
Scientific Consultant until August 1993. Prior to that time, Dr. Aviv was a
professor of molecular biology at the Weizmann Institute of Science. Dr. Aviv is
the principal stockholder of Avitek Ltd. Avitek Ltd. is a stockholder of the
Company. Dr. Aviv is also an officer and/or significant stockholder of several
privately held Israeli biopharmaceutical and venture capital companies. Dr. Aviv
is a member of the Board of Directors of Ben Gurion University at Beer-Sheva,
Israel and Yeda Ltd. at the Weizmann Institute, Rehovot, Israel. Dr. Aviv holds
a Ph.D. degree from the Weizmann Institute of Science.
Gad Riesenfeld, Ph.D., was named President and Secretary in February 1997, and
has served as Chief Operating Officer since March 1995. He served as Executive
Vice President from December 1994 to February 1997, Vice President of Corporate
Development and General Manager of Florida Operations from October 1992 to
December 1994, and was employed by Pharmos from March 1992 until the Merger.
Prior thereto, he was engaged in a variety of Pharmaceutical and Biotechnology
business activities relating to the development and commercialization of
intellectual property, primarily in the pharmaceutical and medical fields. From
March 1990 through May 1991 Dr. Riesenfeld was a Managing Director of Kamapharm
Ltd., a private company specializing in human blood products. Prior thereto,
from May 1986, he was Managing Director of Galisar Ltd., a pharmaceutical
company involved in extracorporeal blood therapy. Dr. Riesenfeld holds a Ph.D.
degree from the Hebrew University of Jerusalem and held a scientist position, as
a post doctorate, at the Cedars Sinai Medical Center in Los Angeles, California.
Robert W. Cook was elected Vice President Finance and Chief Financial Officer of
Pharmos in January 1998 and became Executive Vice President in February 2001.
From May 1995 until his appointment as the Company's Chief Financial Officer, he
was a vice president in GE Capital's commercial finance subsidiary, based in New
York. From 1977 until 1995, Mr. Cook held a variety of corporate finance and
capital markets positions at The Chase Manhattan Bank, both in the U.S. and in
several overseas locations. He was named a managing director of Chase in January
1986. Mr. Cook holds a degree in international finance from The American
University, Washington, D.C.
21
David Schlachet, a Director of the Company from December 1994, served as the
Chairman of Elite Industries Ltd. from July 1997 until June 2000. From January
1996 to June 1997, Mr. Schlachet served as the Vice President of the Strauss
Group and Chief Executive Officer of Strauss Holdings Ltd, one of Israel's
largest privately owned food manufacturers. He was Vice President of Finance and
Administration at the Weizmann Institute of Science in Rehovot, Israel from 1990
to December 1995, and was responsible for the Institute's administration and
financial activities, including personnel, budget and finance, funding,
investments, acquisitions and collaboration with the industrial and business
communities. From 1989 to 1990, Mr. Schlachet was President and Chief Executive
Officer of YEDA Research and Development Co. Ltd., a marketing and licensing
company at the Weizmann Institute of Science. Today Mr. Schlachet serves as
Chairman of Harel Capital Markets (Israeli broker, underwriter and asset
management firm) and as a Director of Israel Discount Bank Ltd., Hapoalim
Capital Markets Ltd, Teldor Ltd. (software and computer company), Proseed Ltd.,
a Venture Capital investment company, Compugen Ltd. and Taya Investment Company
Ltd., and also serves as Managing Partner in Biocom, a V.C. Fund in the field of
Life Science.
Mony Ben Dor, a director of the Company since September 1997, has been managing
partner of Biocom, a V.C Fund in the field of Life Science since April 2000.
Prior to that he was Vice President of the Israel Corporation Ltd. from May
1997, and Chairman of two publicly traded subsidiaries: H.L. Finance and Leasing
and Albany Bonded International Trade. He was also a Director of a number of
subsidiary companies such as Israel Chemicals Ltd., Zim Shipping Lines, and
Tower Semi Conductors. From 1992-1997 Mr. Ben Dor was Vice President of Business
Development for Clal Industries Limited, which is one of the leading investment
groups in Israel. He was actively involved in the acquisition of companies
including a portfolio of pharmaceutical companies Pharmaceutical Resources Inc.,
Finetech Ltd., BioDar Ltd., to name a few. He served as a director representing
Clal Industries in all of the acquired companies as well as other companies of
Clal Industries. Prior to his position at Clal Industries, Mr. Ben Dor served as
Business Executive at the Eisenberg Group of companies.
Georges Anthony Marcel, M.D., Ph.D., a Director of the Company since September
1998, is President and Chairman of TMC Development S.A., a biopharmaceutical
consulting firm based in Paris, France. Prior to founding TMC Development in
1992, Dr. Marcel held a number of senior executive positions in the
pharmaceutical industry, including Chief Executive Officer of Amgen's French
subsidiary, Vice President of Marketing for Rhone-Poulenc Sante and Director of
Development for Roussel-Uclaf. Dr. Marcel is a member of the Board of Directors
of Hybridon, Inc., and of the Scientific Advisory Board of the Swiss Corporation
TECAN Ltd. Dr. Marcel teaches biotechnology industrial issues and European
regulatory affairs at the Faculties of Pharmacy of Paris and Lille as well as at
Versailles Law School. Dr. Marcel is also a member of the Gene Therapy Advisory
Committee at the French Medicines Agency.
Elkan R. Gamzu, Ph.D., a Director of the Company since February 2000, is a
consultant to the biotechnology and pharmaceutical industries and a Principal of
the due diligence company BioPharmAnanlysis, LLC. Prior to becoming a
consultant, Dr. Gamzu held a number of senior executive positions in the
biotechnology and pharmaceutical industries, including President and Chief
Executive Officer of Cambridge Neuroscience, Inc. from 1994 until 1998. Dr.
Gamzu also served as President and Chief Operating Officer and Vice President of
Development for Cambridge Neuroscience, Inc. from 1989 to 1994. Previously, Dr.
Gamzu held a variety of senior positions with Warner-Lambert and Hoffmann-La
Roche, Inc. In 2001 and 2002, Dr. Gamzu was part-time Interim VP, Development
Product Leadership for Millennium Pharmaceuticals, Inc. Dr. Gamzu is a member of
the Board of Directors of three other biotechnology companies: the publicly
traded XTL Biopharmaceuticals Ltd. and the privately held biotechnology
companies Neurotech S.A. of Paris, France and Hypnion, Inc. of Worcester, MA. He
recently joined the Board of Clal Biotechnology Industries, Ltd., an
Isreal-based Holding Company.
Lawrence F. Marshall, M.D., a Director of the Company since June 2002, an
internationally recognized neurosurgeon and opinion leader in the field, is
currently Professor and Chair of the Division of Neurological Surgery at the
University of California, San Diego Medical Center. Dr. Marshall's 30-year
career as a scientist and neurosurgeon has been at the forefront in the search
for new and better treatment measures to improve patient outcome. He has been
principal investigator or co-investigator in over two dozen preclinical and
22
clinical trials primarily relating to head and spinal cord injury, including
projects funded by the National Institutes of Health, the Insurance Institute
for Highway Safety, and several large pharmaceutical companies. Results of
research undertaken by Dr. Marshall, which cover a wide range of issues related
to TBI and other conditions of the brain, have been published in dozens of
scientific journals. Among the numerous board, committee, editorial and other
positions Dr. Marshall has held or holds are board and committee memberships
with the American Brain Injury Consortium, the National Head Injury Foundation,
the American Association of Neurological Surgeons and the Congress of
Neurological Surgeons. Dr. Marshall is the recipient of many distinguished
medical prizes and awards.
Section 16 Filings
No person who, during the fiscal year ended December 31, 2002, was a director,
officer or beneficial owner of more than ten percent of the Company's Common
Stock which is the only class of securities of the Company registered under
Section 12 of the Securities Exchange Act of 1934 (the "Act"), a "Reporting
Person" failed to file on a timely basis, reports required by Section 16 of the
Act during the most recent fiscal year. The foregoing is based solely upon a
review by the Company of Forms 3 and 4 during the most recent fiscal year as
furnished to the Company under Rule 16a-3(d) under the Act, and Forms 5 and
amendments thereto furnished to the Company with respect to its most recent
fiscal year, and any representation received by the Company from any reporting
person that no Form 5 is required.
Item 11. Executive Compensation
The following table summarizes the total compensation of the Chief Executive
Officer of the Company for 2002 and the two previous years, as well as all other
executive officers of the Company who received compensation in excess of
$100,000 for 2002.
Annual
Compensation Long Term Compensation
--------------- -----------------------
Stock
Name/ Restricted Underlying
Principal Position Year Salary Bonus Other Stock Options
- --------------------------- ---- -------- -------- ------- ---------- ----------
Haim Aviv, Ph.D
Chairman, Chief 2002 $289,459 $100,000 $19,833(1) 150,000
Executive Officer, and 2001 $268,000 $ 80,000 $ 2,844 100,000
Chief Scientist 2000 $244,662 $ 74,044 $ 2,925 100,000
Gad Riesenfeld, Ph.D
President and 2002 $255,157 $ 80,000 $74,924(2) 100,000
Chief Operating Officer 2001 $209,790 $ 42,000 $56,556(2) 50,000
2000 $194,250 $ 20,000 $71,125(2) 60,000
Robert W. Cook
Executive Vice President 2002 $222,264 $ 75,000 $15,338(1) 80,000
and Chief Financial Officer 2001 $198,450 $ 40,000 $15,338(1) 40,000
2000 $183,750 $ 40,000 $ 4,800(1) 45,000
(1) Consists of contributions to insurance premiums and car allowance.
(2) Consists of housing allowance, contributions to insurance premiums, car
allowance and car expense.
The following tables set forth information with respect to the named executive
officers concerning the grant and exercise of options during the last fiscal
year and unexercised options held as of the end of the fiscal year.
23
Option Grants for the Year Ended December 31, 2002
Common
Stock % of Total
Underlying Options Exercise
options Granted to Price per
Granted Employees Share Expiration Date
---------- ---------- --------- ---------------
Haim Aviv, Ph.D 150,000 20.9% $1.90 March 5, 2012
Gad Riesenfeld, Ph.D 100,000 13.9% $1.90 March 5, 2012
Robert W. Cook 80,000 11.2% $1.90 March 5, 2012
Aggregated Option Exercises for the Year Ended December 31, 2002 and Option
Values as of December 31, 2002:
Value of Unexercised
Number of Number of Unexercised In-the-Money Options
Shares Options at December 31, 2002 at December 31, 2002
Acquired on Value ---------------------------- ---------------------------
Name Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
- -------------------- ----------- -------- ----------- ------------- ----------- -------------
Haim Aviv, Ph.D 0 0 423,126 291,250 $0 $0
Gad Riesenfeld, Ph.D 0 0 239,333 180,000 $0 $0
Robert W. Cook 0 0 162,500 142,500 $0 $0
Stock Option Plans
It is currently the Company's policy that all full time key employees are
considered annually for the possible grant of stock options, depending upon
employee performance. The criteria for the awards are experience, uniqueness of
contribution to the Company and level of performance shown during the year.
Stock options are intended to generate greater loyalty to the Company and help
make each employee aware of the importance of the business success of the
Company.
As of December 31, 2002, the Company had 3,095,205 options to purchase shares of
the Company's Common Stock outstanding under various option plans, 523,942 of
which are non-qualified options. During 2002, the Company granted 872,000
options to purchase shares of its Common Stock to employees, and directors, of
which 180,000 are non-qualified options.
A summary of the various established stock option plans is as follows:
1992 Plan. The maximum number of shares of the Company's Common Stock available
for issuance under the 1992 Plan is 750,000 shares, subject to adjustment in the
event of stock splits, stock dividends, mergers, consolidations and the like.
Common Stock subject to options granted under the 1992 Plan that expire or
terminate would again be available for options to be issued under the 1992 Plan.
As of December 31, 2002, there were 285,086 options outstanding to purchase the
Company's Common Stock under this plan. Each option granted which is outstanding
under the 1992 plan as of December 31, 2002 expires on October 31, 2005.
1997 Plan and 2000 Plan. The 1997 Plan and the 2000 Plan are each administered
by a committee appointed by the Board of Directors (the "Compensation
Committee"). The Compensation Committee will designate the persons to receive
options, the number of shares subject to the options and the terms of the
options, including the option price and the duration of each option, subject to
certain limitations.
The maximum number of shares of Common Stock available for issuance under the
1997 Plan is 1,500,000 shares, as amended, and under the 2000 Plan is 3,500,000
shares. Each plan is subject to adjustment in the event of stock splits, stock
dividends, mergers, consolidations and the like. Common Stock subject to options
granted under the 1997 Plan and the 2000 Plan that expire or terminate will
again be available for options to be issued under each Plan.
24
The price at which shares of Common Stock may be purchased upon exercise of an
incentive stock option must be at least 100% of the fair market value of Common
Stock on the date the option is granted (or at least 110% of fair market value
in the case of a person holding more than 10% of the outstanding shares of
Common Stock (a "10% Stockholder")).
The aggregate fair market value (determined at the time the option is granted)
of Common Stock with respect to which incentive stock options are exercisable
for the first time in any calendar year by an optionee under the 1997 Plan, the
2000 Plan or any other plan of the Company or a subsidiary, shall not exceed
$100,000. The Compensation Committee will fix the time or times when, and the
extent to which, an option is exercisable, provided that no option will be
exercisable earlier than one year or later than ten years after the date of
grant (or five years in the case of a 10% Stockholder). The option price is
payable in cash or by check. However, the Board of Directors may grant a loan to
an employee, pursuant to the loan provision of the 1997 Plan or the 2000 Plan,
for the purpose of exercising an option or may permit the option price to be
paid in shares of Common Stock at the then current fair market value, as defined
in the 1997 Plan or the 2000 Plan.
Under the 1997 Plan, upon termination of an optionee's employment or
consultancy, all options held by such optionee will terminate, except that any
option that was exercisable on the date employment or consultancy terminated
may, to the extent then exercisable, be exercised within three months thereafter
(or one year thereafter if the termination is the result of permanent and total
disability of the holder), and except such three month period may be extended by
the Compensation Committee in its discretion. If an optionee dies while he is an
employee or a consultant or during such three-month period, the option may be
exercised within one year after death by the decedent's estate or his legatees
or distributees, but only to the extent exercisable at the time of death. The
2000 Plan provides that the Compensation Committee may in its discretion
determine when any particular stock option shall expire. A stock option
agreement may provide for expiration prior to the end of its term in the event
of the termination of the optionee's service to the Company or death or any
other circumstances.
The 1997 Plan and the 2000 Plan each provides that outstanding options shall
vest and become immediately exercisable in the event of a "sale" of the Company,
including (i) the sale of more than 75% of the voting power of the Company in a
single transaction or a series of transactions, (ii) the sale of substantially
all assets of the Company, (iii) approval by the stockholders of a
reorganization, merger or consolidation, as a result of which the stockholders
of the Company will own less than 50% of the voting power of the reorganized,
merged or consolidated company.
The Board of Directors may amend, suspend or discontinue the 1997 Plan, but it
must obtain stockholder approval to (i) increase the number of shares subject to
the 1997 Plan, (ii) change the designation of the class of persons eligible to
receive options, (iii) decrease the price at which options may be granted,
except that the Board may, without stockholder approval accept the surrender of
outstanding options and authorize the granting of new options in substitution
therefore specifying a lower exercise price that is not less than the fair
market value of Common Stock on the date the new option is granted, (iv) remove
the administration of the 1997 Plan from the Compensation Committee, (v) render
any member of the Compensation Committee eligible to receive an option under the
1997 Plan while serving thereon, or (vi) amend the 1997 Plan in such a manner
that options issued under it intend to be incentive stock options, fail to meet
the requirements of Incentive Stock Options as defined in Section 422 of the
Code.
The Board of Directors may amend, suspend or discontinue the 2000 Plan, but it
must obtain stockholder approval to (i) increase the number of shares subject to
the 2000 Plan or (ii) change the designation of the class of persons eligible to
receive options.
In February 2003, the 2000 Plan was amended by the Board of Directors to provide
that options to be granted to those employees of Pharmos or its subsidiary
Pharmos Ltd. who are residents of Israel will be issued to a trustee for their
benefit instead of to them directly. This amendment is to afford recipients more
favorable tax
25
treatment under the laws of the State of Israel. Since this change is not
material to the Plan, stockholder approval is not required.
Under current federal income tax law, the grant of incentive stock options under
the 1997 Plan or the 2000 Plan will not result in any taxable income to the
optionee or any deduction for the Company at the time the options are granted.
The optionee recognizes no gain upon the exercise of an option. However the
amount by which the fair market value of Common Stock at the time the option is
exercised exceeds the option price is an "item of tax preference" of the
optionee, which may cause the optionee to be subject to the alternative minimum
tax. If the optionee holds the shares of Common Stock received on exercise of
the option at least one year from the date of exercise and two years from the
date of grant, he will be taxed at the time of sale at long-term capital gains
rates, if any, on the amount by which the proceeds of the sale exceed the option
price. If the optionee disposes of the Common Stock before the required holding
period is satisfied, ordinary income will generally be recognized in an amount
equal to the excess of the fair market value of the shares of Common Stock at
the date of exercise over the option price, or, if the disposition is a taxable
sale or exchange, the amount of gain realized on such sale or exchange if that
is less. If, as permitted by the 1997 Plan or the 2000 Plan, the Board of
Directors permits an optionee to exercise an option by delivering already owned
shares of Common Stock valued at fair market value) the optionee will not
recognize gain as a result of the payment of the option price with such already
owned shares. However, if such shares were acquired pursuant to the previous
exercise of an option, and were held less than one year after acquisition or
less than two years from the date of grant, the exchange will constitute a
disqualifying disposition resulting in immediate taxation of the gain on the
already owned shares as ordinary income. It is not clear how the gain will be
computed on the disposition of shares acquired by payment with already owned
shares.
2001 Employee Stock Purchase Plan. The 2001 Plan is intended to qualify as an
employee stock purchase plan under Section 423 of the Code. All employees of the
Company, its Pharmos Ltd. subsidiary or any other subsidiaries or affiliated
entities who have completed 180 consecutive days of employment and who
customarily work at least 20 hours per week will be eligible to participate in
the 2001 Plan, except for any employee who owns five percent or more of the
total combined voting power or value of all classes of stock of the Company or
any subsidiary on the date a grant of a right to purchase shares under the 2001
Plan (Right) is made. There currently are no such employees with such large
holdings. Participation by officers in the 2001 Plan will be on the same basis
as that of any other employee. No employee will be granted a Right which permits
such employee to purchase shares under the 2001 Plan at a rate which exceeds
$25,000 of fair market value of such shares (determined at the time such Right
is granted) for each calendar year in which such Right is outstanding. Each
Right will expire if not exercised by the date specified in the grant, which
date will not exceed 27 months from the date of the grant. Rights will not be
assignable or transferable by a participating employee, other than in accordance
with certain qualified domestic relations orders, as defined in the Code, or by
will or the laws of descent and distribution.
The total number of shares reserved for issuance under the 2001 Plan is 500,000
shares. Under the 2001 Plan, for any given calendar year, a participating
employee can only be granted Rights to purchase that number of shares which,
when multiplied by the exercise price of the Rights, does not exceed more than
10% of the employee's base pay. The Company contemplates that payroll deductions
generally will be used by participating employees to acquire the shares covered
by their Rights. As of December 31, 2002, the Company issued 23,384 shares of
its common stock through the 2001 Plan.
From time to time, the Board of Directors may fix a date or a series of dates on
which the Company will grant Rights to purchase shares of Common Stock under the
2001 Plan at prices not less than 85% of the lesser of (i) the fair market value
of the shares on the date of grant of such Right or (ii) the fair market value
of the shares on the date such Right is exercised.
The 2001 Plan also provides that any shares of Common Stock purchased upon the
exercise of Rights cannot be sold for at least six months following exercise, to
avoid potential violations of the "short swing" trading provisions of Section 16
of the Securities Exchange Act of 1934, as amended.
26
The Board of Directors or a committee to which it delegates its authority under
the 2001 Plan will administer, interpret and apply all provisions of the 2001
Plan. The Board has delegated such authority to the Compensation and Stock
Option Committee.
The Board of Directors may amend, modify or terminate the 2001 Plan at any time
without notice, provided that no such amendment, modification or termination may
adversely affect any existing Rights of any participating employee, except that
in the case of a participating employee of a foreign subsidiary of the Company,
the 2001 Plan may be varied to conform with local laws. In addition, subject to
certain appropriate adjustments to give effect to relevant changes in the
Company's capital stock, no amendments to the 2001 Plan may be made without
stockholder approval if such amendment would increase the total number of shares
offered under the 2001 Plan or would render Rights "unqualified" for special tax
treatment under the Code.
No taxable income will be recognized by a participant either at the time a Right
is granted under the 2001 Plan or at the time the shares are purchased. Instead,
tax consequences are generally deferred until a participant disposes of the
shares (e.g., by sale or gift). The federal income tax consequences of a sale of
shares purchased under the 2001 Plan will depend on the length of time the
shares are held after the relevant date of grant and date of exercise, as
described below.
If shares purchased under the 2001 Plan are held for more than one year after
the date of purchase and more than two years from the date of grant, the
participant generally will have taxable ordinary income on a sale or gift of the
shares to the extent of the lesser of: (i) the amount (if any) by which the fair
market value of the stock at the date of grant exceeds the exercise price paid
by the participant; or (ii) the amount by which the fair market value of the
shares on the date of sale or gift exceeds the exercise price paid by the
participant for the shares. In the case of a sale, any additional gain will be
treated as long-term capital gain. If the shares are sold for less than the
purchase price, there will be no ordinary income, and the participant will have
a long-term capital loss for the difference between the purchase price and the
sale price.
If the stock is sold or gifted within either one year after the date of purchase
or two years after the date of grant (a "disqualifying disposition"), the
participant generally will have taxable ordinary income at the time of the sale
or gift to the extent that the fair market value of the stock at the date of
exercise was greater than the exercise price. This amount will be taxable in the
year of sale or disposition even if no gain is realized on the sale, and the
Company would be entitled to a corresponding deduction. A capital gain would be
realized upon the sale of the shares to the extent the sale proceeds exceed the
fair market value of those shares on the date of purchase. A capital loss would
be realized to the extent the sales price of the shares disposed of is less than
the fair market value of such shares on the date of purchase. Special tax
consequences may follow from dispositions other than a sale or gift.
1997 Employees and Directors Warrants Plan
The 1997 Employees and Directors Warrants Plan was approved by the Stock Option
Committee as of February 12, 1997 and March 19, 1997. 1,030,000 Warrants to
purchase 1,030,000 shares of Common Stock were granted to certain employees of
the Company. Of such warrants, 955,000 were granted at an exercise price of
$1.59 per share and 75,000 were granted and an exercise price of $1.66 per share
(together, the "1997 Employees Warrants"). The 1997 Employees Warrants become
exercisable in increments of 25% each on their first, second, third and fourth
anniversaries, respectively, and shall expire in the year 2007. 100,000 Warrants
to purchase 100,000 shares of Common Stock were granted to directors of the
Company at an exercise price of $1.59 per share (the "1997 Directors Warrants")
on February 12, 1997. The 1997 Directors Warrants become exercisable in
increments of 25% each on the first, second, third and fourth anniversaries of
February 12, 1997 and shall expire on February 12, 2007. At December 31, 2002,
there were 481,500 1997 Employees Warrants at $1.59, no 1997 Employees Warrants
at $1.66 and 5,000 1997 Directors Warrants at $1.59 outstanding.
Upon termination of a Warrant Holder's employment, consultancy or affiliation
with the Company, all Warrants held by such Warrant Holder will terminate,
except that any Warrant that was exercisable on the
27
date which the employment, consultancy or affiliation terminated may, to the
extent then exercisable, be exercised within three months thereafter (or one
year thereafter if the termination is the result of permanent and total
disability of the holder). If a Warrant Holder dies while he or she is an
employee, consultant or affiliate of the Company, or during such three month
period, the Warrant may be exercised within one year after death by the
decedent's estate or his legatees or distributees, but only to the extent
exercisable at the time of death.
Employment/Consulting Contracts/Directors' Compensation
Haim Aviv, Ph.D. In April 2001, the Compensation and Stock Option Committee of
the Board of Directors recommended, and the Board approved, a one-year
employment/consulting agreement for Dr. Aviv, as Chairman of the Board and Chief
Executive Officer of the Company. Dr. Aviv has agreed to devote a majority of
his business time to the Company and to Pharmos Ltd. The agreement provides for
automatic one year renewals unless either the Company terminates the agreement
at least 180 days prior to the scheduled expiration date during for the initial
one year term (and 90 days for subsequent terms) or Dr. Aviv terminates the
agreement at least 60 days prior to the scheduled expiration date. Dr. Aviv's
base compensation for 2002 and for 2003 was $281,400, to be allocated between
the Company and Pharmos Ltd. The Company also agreed to make available for Dr.
Aviv's benefit following his death, termination of employment for disability or
retirement at the age of at least 62 an amount equal to the cost of insurance
premiums the Company would otherwise have incurred to obtain and maintain a
"split-dollar" life insurance policy on his life (approximately $10,000 per
year, accruing interest at 8% per year). In addition, the Company agreed to pay,
in lieu of contributing to other benefits plans on his behalf, an amount equal
to an aggregate of approximately 21% of his base compensation toward the
"Management Insurance Scheme" managed by the government of Israel for members of
management of Israeli companies.
Dr. Aviv's employment agreement also provides that if his employment is
terminated within one year following a "change of control," he will receive
severance pay of 18 months of base salary for the then-current year, accelerated
vesting of all unvested stock options and extended exercisability of all stock
options until their respective expiration dates. A "change of control" involves
an acquisition of at least 50% of the voting power of the Company's securities,
a change in at least 51% of the composition of the current Board of Directors,
or approval by the Board of Directors or stockholders of the Company of a
transaction where such change of voting control or composition of the Board
would occur, where the Company would be liquidated or where all or substantially
all of its assets would be sold.
If Dr. Aviv's employment is terminated by the Company, after notice, other than
for a change in control, death, disability or for "cause," as defined in his
employment agreement, or if he terminates his employment within one year of a
change in control or otherwise for "good reason," as defined in his employment
agreement, he will receive severance pay of 12 months of base salary for the
then-current year, accelerated vesting of all unvested stock options and
extended exercisability of all stock options until their respective expiration
dates. The employment agreement also contains customary confidentiality and
non-competition undertakings by Dr. Aviv.
Gad Riesenfeld, Ph.D. In April 2001, the Compensation and Stock Option Committee
of the Board of Directors recommended, and the Board approved, a one year
employment agreement for Dr. Riesenfeld, as full-time President and Chief
Operating Officer of the Company. Dr. Riesenfeld's base compensation for 2002
and for 2003 was $234,965.
The other provisions of Dr. Riesenfeld's employment agreement relating to
benefits, severance arrangements and confidentiality and non-competition
obligations are substantially similar to the those included in Dr. Aviv's
employment agreement, as described above, except that the Company's contribution
to the "Management Insurance Scheme" on Dr. Riesenfeld's behalf is approximately
16%. In addition, the Compensation Committee and the Board of Directors in April
2001 also authorized an amendment to Dr. Riesenfeld's employment agreement to
provide that if the Company hires a new Chief Executive Officer, Dr. Riesenfeld
will be awarded, at the time of commencement of employment, a one-time stock
option grant equal to the highest grant he received during the previous three
years, in addition to his annual stock option
28
awards. In addition, any termination by the Company within 12 months after such
commencement of employment will require 180 days' prior written notice to Dr.
Riesenfeld and will entitle him to severance pay equal to 12 months of base
salary. In such circumstances, any resignation by Dr. Riesenfeld within 12
months thereafter other than for "good reason" (as defined in his employment
agreement) will require 90 days' prior written notice by Dr. Riesenfeld and will
entitle him to 12 months of base salary. The amendment to his employment
agreement also provides that Dr. Riesenfeld will act as an unpaid consultant to
the Company for a one year period following any such termination or resignation.
Robert W. Cook. In April 2001, the Compensation and Stock Option Committee of
the Board of Directors recommended, and the Board approved, a one year
employment agreement for Mr. Cook, as full-time Vice President Finance and Chief
Operating Officer of the Company. Mr. Cook's base compensation for 2002 and for
2003 was $222,264.
The other provisions of Mr. Cook's employment agreement relating to benefits,
severance arrangements and confidentiality and non-competition obligations are
substantially similar to the those included in Dr. Aviv's employment agreement,
as described above, except that Mr. Cook does not participate in the "Management
Insurance Scheme" of the Company's Israeli subsidiary, and that in lieu of
investing life insurance premiums for his benefit, the Company has actually
obtained a $500,000 "split-dollar" life insurance policy for the benefit of Mr.
Cook.
Elkan R. Gamzu, Ph.D. In January 2000, the Company entered into a consulting
agreement with Dr. Gamzu with a term of one year (subject to extension by
written agreement of the Company and Dr. Gamzu), pursuant to which Dr. Gamzu may
provide certain assistance and consulting services to the Company as and when
needed. The agreement provides for compensation on a per diem basis in
connection with the provision of such assistance and consulting services at the
rate of $3,000 per day. In 2002, the Company paid $12,533 to Dr. Gamzu pursuant
to the consulting agreement.
The Company also entered into a consulting agreement with one of our Directors,
Dr. Georges Anthony Marcel, pursuant to which Dr. Marcel may provide certain
assistance and consulting services to the Company as and when needed. In 2002,
the Company paid $38,791 to Dr. Marcel pursuant to the consulting agreement.
Directors' Compensation. In 2001, Directors did not receive any compensation for
service on the Board or for attending Board meetings. In March 2002, the Board
of Directors of the Company adopted a compensation policy with respect to
outside members of the Board. Specifically, the board approved:
Cash Compensation
1) Two payments of $2,500 each per annum, the first due on January 1,
and the second immediately after the earlier of the director's
initial appointment to the board or election by the shareholders;
and
2) $1,000 per each board or committee meeting attended in person or by
conference call; no payment for a committee meeting if it occurs on
the same day as the board meeting.
Stock Compensation
1) An initial grant of 30,000 options, awardable on the earlier of the
director's initial appointment to the board or election by the
shareholders; and
2) 20,000 options annually thereafter, awardable on the earlier of the
date of the director's re-election by the shareholders or the date
on which a general option grant is made by the Company for its key
employees and directors; and
3) Special, one-time awards may be granted for attaining certain
corporate achievements at the recommendation of the Chairman.
Item 12. Security Ownership of Certain Beneficial Owners and Management
29
The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of March 15, 2003, by (i)
each person who was known by the Company to own beneficially more than 5% of any
class of the Company's Common Stock, (ii) each of the Company's Directors, and
(iii) all current Directors and executive officers of the Company as a group.
Except as otherwise noted, each person listed below has sole voting and
dispositive power with respect to the shares listed next to such person's name.
Amount of
Name and Address of Beneficial Percentage of
Beneficial Ownership Ownership Total (1)
- ------------------------------------- ---------- -------------
Haim Aviv, Ph.D. (2) 1,459,758 2.4%
c/o Pharmos Ltd.
Kiryat Weitzman
Rehovot 76326, Israel
David Schlachet (3) 41,250 *
BioCom (Management) Limited
40 Einstein St., Ramat Aviv Tower
Tel-Aviv 69102, Israel
Mony Ben Dor (3) 40,000 *
BioCom (Management) Limited
40 Einstein St., Ramat Aviv Tower
Tel-Aviv 69102, Israel
Georges Anthony Marcel M.D., Ph.D.(3) 33,750 *
TMC Development
9, rue de Mesnil
75116 Paris, France
Elkan R. Gamzu, Ph.D. (3) 32,750 *
enERGetics
199 Wells Avenue, Suite 302
Newton, MA 02459
Lawrence F. Marshall, M.D. (5) 0 *
University of California, San Diego
Regents Court Bldg., Suite 200
4130 LaJolla Village Drive
LaJolla, CA 92037-1480
All Directors and 2,135,741 3.5%
Executive Officers as a group
(8 persons)(4)
- ----------
* Indicates ownership of less than 1%.
(1) Based on 61,619,487 shares of Common Stock outstanding, plus each
individual's currently exercisable warrants or options. Assumes that no
other individual will exercise any warrants and/or options.
(2) Includes 276,153 shares of Common Stock held in the name of Avitek Ltd.,
of which Dr. Aviv is the Chairman of the Board of Directors and the
principal stockholder, and, as such, shares the right to vote and dispose
of such shares. Also includes currently exercisable options and warrants
to purchase 710,626 shares of Common Stock.
(3) Consists of currently exercisable options and warrants to purchase Common
Stock.
(4) Based on the number of shares of Common Stock outstanding, plus 1,348,959
currently exercisable warrants and options held by the Directors and
executive officers.
30
(5) Dr. Marshall was granted 30,000 stock options upon his appointment to the
Board of Directors on May 21, 2002. According to the terms of the options,
7,500 options will vest on May 21, 2003.
Item 13. Certain Relationships and Related Transactions
In January 2000, the Company entered into a consulting agreement with one of our
Directors, Dr. Elkan Gamzu, for a term of one year (subject to extension by
written agreement of the Company and Dr. Gamzu), pursuant to which Dr. Gamzu may
provide certain assistance and consulting services to the Company as and when
needed. The agreement provides for compensation on a per diem basis in
connection with the provision of such assistance and consulting services at the
rate of $3,000 per day. In 2002, the Company paid $12,533 to Dr. Gamzu pursuant
to the consulting agreement.
The Company also entered into a consulting agreement with one of our Directors,
Dr. Georges Anthony Marcel, pursuant to which Dr. Marcel may provide certain
assistance and consulting services to the Company as and when needed. In 2002,
the Company paid $38,791 to Dr. Marcel pursuant to the consulting agreement.
In December 2001, the Company's Pharmos Ltd. subsidiary renewed a License
Agreement with Herbamed, Ltd., a company controlled by Dr. Haim Aviv, the
Company's Chairman and Chief Executive Officer. The License Agreement,
originally entered into in May 1997, licenses to Herbamed the Company's patent
rights for the oral delivery of lipophilic substances in the limited field of
nutraceuticals, which include food and dietary supplements, food additives,
vitamins and herbs. Under the terms of the revised License Agreement, Herbamed
will pay to Pharmos Ltd. royalties of 6% on net sales of up to $20 million, 5%
on net sales between $20 million and $50 million and 4% on net sales in excess
of $50 million. There have been no sales to date and accordingly Herbamed has
made no payments to Pharmos Ltd.
Neither the Company nor its Pharmos Ltd. subsidiary is involved in the field of
nutraceuticals generally, and specifically in developing improved oral delivery
of nutraceuticals. Pharmos Ltd., therefore, licensed its technology in this
narrow non-pharmaceutical field of use to Dr. Aviv's company as a way of seeking
to benefit from a potential stream of royalty payments without having to devote
any resources to the development of an application it otherwise would not have
pursued. In addition, if the technology proves to be successful for the delivery
of nutraceuticals, Pharmos hopes that it could be able to interest potential
strategic partners in licensing the technology for pharmaceuticals applications.
Dr. Aviv was not involved with either party in negotiating the terms of the
License Agreement with Herbamed. Pharmos Ltd. concluded that the royalty rates
and other terms of the License Agreement are commercially reasonable to it, and
the License Agreement was recently ratified by the Board of the Company.
Item 14. Controls and Procedures
Within the 90-day period prior to the filing of this report, Pharmos management,
including the Chief Executive Officer and Chief Financial Officer, conducted an
evaluation of the effectiveness of the design and operation of the company's
disclosure controls and procedures as defined in Exchange Act Rule 13a-14(c).
Based on that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that the company's disclosure controls and procedures were
effective as of the date of that evaluation. There have been no significant
changes in internal controls, or in factors that could significantly affect
internal controls, subsequent to the date the Chief Executive Officer and Chief
Financial Officer completed their evaluation.
31
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Financial Statements and Exhibits
(1) FINANCIAL STATEMENTS
Report of Independent Accountants
Consolidated Balance Sheets at December 31, 2002 and 2001
Consolidated Statements of Operations for the years ended December 31,
2002, 2001 and 2000
Consolidated Statements of Changes in Shareholders' Equity for the years
ended December 31, 2002, 2001 and 2000
Consolidated Statements of Cash Flows for the years ended December 31,
2002, 2001 and 2000
Notes to Consolidated Financial Statements
(2) FINANCIAL STATEMENT SCHEDULES
All financial statement schedules are omitted because they are not
applicable or the required information is shown in the financial
statements or note thereto.
(3) EXHIBITS
3 Articles of Incorporation and By-Laws
3(a) Restated Articles of Incorporation (Incorporated by reference
to Appendix E to the Joint Proxy Statement/Prospectus included
in the Form S-4 Registration Statement of the Company dated
September 28, 1992 (No. 33-52398) (the "Joint Proxy
Statement/Prospectus").
3(b) Certificate of Amendment of Restated Articles of Incorporation
dated January 30, 1995 (Incorporated by reference to Annual
Report on Form 10-K for the year ended December 31, 1994).
3(c) Certificate of Amendment of Restated Articles of Incorporation
dated January 16, 1998 (Incorporated by reference to the
Company's Current Report on Form 8-K, dated February 6, 1998).
3(d) Certificate of Amendment of Restated Articles of Incorporation
dated October 21, 1999 (Incorporated by reference to Form S-3
Registration Statement of the Company dated September 28, 2000
(No. 333-46818).
3(e) Certificate of Amendment of Restated Articles of Incorporation
dated July 12, 2002 (Incorporated by reference to Exhibit 3 to
the Company's Report on Form 10-Q for the quarter ended June
30, 2002)
3(f) Amended and Restated By-Laws (Incorporated by reference to
Exhibit 99.4 to the Company's Current Report on Form 8-K filed
on October 24, 2002.
32
4 Instruments defining the rights of security holders, including indentures
4(a) Form of Employee Warrant Agreement, dated April 11, 1995,
between the Company and Oculon Corporation (Incorporated by
reference to the Company's Current Report on Form 8-K, dated
April 11, 1995, as amended).
4(b) Form of Warrant Agreement dated as of April 30, 1995 between
the Company and Charles Stolper (Incorporated by reference to
Form S-3 Registration Statement of the Company dated November
14, 1995, as amended [No. 33-64289]).
4(c) Form of Stock Purchase Warrant dated as of September 30, 1996
between the Company and Alan M. Mark (Incorporated by
reference to Form S-3 Registration Statement of the Company
dated December 20, 1996, as amended [No. 333-15165]).
4(d) Stock Purchase Agreement, dated December 12, 1996, between the
Company and Bausch & Lomb Pharmaceuticals, Inc. (Incorporated
by reference to Annual Report on Form 10-K dated March 29,
1997).
4(e) Form of Stock Purchase Warrant dated as of March 31, 1997
between the Company and the Investor (Incorporated by
reference to Form S-3 Registration Statement of the Company
dated March 5, 1998 [No. 333-47359]).
4(f) Purchase Agreement between the Company, Millennium Partners
LP, Strong River Investments Inc. and St. Albans Partners
Ltd., dated as of September 1, 2000 (Incorporated by reference
to Exhibit 4.1 to the Company's Current Report on Form 8-K
filed on September 11, 2000).
4(g) Form of 6% convertible debenture due February 28, 2002
(Incorporated by reference to Exhibit 4.2 to the Company's
Current Report on Form 8-K filed on September 11, 2000).
4(h) Registration Rights Agreement between the Company, Millennium
Partners LP, Strong River Investments Inc. and St. Albans
Partners Ltd., dated as of September 1, 2000 (Incorporated by
reference to Exhibit 4.3 to the Company's Current Report on
Form 8-K filed on September 11, 2000).
4(i) Form of Common Stock Purchase Warrant exercisable until
September 1, 2005 (Incorporated by reference to Exhibit 4.4 to
the Company's Current Report on Form 8-K filed on September
11, 2000).
4(j) Escrow Agreement between the company, Millennium Partners LP,
Strong River Investments Inc., St. Albans Partners Ltd. and
Kleinberg Kaplan Wolff & Cohen PC, dated as of September 1,
2000 (Incorporated by reference to Exhibit 4.5 to the
Company's Current Report on Form 8-K filed on September 11,
2000).
4(k) Common Stock Investment Agreement between the Company,
Millennium Partners LP, Strong River Investments Inc. and
Laterman & Co. LP, dated as of September 1, 2000 (Incorporated
by reference to Exhibit 4.6 to the Company's Current Report on
Form 8-K filed on September 11, 2000).
4(l) Registration Rights Agreement between the Company, Millennium
Partners LP, Strong River Investments Inc. and Laterman & Co.
LP, dated as of September 1, 2000 (Incorporated by reference
to Exhibit 4.7 to the Company's Current Report on Form 8-K
filed on September 11, 2000).
4(m) Form of placement agent warrant with Ladenburg Thalmann & Co.
Inc. (Incorporated by reference to Form S-3 Registration
Statement of the Company dated September 28, 2000 (No.
333-46818).
4(n) Form of placement agent warrant with SmallCaps OnLine LLC
(Incorporated by reference to Form S-3 Registration Statement
of the Company dated September 28, 2000 (No. 333-46818).
4(o) Form of consulting warrant with SmallCaps OnLine LLC
(Incorporated by reference to Form S-3 Registration Statement
of the Company dated September 28, 2000 (No. 333-46818).
33
4(p) Form of 6% convertible debenture due June 30, 2003 with $2.15
exercise price (Incorporated by reference to Exhibit 4.2 to
the Company's Current Report on Form 8-K filed on January 4,
2002).
4(q) Form of 6% convertible debenture due June 30, 2003 with $2.63
exercise price (Incorporated by reference to Exhibit 4.3 to
the Company's Current Report on Form 8-K filed on January 4,
2002).
4(r) Certificate of Designation, Rights Preferences and Privileges
of Series D Preferred Stock of the Company (Incorporated by
reference to Exhibit 99.3 to the Company's Current Report on
Form 8-K filed on October 24, 2002).
4(s) Rights Agreement dated as of October 23, 2002 between the
Company and American Stock Transfer & Trust Company, as Rights
Agent (Incorporated by reference to Exhibit 99.2 to the
Company's Current Report on Form 8-K filed on October 24,
2002).
4(t) Form of Senior Indenture (Incorporated by reference to Exhibit
4(a) to Amendment No. 1 to the Form S-3 Registration Statement
of the Company filed November 27, 2002 (No.333-82046).
4(u) Form of Subordinated Indenture (Incorporated by reference to
Exhibit 4(b) to Amendment No. 1 to the Form S-3 Registration
Statement of the Company filed November 27, 2002
(No.333-82046).
4(v) Form of Investor Warrant dated March 4, 2003 (Incorporated by
reference to Exhibit 99.2 to the Company's Current Report on
Form 8-K filed on March 4, 2003).
4(x) Form of Placement Agent's Warrant dated March 4, 2003
(Incorporated by reference to Exhibit 99.1 to the Company's
Current Report on Form 8-K filed on March 4, 2003).
10 Material Contracts
10(a) Agreement between Avitek Ltd. ("Avitek") and Yissum Research
Development Company of the Hebrew University of Jerusalem
("Yissum") dated November 20, 1986 (Incorporated by reference
to Annual Report on Form 10-K, as amended by Form10-K/A, for
year ended December 31, 1992). (1)
10(a)(1) Supplement to Agreement (Incorporated by reference to Annual
Report on Form 10-K, as amended by Form 10-K/A, for year ended
December 31, 1992). (1)
10(a)(2) Hebrew language original executed version of Agreement
(Incorporated by reference to Annual Report on Form 10-K, as
amended by Form 10-K/A, for year ended December 31, 1992). (1)
10(b) Agreement between Avitek and Yissum dated January 25, 1987
(Incorporated by reference to Annual Report on Form 10-K, as
amended by Form 10-K/A, for year ended December 31, 1992). (1)
10(b)(1) Schedules and Appendixes to Agreement (Incorporated by
reference to Annual Report on Form 10-K, as amended by Form
10-K/A, for year ended December 31, 1992). (1)
10(b)(2) Hebrew language original executed version of Agreement
(Incorporated by reference to Annual Report on Form 10-K, as
amended by Form 10-K/A, for year ended December 31, 1992). (1)
10(c) Research, Development and License Agreement between Pharmos
Ltd., Pharmos Corporation ("Old Pharmos") and Yissum dated
February 5, 1991 (Incorporated by reference to Annual Report
on Form 10-K, as amended by Form 10-K/A, for year ended
December 31, 1992). (1)
10(c)(1) Schedules and Appendixes to Agreement (Incorporated by
reference to Annual Report on Form 10-K, as amended by Form
10-K/A, for year ended December 31, 1992). (1)
10(d) 1992 Incentive and Non-Qualified Stock Option Plan (Annexed as
Appendix F to the Joint Proxy Statement/Prospectus). **
34
10(e) 1997 Incentive and Non-Qualified Stock Option Plan (Annexed as
Appendix B to the Proxy Statement on Form 14A filed November
5, 1997). **
10(f) Agreement dated as of January 21, 2000 between the Company and
Dr. Elkan R. Gamzu (Incorporated by reference to Exhibit 10(n)
to the Company's Annual Report for the fiscal year ended
December 31, 2000).**
10(g) Employment Agreement dated as of April 2, 2001, between
Pharmos Corporation and Haim Aviv.**
10(h) Employment Agreement dated as of April 2, 2001, between
Pharmos Corporation and Gad Riesenfeld.**
10(i) Amendment of Employment Agreement dated as of April 23, 2001,
between Pharmos Corporation and Gad Riesenfeld.**
10(j) Employment Agreement dated as of April 2, 2001, between
Pharmos Corporation and Robert W. Cook.**
10(k) 2001 Employee Stock Purchase Plan (Incorporated by reference
to Exhibit B to the Company's Definitive Proxy Statement on
Form 14A filed on June 6, 2001).**
10(l) Asset Purchase Agreement between Bausch & Lomb Incorporated
and Pharmos Corporation dated October 9, 2001 (Incorporated by
reference to Exhibit 2.1 to the Company's Current Report on
Form 8-K filed on October 16, 2001).
10(m) License Assignment and Amendment Agreement dated as of October
9, 2001 by and among Dr. Nicholas S. Bodor, Pharmos
Corporation and Bausch & Lomb Incorporated (Incorporated by
reference to Exhibit 2.2 to the Company's Current Report on
Form 8-K filed on October 16, 2001).
10(n) Amendment Agreement between Pharmos Corporation, Millennium
Partners LP and St. Albans Partners Ltd., dated as of December
31, 2001 (Incorporated by reference to Exhibit 4.1 to the
Company's Current Report on Form 8-K filed on January 4,
2002).
10(o) Amendment No. 1 to Asset Purchase Agreement dated as of
December 28, 2001 between Bausch & Lomb Incorporated and
Pharmos Corporation
10(p)*** License Agreement dated as of December 18, 2001 between
Pharmos Ltd. and Herbamed Ltd.
10(q)*** Amended and Restated 2000 Incentive and Non-Qualified Stock
Option Plan.**
10(r) Letter Agreement dated February 28, 2003 between Pharmos
Corporation and Rodman & Renshaw, Inc. (Incorporated by
reference to Exhibit 99.1 to Amendment No. 1 to the Company's
Current Report on Form 8-K filed on March 4, 2003).
10(s)*** Note Purchase Agreement dated February 28, 2003 between
Pharmos Corporation and Millennium Partners LP.
10(t)*** Note Purchase Agreement dated February 28, 2003 between
Pharmos Corporation and St. Albans Partners Ltd.
21 Subsidiaries of the Registrant
21(a) Subsidiaries of the Registrant (Incorporated by reference to
Annual Report on Form 10-K, as amended by Form 10-K/A, for
year ended December 31, 1992).
23 Consents of Experts and Counsel
23(a)*** Consent of PricewaterhouseCoopers LLP
- ----------
(1) Confidential information is omitted and identified by a * and filed
separately with the SEC.
(**) This document is a management contract or compensatory plan or
arrangement.
35
(***) Filed herewith.
(b) Reports on Form 8-K
1. Current Report filed on October 24, 2002 (date of earliest event
reported October 23, 2002); Item 5 was reported.
2. Current Report filed on March 4, 2003 (date of earliest event
reported March 4, 2003); Item 5 was reported.
3. Current Report filed on March 7, 2003 (date of earliest event
reported March 7, 2003); Item 5 was reported.
36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
By: /s/ Haim Aviv
-------------------------------------------------------
Dr. Haim Aviv, Chairman of the Board and Chief
Executive Officer (Principal Executive Officer)
Date: March 31, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Signature Title Date
- -------- ----- -----
/s/ Robert W. Cook Chief Financial Officer March 31, 2003
- ----------------------------------- (Principal Financial and
Robert W. Cook Accounting Officer), and
Secretary
/s/ David Schlachet Director March 31, 2003
- -----------------------------------
David Schlachet
/s/ Mony Ben Dor Director March 31, 2003
- -----------------------------------
Mony Ben Dor
/s/ Georges Anthony Marcel Director March 31, 2003
- -----------------------------------
Georges Anthony Marcel, M.D., Ph.D.
/s/ Elkan R. Gamzu Director March 31, 2003
- -----------------------------------
Elkan R. Gamzu, Ph.D.
/s/ Lawrence F. Marshall Director March 31, 2003
- -----------------------------------
Lawrence F. Marshall, M.D.
37
CERTIFICATE OF CHIEF EXECUTIVE OFFICER
I, Haim Aviv, certify that:
1. I have reviewed this annual report on Form 10-K of Pharmos Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
/s/ HAIM AVIV
- -----------------------
Haim Aviv
Chief Executive Officer
Date: March 31, 2003
38
CERTIFICATE OF CHIEF FINANCIAL OFFICER
I, Robert W. Cook, certify that:
1. I have reviewed this annual report on Form 10-K of Pharmos Corporation;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this annual report is being prepared;
(b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our evaluation
as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
the registrant's board of directors (or persons performing the equivalent
functions):
(a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in this annual
report whether or not there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
/s/ ROBERT W. COOK
- -----------------------
Robert W. Cook
Chief Financial Officer
Date: March 31, 2003
39
Pharmos Corporation
Index to Consolidated Financial Statements
Report of Independent Accountants F-2
Consolidated balance sheets as of December 31, 2002 and 2001 F-3
Consolidated statements of operations for the years ended
December 31, 2002, 2001 and 2000 F-4
Consolidated statements of changes in shareholders' equity
for the years ended December 31, 2002, 2001 and 2000 F-5
Consolidated statements of cash flows for the years ended
December 31, 2002, 2001 and 2000 F-6
Notes to consolidated financial statements F-7
F-1
Report of Independent Accountants
To the Board of Directors and
Shareholders of Pharmos Corporation:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in shareholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Pharmos Corporation and its subsidiary at December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2002 in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
New York, New York
February 7, 2003 (except with respect to the matters discussed in Note 19,
first paragraph as of February 18, 2003 and second paragraph as of March 4,
2003)
F-2
Pharmos Corporation
Consolidated Balance Sheets
December 31,
------------------------------
2002 2001
------------- -------------
Assets
Current assets
Cash and cash equivalents $ 19,579,287 $ 35,269,114
Restricted cash 2,199,999 2,275,251
Other receivables 698,800 690,067
Prepaid expenses and other current assets 323,991 997,695
------------- -------------
Total current assets 22,802,077 39,232,127
Fixed assets, net 1,792,322 1,918,281
Restricted cash 60,000 3,090,550
Other assets 32,283 22,033
------------- -------------
Total assets $ 24,686,682 $ 44,262,991
============= =============
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable $ 3,742,460 $ 2,197,299
Accrued expenses 3,241,581 5,809,642
Accrued wages and other compensation 999,647 1,317,934
Convertible debentures, net 3,446,658 1,949,317
------------- -------------
Total current liabilities 11,430,346 11,274,192
Other liability 10,000 --
Convertible debentures, net -- 5,847,951
------------- -------------
Total liabilities 11,440,346 17,122,143
------------- -------------
Commitments and Contingencies (Note 15)
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, 56,560,660 and 55,356,307 shares
outstanding (excluding $426 (14,189 shares) in
2002, and $551 (18,356 shares) in 2001, held
in Treasury) in 2002 and 2001, respectively 1,696,820 1,660,688
Deferred compensation (119,988) (223,144)
Paid in capital 114,187,558 111,151,758
Accumulated deficit (102,518,054) (85,448,454)
------------- -------------
Total shareholders' equity 13,246,336 27,140,848
------------- -------------
Total liabilities and shareholders' equity $ 24,686,682 $ 44,262,991
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
Pharmos Corporation
Consolidated Statements of Operations
Year Ended December 31,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
Revenues
Product sales -- $ 4,218,441 $ 4,873,504
License fee -- 80,000 225,000
------------ ------------ ------------
Total Revenues -- 4,298,441 5,098,504
Cost of Goods Sold (exclusive of depreciation
and amortization shown below) -- 1,268,589 1,875,955
------------ ------------ ------------
Expenses
Research and development, net $ 12,337,840 9,349,025 5,443,288
Selling, general and administrative 3,828,750 3,666,293 4,044,867
Depreciation and amortization 691,824 773,973 481,724
------------ ------------ ------------
Total operating expenses 16,858,414 13,789,291 9,969,879
------------ ------------ ------------
Loss from operations (16,858,414) (10,759,439) (6,747,330)
------------ ------------ ------------
Other (expense) income
Interest income 534,229 979,234 1,133,439
Other income (expense), net 12,218 28,509 (10,226)
Interest expense (972,856) (1,713,806) (2,360,085)
Gain from sale of LE product line (Note 4) -- 16,285,324 --
------------ ------------ ------------
Other (expense) income, net (426,409) 15,579,261 (1,236,872)
------------ ------------ ------------
(Loss) income before income taxes (17,284,823) 4,819,822 (7,984,202)
Income tax benefit (215,223) (226,033) --
------------ ------------ ------------
Net (loss) income $(17,069,600) $ 5,045,855 $ (7,984,202)
============ ============ ============
Net (loss) income per share - basic $ (.30) $ .09 $ (.15)
============ ============ ============
Net (loss) income per share - diluted $ (.30) $ .09 $ (.15)
============ ============ ============
Weighted average shares outstanding - basic 56,520,041 54,678,932 52,109,589
============ ============ ============
Weighted average shares outstanding - diluted 56,520,041 55,298,063 52,109,589
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
Pharmos Corporation
Consolidated Statements of Changes in Shareholders' Equity (Notes 9 & 10)
For the Years ended December 31, 2002, 2001 and 2000
Paid-in
Common Stock Deferred Capital in
Shares Amount Compensation Excess of Par
---------- ---------- ------------ -------------
December 31, 1999 45,424,401 $1,362,732 $ 0 $ 83,372,742
Warrant and option exercises 2,615,003 78,450 4,754,443
Option issuances for consultant
compensation 243,449
Issuance of Common Stock and warrants - equity
credit line, net of fees of $77,831 518,424 15,552 2,130,352
Issuance of Common Stock - private equity sales,
net of fees of $382,000 5,524,425 165,733 18,464,365
Net loss (7,984,202)
---------- ---------- ------------ -------------
December 31, 2000 54,082,253 1,622,467 0 108,965,351
Warrant and option exercises 1,109,446 33,283 2,384,259
Option issuances for consultant compensation (50,175) 189,893
Stock option issuances below fair market value (172,969) 207,563
Issuance of Common Stock and adjustments in
connection with private equity sale, net
of fees of $5,924 182,964 5,489 (595,308)
Net income
---------- ---------- ------------ -------------
December 31, 2001 55,374,663 1,661,239 (223,144) 111,151,758
Option issuances for consultant compensation 50,175 13,362
Amortization of stock option issuances below
fair market value 52,981 420,221
Accretion of fair value of refinanced debt
Stock adjustment 40,583 (1,217) 1,092
Issuance of Common Stock - Employee
Stock Purchase Plan 23,284 699 20,057
Conversion of convertible debt and interest
to equity 1,217,485 36,525 2,581,068
Net loss
---------- ---------- ------------ -------------
December 31, 2002 56,574,849 $1,697,246 $ (119,988) $ 114,187,558
========== ========== ============ =============
Total
Accumulated Treasury Stock Shareholders'
Deficit Shares Amount Equity
------------- ------ ------- -------------
December 31, 1999 $ (82,510,107) 18,356 $ (551) $ 2,224,816
Warrant and option exercises 4,832,893
Option issuances for consultant
compensation 243,449
Issuance of Common Stock and warrants - equity
credit line, net of fees of $77,831 2,145,904
Issuance of Common Stock - private equity sales,
net of fees of $382,000 18,630,098
Net loss (7,984,202)
------------- ------ ------- -------------
December 31, 2000 (90,494,309) 18,356 (551) 20,092,958
Warrant and option exercises 2,417,542
Option issuances for consultant compensation 139,718
Stock option issuances below fair market value 34,594
Issuance of Common Stock and adjustments in
connection with private equity sale, net
of fees of $5,924 (589,819)
Net income 5,045,855 5,045,855
------------- ------ ------- -------------
December 31, 2001 (85,448,454) 18,356 (551) 27,140,848
Option issuances for consultant compensation 63,537
Amortization of stock option issuances below
fair market value 52,981
Accretion of fair value of refinanced debt 420,221
Stock adjustment (4,167) 125 --
Issuance of Common Stock - Employee
Stock Purchase Plan 20,756
Conversion of convertible debt and interest
to equity 2,617,593
Net loss (17,069,600) (17,069,600)
------------- ------ ------- -------------
December 31, 2002 $(102,518,054) 14,189 $ (426) $ 13,246,336
============= ====== ======= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
Pharmos Corporation
Consolidated Statements of Cash Flows
Year Ended December 31,
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
Cash flows from operating activities:
Net (loss) income $(17,069,600) $ 5,045,855 $ (7,984,202)
Adjustments to reconcile net (loss) income to net
cash flow used in operating activities:
Depreciation and amortization 691,824 773,973 481,724
Amortization of Beneficial Conversion Feature -- -- 1,796,344
Amortization of Debt Discount and Issuance costs 312,391 1,216,398 449,053
Amortization of fair value of change in Convertible Debt 420,221 -- --
Option issuances - consultant compensation 63,537 139,718 243,449
Stock options issued below fair market value 52,981 34,594 --
Gain from sale of LE product line -- (16,285,324) --
Changes in operating assets and liabilities
Inventories -- 322,620 1,041,201
Other receivables (8,733) (862,542) (226,733)
Prepaid expenses and other current assets 673,704 (116,586) (58,718)
Prepaid royalties -- 6,591 301,079
Other assets (10,250) (3,947) --
Accounts payable 1,545,161 (113,179) (221,550)
Accrued expenses (2,450,469) 25,820 450,909
Accrued wages & other compensation (318,287) 548,959 219,433
Other liabilities 10,000 (100,000) --
------------ ------------ ------------
Net cash used in operating activities (16,087,520) (9,367,050) (3,508,011)
------------ ------------ ------------
Cash flows from investing activities:
Purchases of fixed assets (565,865) (859,174) (932,731)
Proceeds from sale of LE business, net -- 23,136,930 --
------------ ------------ ------------
Net cash (used in) provided by
investing activities (565,865) 22,277,756 (932,731)
------------ ------------ ------------
Cash flows from financing activities:
Advances against future sales, net -- (619,702) (1,567,863)
Proceeds from issuance of common stock
and exercise of options and warrants, net 20,756 2,417,542 23,462,991
(Repayment) proceeds from issuance of convertible
debentures, net (2,000,000) -- 4,335,475
Fees related to refinancing convertible debt (163,000) -- --
Pricing adjustments for private placement, net -- (589,819) --
Proceeds from exercise of equity credit line -- -- 2,145,904
Decrease (Increase) in restricted cash 3,105,802 (1,330,390) (4,035,414)
Decrease in notes payable, net -- -- (338,128)
------------ ------------ ------------
Net cash provided by (used in)
financing activities 963,558 (122,369) 24,002,965
------------ ------------ ------------
Net (decrease) increase in cash and cash equivalents (15,689,827) 12,788,337 19,562,223
Cash and cash equivalents at beginning of year 35,269,114 22,480,777 2,918,554
------------ ------------ ------------
Cash and cash equivalents at end of year $ 19,579,287 $ 35,269,114 $ 22,480,777
============ ============ ============
Supplemental Information:
Interest paid $ 175,165 $ 243,983 $ 3,210
------------ ------------ ------------
Supplemental disclosure of non-cash financing activities:
Conversion of convertible debt and interest to equity $ 2,617,593 -- --
============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
Pharmos Corporation
Notes to Consolidated Financial Statements
1. The Company
Pharmos Corporation (the "Company") is a bio-pharmaceutical company that
discovers and develops new drugs to treat a range of inflammatory and
neurological disorders. Although the Company does not currently have any
approved products, they have an extensive 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 and pilot manufacturing through its
wholly owned subsidiary, Pharmos, Ltd., in Rehovot, Israel.
In October 2001, the Company sold its ophthalmic product line that
included Lotemax(R) and Alrex(R), two products that were being marketed
and future extensions of loteprednol etabonate (see Note 4). As a result
of the sale, the Company is exclusively in the drug candidate development
stage.
2. 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. At December 31,
2002, the Company had an accumulated deficit of $102.5 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 the current cash and cash
equivalents of $19.6 million and restricted cash of $2.3 million as of
December 31, 2002, will be sufficient to support the Company's continuing
operations through early 2004.
The Company is continuing to actively pursue various funding options,
including additional equity offerings, strategic corporate alliances,
business combination 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 projects will need to be scaled back or discontinued.
(See Note 19 for subsequent events)
3. Significant Accounting Policies
Basis of consolidation
The accompanying consolidated financial statements include the Company's
wholly owned subsidiary, Pharmos Ltd. All significant intercompany
transactions are eliminated in consolidation.
Use of estimates
The preparation of the consolidated financial statements in conformity
with generally accepted accounting principles requires the Company to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues, costs
and expenses during the reporting period. The most significant estimates
and assumptions related to revenue recognition and the tax valuation
allowance. Actual results could differ from those estimates.
F-7
Pharmos Corporation
Notes to Consolidated Financial Statements
Net income (loss) per common share
Basic net income (loss) per common share is computed by dividing net
income (loss) for the period, by the sum of the weighted average number
of shares of common stock issued and outstanding. Diluted earnings per
share is computed by dividing net income (loss) for the period by the sum
of the weighted average number of shares of common stock issued and
outstanding, increased to include the number of common shares that would
have been issued if all outstanding preferred stock, stock options, and
stock warrants, and convertible debt that are dilutive are converted.
In accordance with FASB 128 "Earnings per Share," for the years ended
December 31, 2002 and 2000, there were 6,803,278 and 5,005,240,
respectively, of outstanding options, warrants and convertible debt which
were excluded from the dilutive EPS calculation due to the fact that the
results of the exercise of such would be antidilutive.
A reconciliation of the basic and diluted earnings per share computations
for net income for the year ended December 31, 2001 is as follows:
Earnings
Income Shares per Share
---------- ---------- ---------
Basic EPS Net Loss $5,045,855 54,678,932 $.09
Effect of Dilutive Securities:
Warrants 314,738
Options 304,393
---------- ---------- ---------
Dilutive EPS Loss applicable to common
shareholders plus assumed conversion $5,045,855 55,298,063 $.09
========== ========== =========
In accordance with FASB 128 "Earnings per Share," 1,811,961 options,
warrants and the convertible debt were not included in the calculation
above as the results of the exercise of such would be antidilutive.
Cash and cash equivalents
The Company considers all highly liquid instruments purchased with an
original maturity of three months or less to be cash equivalents. Cash
equivalents primarily consist of commercial paper and money market
accounts in 2002 and 2001.
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. Up-front license fees are deferred and recognized
when all performance obligations are completed. The Company had no product
sales revenue during 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 and may never have such sales if products currently under
development fail to be commercialized.
Other receivables
As of December 31, 2002 and 2001, other receivables consist primarily of
grants for research and development relating to certain projects.
F-8
Pharmos Corporation
Notes to Consolidated Financial Statements
Restricted cash
In connection with the September 2000 Convertible Debenture offering, the
terms of the agreement required the Company to establish an escrow
account. The escrowed account is shown as Restricted Cash on the Company's
balance sheet and will be released to the Company in proportion to the
amount of Convertible Debentures converted into common shares or upon the
repayment of the debt.
Fixed assets
Fixed assets are recorded at cost and are depreciated on a straight-line
basis over their estimated useful lives. The Company uses the following
estimated useful lives:
Laboratory, pilot plant and other equipment 7 years to 14 years
Leasehold improvements 5 years to 14 years
Office furniture and fixtures 3 years to 17 years
Computer equipment 3 years
Vehicles 7 years
Leasehold improvements are amortized on a straight-line basis over the
shorter of the lease term or the estimated lives of the related assets.
Maintenance and repairs are expensed as incurred.
Intangible assets
Intangible assets represent the Company's rights to develop and
commercialize certain products derived from certain licensed technologies.
The assets have been amortized over their estimated useful life. As of
December 31, 2001, the intangible assets have been fully amortized. As of
December 31, 2001 and 2000, accumulated amortization was $1,039,780 and
$888,090, respectively. Amortization expense amounted to $151,690 for the
year ended December 31, 2001 and $46,524 in the year ended December 31,
2000. The increase in amortization expense in 2001 is a result of a change
in the estimated useful life. The intangible assets were fully amortized
as of December 31, 2001.
Long-lived assets
The Company periodically evaluates potential impairments of its long-lived
assets, including intangible assets. When the Company determines that the
carrying value of long-lived assets may not be recoverable based upon the
existence of one or more indicators of impairment, the Company evaluates
the projected undiscounted cash flows related to the assets and other
factors. If these cash flows are less than the carrying value of the
assets, the Company measures the impairment using discounted cash flows or
other methods of determining fair value.
Research and development costs
All research and development costs are expensed when incurred. The Company
accounts for reimbursements of research and development costs as a
reduction of research and development expense.
Income taxes
The Company accounts for income taxes in accordance with the provisions of
Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes" ("SFAS 109"). Under the asset and liability method of SFAS
109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss and tax credit carryforwards.
F-9
Pharmos Corporation
Notes to Consolidated Financial Statements
Deferred tax assets and liabilities, if any, are measured using enacted
tax rates expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled. Under SFAS
109, the effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment
date.
Foreign exchange
The Company's foreign operations are principally conducted in U.S.
dollars. Any transactions or balances in currencies other than U.S.
dollars are remeasured and any resultant gains and losses are included in
the determination of current period income and loss. To date, such gains
and losses have been insignificant.
Concentration of credit risk
Financial instruments that potentially expose the Company to
concentrations of credit risk consist primarily of cash and cash
equivalents. The Company maintains some of its cash balances in accounts
that exceed federally insured limits. The Company has not experienced any
losses to date resulting from this practice.
Substantially all product sales have been to a single customer, as a
result of the Company's marketing agreement with that customer.
Fair value of financial instruments
The carrying amounts of the Company's financial instruments, including
cash and cash equivalents, other receivables, other assets, accounts
payable, accrued liabilities, and convertible debentures approximate fair
value due to their short maturities.
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 only if, on the date of grant, the fair value of the underlying
stock exceeds the 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 had been
applied to these transactions. Options issued to non-employees are valued
using the fair value methodology under SFAS No. 123.
F-10
Pharmos Corporation
Notes to Consolidated Financial Statements
The following table illustrates the effect on income from continuing
operations and earnings 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.
Year Ended December 31,
2002 2001 2000
------------ ---------- -----------
Net (loss) income as reported ($17,069,600) $5,045,855 ($7,984,202)
Add: Stock-based employee compensation
expense included in reported net (loss) 52,981 34,594 --
income
Deduct: Total stock-based employee
compensation expense determined under ($1,108,000) ($923,000) ($798,000)
fair value based method for all awards
Pro forma net (loss) income ($18,124,619) ($4,157,449) ($8,782,202)
============ ============ ============
Earnings per share:
Basic - as reported ($0.30) $0.09 ($0.15)
Basic - pro forma ($0.32) $0.08 ($0.17)
Diluted - as reported ($0.30) $0.09 ($0.15)
Diluted - pro forma ($0.32) $.08 ($0.17)
Reclassifications
Certain amounts for 2001 and 2000 have been reclassified to conform to the
fiscal 2002 presentation. Such reclassifications did not have an impact on
the Company's financial position or results of operations.
Recent Accounting Pronouncements
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and
Technical Corrections." SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt," required that gains and losses from
extinguishment of debt be classified as an extraordinary item, net of the
related income tax effect. Any gain or loss on extinguishment of debt that
was classified as an extraordinary item in prior periods presented that
does not meet the criteria in APB Opinion No. 30 for classification as an
extraordinary item shall be reclassified. SFAS No. 13, "Accounting for
Leases," has been amended to require sale-leaseback accounting for certain
lease modifications that are similar to sale-leaseback transactions. The
rescission of SFAS No. 4 and the amendment to SFAS No. 13 shall be
effective for fiscal years and transactions, respectively, occurring after
May 15, 2002. The Company adopted the provisions of SFAS No. 145 during
2002, and the adoption did not have a material effect on the consolidated
financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 addresses the
accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized at fair market value when the liability is
incurred, rather than upon an entity's commitment to an exit plan, as
prescribed by EITF No. 94-3. SFAS No. 146 is effective for exit and
disposal activities initiated after December 31, 2002. The Company does
not believe that the adoption of SFAS No. 146 will have a material impact
on its consolidated financial statements.
F-11
Pharmos Corporation
Notes to Consolidated Financial Statements
In November 2002, the FASB issued FASB Interpretation No. ("FIN") 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others." FIN 45
elaborates on the disclosure requirements of a guarantor in its interim
and annual financial statements about its obligations under certain
guarantees that it has issued. It also requires a guarantor to recognize,
at the inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing certain guarantees. FIN 45 also
incorporates, without change, the guidance in FIN 34, "Disclosure of
Indirect Guarantees of Indebtedness of Others," which it supersedes. The
incremental disclosure requirements of FIN 45 are effective for financial
statements of interim or annual periods ending after December 15, 2002.
The initial recognition and initial measurement provisions are applicable
to guarantees issued or modified after December 31, 2002. The accounting
followed by a guarantor on prior guarantees may not be changed to conform
to the guidance of FIN 45. The Company does not believe that the adoption
of FIN 45 will have a material impact on its consolidated financial
statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition
for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures
in both annual and interim financial statements about the method of
accounting for stock-based employee compensation and the effect of the
method used on reported results. SFAS No. 148 is effective for fiscal
years and interim periods beginning after December 15, 2002. The Company
continues to account for stock-based employee compensation under the
intrinsic value method of APB 25, "Accounting for Stock Issued to
Employees." The Company has adopted the disclosure provisions of SFAS No.
148 on for the year ended December 31, 2002.
4. 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 and Alrex, 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.
Through October 2001, Bausch & Lomb provided the Company with $5 million
in cash advances against future sales. Bausch & Lomb recouped the advances
by withholding a certain percentage of payments to the Company against
payments for purchases of the active drug substance. With the completion
of the sale of the ophthalmic business to Bausch & Lomb in October 2001,
all the advances have been repaid.
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 a 1995 Marketing Agreement with the Company. Bausch &
Lomb also acquired future extensions of LE formulations including LE-T, a
product candidate currently in Phase III clinical trial. Bausch & Lomb
will pay the Company additional fees depending on the approval date with
the FDA as follows: If the earlier of (a) commercial launch or (b) 6
months after FDA approval of LE-T (the "Triggering Event")
F-12
Pharmos Corporation
Notes to Consolidated Financial Statements
occurs before January 1, 2002 the Company was initially to receive $15.4
million. That amount has been decreasing 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
Company can not be assured that FDA approval will be obtained or if at
all. 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, which
will be net against any additional gain recorded.
Upon FDA approval, the Company 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, with Bausch & Lomb,
overseeing the development of LE-T. As of December 31, 2002, Pharmos'
share of these research and development related LE-T expenses was
approximately $1.6 million.
As of October 2001, the Company received $925,780 from the Israel-U.S.
Binational Industrial Research and Development Fo undation to develop
Lotemax(R) and LE-T. During October 2001, in connection with the sale of
the Company's existing ophthalmic business, the Company paid the
foundation royalties for Lotemax(R) which concluded its' obligation to the
foundation in respect to Lotemax(R). The Company retains its' obligation
to repay that portion of funding it received from the foundation with
respect to LE-T of $302,438. The Company's obligation to the foundation is
due only when LE-T is approved by the FDA.
As a result of this transaction, the Company recorded a gain of $16.3
million. The Company incurred transaction and royalty costs of
approximately $2.0 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.
5. Fixed Assets
Fixed assets consist of the following:
December 31,
--------------------------
2002 2001
----------- -----------
Laboratory, pilot plant and other equipment $ 3,003,672 $ 2,826,727
Leasehold improvements 725,221 623,607
Office furniture and fixtures 479,626 397,745
Computer equipment 860,252 704,316
Vehicles 88,231 38,742
----------- -----------
5,157,002 4,591,137
Less - Accumulated depreciation and amortization (3,364,680) (2,672,856)
----------- -----------
$ 1,792,322 $ 1,918,281
=========== ===========
Depreciation and amortization of fixed assets was $691,824, $622,283 and
$435,200 in 2002, 2001 and 2000, respectively.
F-13
6. Accrued expenses
Accrued expenses consist of the following:
December 31,
-----------------------
2002 2001
---------- ----------
Accrued expenses, other $ 524,506 $ 221,795
Accrued interest 341,000 410,800
Research & development cost relating to traumatic brain injury 814,000 182,315
Research & development cost relating to LE-T (Note 4) 1,562,075 3,750,000
Accrued fee due to the LE patent owner (Note 4) -- 1,244,732
---------- ----------
Total accrued expenses $3,241,581 $5,809,642
========== ==========
7. Grants for Research and Development
The Company has entered into agreements with U.S. federal agencies and the
State of Israel, which provide for grants for research and development
relating to certain projects. Amounts received pursuant to these
agreements have been reflected as a reduction of research and development
expense. Such reductions amounted to $2,755,882, $1,336,566 and $326,438
during 2002, 2001 and 2000, respectively. The agreements with agencies of
the State of Israel place certain legal restrictions on the transfer of
the technology and manufacture of resulting products outside Israel. The
Company will be required to pay royalties, at rates ranging from 3% to 5%,
to such agencies from the sale of products, if any, developed as a result
of the research activities carried out with the grant funds.
As of December 31, 2002, the total amounts received under such grants
amounted to $7,609,539. Aggregate future royalty payments related to sales
of products developed, if any, as a result of these grants are limited to
$5,893,889 based on grants received through December 31, 2002.
In April 1997, the Company also signed an agreement with Consortium Magnet
for developing generic technologies for design and development of drugs
and diagnostic kits, operated by the Office of the Chief Scientist of
Israel. Under such agreements the Company is entitled to a non-refundable
grant amounting to approximately 60% of actual research and development
and equipment expenditures on approved projects. No royalty obligations
are required within the framework. The Company received grants totaling
$2,088, $281,453 and $543,807 in 2002, 2001 and 2000, respectively,
pursuant to this agreement.
8. Licensing Arrangements
The Company is a licensee of certain research technologies and has various
license agreements wherein the Company has acquired exclusive or
co-exclusive rights to develop and commercialize certain research
technologies. These agreements generally require the Company to pay
royalties on the sale of products developed and contingent royalties based
upon milestones from the licensed technologies and fees on revenues from
sublicenses, where applicable. The royalty rates, as defined in the
respective license agreements, are customary and usual in the
pharmaceutical industry. The royalties will be payable for periods up to
fifteen years from the date of specified events, including the date of the
first sale of such products, or the date from which the first registered
patent from the developed technologies is in force, or the year following
the date on which approval from the FDA is received for a developed
product. No amounts have been recorded as a liability with respect to any
contingent royalties as of December 31, 2002.
F-14
Pharmos Corporation
Notes to Consolidated Financial Statements
Certain of the license agreements, which include agreements related to
Lotemax and Alrex, required annual payments for periods extending through
2012. Minimum annual payments under licensing agreements are $103,500.
License fee expense amounted to approximately $0, $103,500, and $103,500
in 2002, 2001, and 2000, respectively. With the completion of the sale of
the ophthalmic business to Bausch & Lomb in October 2001, the obligations
under these agreements have been assumed by Bausch & Lomb.
9. Private Placement
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.
Convertible Debentures
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 may 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 will be released to the Company in proportion
to the amount of Convertible Debentures converted into common shares or
upon the repayment of the debt.
During 2001, the Company paid $589,819 and issued 182,964 shares of the
common stock of the Company to the investors in the convertible debenture.
The payment of cash and stock were the option chosen by the Company and
represent adjustments to the pricing based upon the Company's stock price
during the adjustment period. Additional shares were issued for no
additional consideration resulting in an increase in common stock of
$5,489 and a corresponding decrease in additional paid in capital.
Emerging Issues Task Force Issue No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios, require the Company to compute the Beneficial
Conversion Feature ("BCF") on the convertible debt due to the spread
between the fair market value of the common stock at the date of issuance
of the convertible debt and the conversion price taking into consideration
the relative fair value of the warrants issued in conjunction with this
financing. The BCF is netted out of the proceeds and is amortized from the
closing date until the earliest date that the investors have the right to
convert the debt into common shares. The BCF 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. Additionally, the discount
on the Convertible Debenture due to the warrants issued in connection with
the convertible debenture of approximately $800,000 will be amortized to
interest expense over the life of the debt. For the years ended December
31, 2002, 2001 and 2000, $88,988, $533,932 and $177,976, respectively, has
been amortized.
In December 2001, the holders of the Convertible Debentures and the
Company agreed to modify the repayment and conversion terms. 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 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
F-15
Pharmos Corporation
Notes to Consolidated Financial Statements
to January 31, 2002 in exchange for lowering the conversion price for the
other holders. As the modification wasnot significant in accordance with
EITF 96-19 the change in the fair value between the original convertible
debt and the modified convertible debt will be accreted over the remaining
term of the convertible debt with a corresponding charge to interest
expense.
During 2002, the Company issued 1,217,485 shares of its common stock upon
the conversion of $2.6 million of the Company's convertible debentures
relating to the September 2000 offering. The conversion amount includes
approximately $118,000 of accrued interest. Additionally, $2 million of
convertible debentures were repaid in January 2002, leaving $3.5 million
of outstanding principal due in June 2003,See Note 19. In connection with
the conversion and repayment, $3.6 million of restricted cash was released
to the Company.
Common Stock
In September 2000, the Company issued 1,024,425 common shares in the
private placement that generated gross proceeds of $3 million. Under the
terms of the transaction, 821,515 shares were issued at closing. In
accordance with the terms of the agreement, since the average closing
price of the Company's common stock during the 30 business days following
the effective date of the registration statement relating to the shares
purchased did not exceed 110% of the initial closing price of $3.65 per
share, the Company issued an additional 202,910 shares, calculated in
accordance with the stock purchase agreement. The additional shares were
issued in the fourth quarter of 2000 for no additional consideration,
resulting in an increase in common stock of $6,087 and a corresponding
decrease in additional paid in capital.
One common stock investor has an option ("Call Warrant"), in the form of a
warrant, to purchase an additional $2 million of common shares for a
period of one year provided that the future purchase price is greater than
the initial closing price of $3.65 per share. The maximum number of shares
that can be issued from this warrant is 547,945 and is part of the maximum
number of warrants issued for the total private placement of 1,115,730,
including placement agent warrants at prices ranging from $3.65 to $6.08
per share. The warrants to the one investor for the purchase of an
additional $2 million of common stock were valued using the Black Scholes
option-pricing model (assumptions: volatility of 78%, risk free rate of
5.89% and a zero dividend yield). The warrants to the placement agents
were valued using the Black Scholes option-pricing model using the same
assumptions as above. Both warrant issuances were recorded upon issuance
as additional paid-in-capital. The investor exercised the Call Warrant in
the third quarter of 2001, with the Company issuing 542,299 common shares.
During the fourth quarter of 2001, the Company issued 281,659 shares as an
adjustment to the pricing of the Call Warrant based upon the Company's
stock price during the adjustment period as defined in the Call Warrant
agreement.
The issuance costs related to the Private Placement of approximately $1.4
million, included the value of 187,929 warrants to purchase common shares
(included in the total warrants of 1,115,730 issued in connection with the
private placement) at prices ranging from $4.34 to $4.56. The issuance
costs relating to the Convertible Debenture of $981,000 will be amortized
over the life of the debt. For the year ending December 31, 2001 and 2000,
$682,464 and $224,691, respectively, has been amortized and included as
interest expense. The issuance costs related to the common stock of
$382,000 were netted against the proceeds.
Of the warrants issued in connection with the private placement, warrants
for the purchase of 567,785 common shares at exercise prices ranging from
$4.34 to $6.08 per share and an expiration date of September 2005, remain
outstanding at December 31, 2002.
The warrants that were issued in connection with the private placement
noted above were valued using the Black-Scholes option pricing model with
the following assumption: volatility 78%, risk free rate 5.89% and zero
dividend yield.
F-16
Pharmos Corporation
Notes to Consolidated Financial Statements
10. Common and Preferred Stock Transactions
2002 Transactions
During, 2002, the Company issued 23,384 shares of common stock with gross
proceeds of $20,756 pursuant to the Pharmos Corporation 2001 Employee
Stock Purchase Plan. All full-time and part-time employees of the Company
who have completed a minimum of 6 months of employment are eligible to
participate. The price of the Common Stock is calculated at 85% of the
lower of either the mean between the highest and lowest prices at which
Pharmos common stock trades on the first business day of the month, or the
mean between the highest and lowest trading prices on the day of exercise
(the last day of the month). A participant can purchase shares not to
exceed 10% of one's annualized base pay; $25,000; or 5% or more of shares
outstanding. The total number of shares reserved for issuance under the
2001 Plan is 500,000 shares.
In July 2002 the shareholders of the Company approved the increase in the
number of authorized shares of the Company's Common Stock to 110,000,000
from 80,000,000.
On October 23, 2002, the Board of Directors of the Company approved a
stockholder rights plan as set forth in the Rights Agreement, dated as of
October 23, 2002, between the Company and American Stock Transfer & Trust
Company, as Rights Agent. Under the Rights Agreement, each common
stockholder of record as of the close of business on November 6, 2002,
received a dividend of one right for each share of common stock held. Each
right entitled the holder to purchase from the Company one one-thousandth
of a share of a new series of participating preferred stock at an initial
purchase price of $15.00. The plan is designed to impose a significant
penalty upon any person or group that acquires 15% or more of our
outstanding common stock without the approval of our board. The
stockholder rights are triggered either ten days after a third party
announces its acquisition of 15% or more of the Company's common stock or
ten business days after someone starts a tender offer to acquire such
amount of shares. At that time, all stockholders, other than the person
who acquired the block or started the tender offer, will have the right
for 60 days, upon payment of $15, to purchase $30 worth of common stock of
the Company, in substitution for the new preferred stock authorized by the
stockholder rights plan, at the time current market price. As a result,
the stockholders of the Company will be able to purchase a large number of
shares at a discount, significantly diluting the interest of the acquiring
person and making it significantly more expensive for that person to
acquire control of the Company.
As of December 31, 2002, the Company had reserved 2,534,089 common shares
for the possible conversion of the convertible debentures, 2,452,030 for
outstanding stock options and 2,297,277 for outstanding warrants.
2001 Transactions
The Company issued 1,109,446 shares of its common stock upon the exercise
of stock options and warrants, and received consideration of $2,417,542.
On January 1, 2001 the Company terminated the employment contract for two
employees and they became independent consultants. In accordance with the
incentive option plan, all terminated employees who are extended a
consulting contract may continue to vest their options. Since the
employees became consultants on a prospective basis, the options
outstanding on the date of termination are marked to market each quarter
until the options vest. The Company is recording the value of the services
being received based on the fair market value of the options using the
Black-Scholes option-pricing model, which was more reliable than the value
of the services provided. The fair value of these options has been
estimated based on the following weighted average assumptions:
F-17
Pharmos Corporation
Notes to Consolidated Financial Statements
2000 Transactions
volatility of 78%, risk free rate of 5.89% and a zero dividend yield. For
the year ended December 31, 2001 the Company recorded professional fees
relating to these terminated employees of $139,718. During 2000, the
Company issued 1,024,425 shares of common stock in a private placement
transaction that generated gross proceeds of $3 million. Additionally, the
Company issued warrants to purchase up to 1,115,730 shares of common stock
at prices ranging from $3.65 to $6.08 per share and expiring in 2001 and
2005 in connection with the private placement of convertible debt and
common stock described in Note 9.
The Company issued 2,615,003 shares of its common stock upon the exercise
of stock options and warrants, and received consideration of $4,832,893.
During the first quarter of 2000, the Company issued 4,500,000 registered
shares of its common stock under a "shelf" registration to several
investors, and received consideration, net of offering costs and expenses,
of $12,648,383.
During 2000, the Company issued 518,424 shares of its Common Stock and
warrants to purchase 51,162 shares of its Common Stock to an investor for
consideration of $2,145,904, net of fees. The warrants have exercise
prices ranging from $2.19 to $16.80 per share and expire in 2003. The
proceeds from the common stock issuance were allocated to the common stock
and warrants based on the fair value of the securities. The warrants were
valued using the Black-Scholes option-pricing model (assumptions:
volatility of 78%, risk free rate of 5.89% and a zero dividend yield) and
recorded as additional paid in capital.
During 2000, the Company issued warrants to purchase 32,000 shares of its
common stock (4,000 warrants each month through August 2000) as
compensation to a consultant. The warrants were immediately exercisable,
have an exercise price of $1.19 per share and expire by 2005. The warrants
were valued using the Black-Scholes option-pricing model (assumptions:
volatility of 78%, risk free rate of 5.89% and a zero dividend yield) and
recorded as additional paid in capital.
F-18
Pharmos Corporation
Notes to Consolidated Financial Statements
11. Warrants
Some of the warrants issued in connection with various equity financing
and related transactions during 1991 through 2001 contain anti-dilution
provisions requiring adjustment. The following table summarizes the common
shares issuable upon exercise of warrants outstanding at December 31, 2002
as adjusted for the events which have triggered anti-dilution provisions
contained in the respective warrant agreements:
Common Shares
Issuable Exercise
Issuance Date Expiration Date Upon Exercise Price
---------------- --------------- ------------- --------
April 1995 April 2005 341,600 $ 2.75
April 2005 10,000 $ 0.78
February 1997 February 2007 486,500 $ 1.59
March 1997 March 2008 171,052 $ 1.38
January 1998 October 2005 17,000 $ 1.66
February 1998 January 2003 531,072 $ 2.52
January 2003 157,247 $ 2.18
November 1999 November 2004 4,000 $ 1.19
December 1999 December 2004 4,000 $ 1.19
January 2000 January 2005 4,000 $ 1.19
February 2000 February 2005 4,000 $ 1.19
March 2000 March 2005 4,000 $ 1.19
April 2000 April 2005 4,000 $ 1.19
May 2000 May 2005 4,000 $ 1.19
June 2000 June 2005 4,000 $ 1.19
June 2003 12,574 $ 5.00
July 2000 July 2005 4,000 $ 1.19
August 2000 August 2005 4,000 $ 1.19
September 2000 September 2005 95,843 $ 4.56
September 2005 92,086 $ 4.34
September 2005 379,856 $ 6.08
------------- --------
Total shares and
average exercise
price 2,334,830 $ 2.97
============= ========
F-19
Pharmos Corporation
Notes to Consolidated Financial Statements
12. Stock Option Plans
The Company's shareholders have approved incentive stock option plans for
officers and employees. Options granted are generally exercisable over a
specified period, not less than one year from the date of grant, generally
expire ten years from the date of grant and vest evenly over four years.
A summary of the various established stock option plans is as follows:
1992 Plan. The maximum number of shares of the Company's Common Stock
available for issuance under the 1992 Plan is 750,000 shares, subject to
adjustment in the event of stock splits, stock dividends, mergers,
consolidations and the like. Common Stock subject to options granted under
the 1992 Plan that expire or terminate would again be available for
options to be issued under the 1992 Plan. As of December 31, 2002, there
were 285,086 options outstanding to purchase the Company's Common Stock
under this plan. Each option granted which is outstanding under the 1992
plan as of December 31, 2002 expires on October 31, 2005.
1997 Plan and 2000 Plan. The 1997 Plan and the 2000 Plan are each
administered by a committee appointed by the Board of Directors (the
"Compensation Committee"). The Compensation Committee will designate the
persons to receive options, the number of shares subject to the options
and the terms of the options, including the option price and the duration
of each option, subject to certain limitations.
The maximum number of shares of Common Stock available for issuance under
the 1997 Plan is 1,500,000 shares, as amended, and under the 2000 Plan is
3,500,000 shares. Each plan is subject to adjustment in the event of stock
splits, stock dividends, mergers, consolidations and the like. Common
Stock subject to options granted under the 1997 Plan and the 2000 Plan
that expire or terminate will again be available for options to be issued
under each Plan.
All incentive stock option grants during 2002 were made from the Pharmos
Corporation 2000 Incentive and Non-Qualified Stock Option Plan. The
Company does not plan to issue any additonal options under the 1992 and
1997 Plans.
The following table summarizes activity in approved incentive stock
options approved by the Company's Board of Directors:
Weighted
Under Average
Option Exercise Price
--------- --------------
Options Outstanding at 12/31/99 1,312,336 $2.19
Granted 449,252 $4.03
Exercised (214,167) $2.31
Cancelled (27,583) $2.65
--------- --------------
Options Outstanding at 12/31/00 1,519,838 $2.71
--------- --------------
Granted at fair market value 57,000 $2.56
Granted below fair market value 453,500 $1.88
Exercised (12,500) $1.25
Cancelled (3,000) $4.03
--------- --------------
Options Outstanding at 12/31/01 2,014,838 $2.53
Granted 692,000 $1.90
Cancelled (135,575) $2.41
--------- --------------
Options Outstanding at 12/31/02 2,571,263 $2.36
========= ==============
Options exercisable at 12/31/02 1,282,837 $2.51
========= ==============
Options exercisable at 12/31/01 898,399 $2.47
========= ==============
Options exercisable at 12/31/00 602,836 $2.29
========= ==============
Additional information with respect to the outstanding incentive stock
options as of December 31, 2002 is as follows:
Options Outstanding Options Exercisable
----------------------------------------------- ----------------------------
Weighted
Average Weighted Weighted
Range of Exercise Options Remaining Average Options Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ----------------- ----------- ---------------- -------------- ----------- --------------
$1.25 - $1.88 691,375 7.5 years $1.63 306,125 $1.47
$1.90 - $2.78 1,452,136 6.7 years $2.23 765,086 $2.50
$3.68 - $4.03 427,752 7.5 years $4.02 211,626 $4.03
----------- ---------------- -------------- ----------- --------------
2,571,263 7.0 years $2.36 1,282,837 $2.51
F-20
Pharmos Corporation
Notes to Consolidated Financial Statements
The Company's Board of Directors approved nonqualified stock options for
key employees, directors and certain non-employee consultants. All
nonqualified stock option grants during 2002 were made from the Pharmos
Corporation 2000 Incentive and Non-Qualified Stock Option Plan.
The following table summarizes activity in Board-approved nonqualified
stock options:
Weighted
Under Average
Option Exercise Price
-------- --------------
Options Outstanding at 12/31/99 616,765 $2.31
Granted 190,748 $3.81
Exercised (283,333) $2.23
Cancelled (20,000) $1.25
-------- --------------
Options Outstanding at 12/31/00 504,180 $2.97
-------- --------------
Granted below fair market value 100,000 $1.88
Exercised (136,988) $2.20
Cancelled (30,000) $2.77
-------- --------------
Options Outstanding at 12/31/01 437,192 $2.97
-------- --------------
Granted 180,000 $1.74
Cancelled (93,250) $3.59
-------- --------------
Options Outstanding at 12/31/02 523,942 $2.41
======== ==============
Options exercisable at 12/31/02 253,568 $2.72
======== ==============
Options exercisable at 12/31/01 184,756 $3.18
======== ==============
Options exercisable at 12/31/00 287,807 $2.77
======== ==============
Additional information with respect to the outstanding nonqualified stock
options as of December 31, 2002 is as follows:
Options Outstanding Options Exercisable
----------------------------------------------- ----------------------------
Weighted
Average Weighted Weighted
Range of Exercise Options Remaining Average Options Average
Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
----------------- ----------- ---------------- -------------- ----------- --------------
$1.08 - $1.88 200,000 7.9 years $1.55 83,750 $1.61
$1.90 - $2.50 188,194 6.7 years $2.16 83,194 $2.48
$4.00 - $5.20 135,748 7.5 years $4.01 86,624 $4.01
----------- ---------------- -------------- ----------- --------------
523,942 7.4 years $2.41 253,568 $2.72
As of December 31, 2002, there were 2,055,825 shares remaining available
for issuance under these plan.
During 2000, the Company modified the terms of certain nonqualified stock
options granted to two of the Company's former Directors who entered into
consulting relationships with the Company. The modifications included the
immediate vesting of the nonqualified options and, accordingly, the
Company expensed the value of these options as consultant compensation for
the year ended December 31, 2000.
The Company applies Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations in accounting
for its plans. During 2001, the Company issued 453,500 incentive stock
options and 100,000 non-qualified stock options to employees and directors
at an exercise price of $1.88 per share. The exercise price of $1.88 was
representative of the average price during the month the options were
granted, but was below the closing market price on the date of
F-21
Pharmos Corporation
Notes to Consolidated Financial Statements
the grant. Accordingly, the Company recorded compensation expense of
$34,594 and deferred compensation expense of $172,969 to reflect the
difference between the exercise price and the closing market price on the
date of the grant. The deferred compensation expense is being amortized
over the four-year vesting period.
Fair value of options:
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 assumptions:
Year Ended December 31,
-------------------------------------------
2002 2001 2000
------------ ------------ -------
Risk-interest rates 2.63 - 4.39% 3.90 - 4.94% 5.89%
Expected lives (in years) 1 to 5 1 to 5 1 to 5
Dividend yield 0% 0% 0%
Expected volatility 75% 78% 78%
13. Related Parties
In December 2001, the Company's Pharmos Ltd. subsidiary renewed a License
Agreement with Herbamed, Ltd., a company controlled by the Company's
Chairman and Chief Executive Officer. The License Agreement, originally
entered into in May 1997, licenses to Herbamed the Company's patent rights
for the oral delivery of lipophilic substances in the limited field of
nutraceuticals, which include food and dietary supplements, food
additives, vitamins and herbs. Under the terms of the revised License
Agreement, Herbamed will pay to Pharmos Ltd. royalties of 6% on net sales
of up to $20 million, 5% on net sales between $20 million and $50 million
and 4% on net sales in excess of $50 million. There have been no sales to
date and accordingly Herbamed has made no payments to Pharmos Ltd.
14. Income Taxes
No provision for federal income taxes was recorded for the years ended
December 31, 2002 and 2000 due to net operating losses incurred. No
provision for income taxes was recorded for the year ended December 31,
2001 since the Company was be able to utilize its net operating loss
carryforwards and offset the taxes due. Net operating loss carryforwards
for U.S. tax purposes of approximately $78,100,000 expire from 2006
through 2022.
During 2002 and 2001, the Company sold a portion of its New Jersey net
operating loss carryforwards to a third party under the New Jersey's
Technology Business Tax Certificate Transfer Program and, as a result,
recorded a tax benefit of $215,223 and $226,033, respectively.
The Company's gross deferred tax assets of $28,900,000 and $26,900,000 at
December 31, 2002 and 2001, respectively, represented primarily the tax
effect of both the net operating loss carryforwards ($25.1 million in 2002
and $22.4 million in 2001), deferred research and development costs ($1.3
million in 2002 and $2.4 million in 2001) and research and development tax
credit carryforwards ($1.7 million in 2002 and $1.9 million in 2001). As a
result of previous business combinations and changes in stock ownership,
substantially all of these net operating losses and tax credit
carryforwards are subject to significant restriction with regard to annual
utilization. A full valuation allowance has been established with regard
to the gross deferred tax assets due to management's uncertainty of the
recoverability of the deferred tax assets.
F-22
Pharmos Corporation
Notes to Consolidated Financial Statements
15. Commitments and Contingencies
Leases
The Company leases research and office facilities in Israel and New
Jersey. The facilities in Israel are used in the operation of the
Company's research and administration activities.
All of the leases and subleases described above call for base rentals,
payment of certain building maintenance costs (where applicable) and
future increases based on the consumer price indices.
At December 31, 2002, the future minimum lease commitments with respect to
non-cancelable operating leases (including office and equipment leases),
net of sublease agreements, with initial terms in excess of one year are
as follows:
Lease
Commitments
-----------
2003 523,768
2004 377,736
2005 81,375
2006 57,978
2007 12,212
-----------
$1,053,069
===========
Rent expense during 2002, 2001 and 2000 amounted to $467,879, $353,793 and
$329,246, respectively. In 2002, rent expense is net of sublease income of
$81,358.
Clinical service fees
In addition, the Company has certain professional clinical service fees
relating to the European Phase III clinical study for dexanabinol. Upon
the completion of certain agreed upon milestones, additional fees will be
paid. The fees that the Company is obligated to pay upon the reaching of
the agreed upon milestones is not included in the above table due to
uncertainties in timing. The maximum amount that could be paid is
approximately $7.8 million. As of December 31, 2002, the Company has
recorded $4.8 million as an expense.
Consulting contracts and employment agreements
In the normal course of business, the Company enters into annual
employment and consulting contracts with various employees and
consultants.
Dividend restrictions
Dividends may be paid by the Company's subsidiary, Pharmos Limited, only
out of retained earnings as determined for Israeli statutory purposes.
There are no retained earnings in Israel available for distribution as
dividends as of December 31, 2002, 2001 or 2000. The Company does not
intend to pay a cash dividend in the foreseeable future.
16. Employee Benefit Plan
The Company has a 401-K defined contribution profit-sharing plan covering
certain employees. Contributions to the plan are based on salary
reductions by the participants, matching employer contributions as
determined by the Company, and allowable discretionary contributions, as
determined
F-23
Pharmos Corporation
Notes to Consolidated Financial Statements
by the Company's Board of Directors, subject to certain limitations.
Contributions by the Company to the plan amounted to $45,296, $39,637 and
$26,570 in 2002, 2001 and 2000, respectively.
17. 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 years ending December 31, 2002, 2001 and
2000 are as follows:
2002 2001 2000
------------ ------------ ------------
Net revenues
United States -- $ 4,298,441 $ 5,098,504
Israel -- -- --
------------ ------------ ------------
-- $ 4,298,441 $ 5,098,504
============ ============ ============
Net income (loss)
United States $(16,514,635) $ 5,564,634 $ (7,597,846)
Israel (554,965) (518,779) (386,356)
------------ ------------ ------------
$(17,069,600) $ 5,045,855 $ (7,984,202)
============ ============ ============
Total assets
United States $ 20,656,322 $ 40,648,880 $ 28,073,517
Israel 4,030,360 3,614,111 2,709,592
------------ ------------ ------------
$ 24,686,682 $ 44,262,991 $ 30,783,109
============ ============ ============
Long lived assets, net
United States $ 232,734 $ 164,517 $ 61,243
Israel 1,559,588 1,753,764 1,620,147
------------ ------------ ------------
$ 1,792,322 $ 1,918,281 $ 1,681,390
============ ============ ============
Capital expenditures, net
United States $ 155,467 $ 138,424 $ 54,746
Israel 410,398 720,750 877,985
------------ ------------ ------------
$ 565,865 $ 859,174 $ 932,731
============ ============ ============
F-24
Pharmos Corporation
Notes to Consolidated Financial Statements
18. Quarterly Information (Unaudited)
Year ended
December 31, 2002 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
- ------------------------------- ------------ ------------ ------------ ------------
Revenues -- -- -- --
Gross Margin -- -- -- --
Operating Expenses $ 4,752,088 $ 3,293,525 $ 5,394,968 $ 3,417,883
Loss from Operations (4,752,088) (3,293,525) (5,394,968) (3,417,833)
Other Income (Expense), net (215,981) (57,498) (53,596) (99,334)
Net income (loss) applicable to
common shareholders $ (4,968,069) $ (3,351,023) $ (5,448,564) $ (3,517,167)
Net income (loss)
per share - basic & diluted $ (.09) $ (.06) $ (.10) $ (.06)
Year ended
December 31, 2001 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
- ------------------------------- ------------ ------------ ------------ ------------
Revenues $ 1,105,058 $ 1,480,737 $ 1,712,646 --**
Gross Margin 693,717 1,026,829 1,309,306 --**
Operating Expenses 3,350,345 3,189,482 3,093,611 $ 4,155,853
Loss from Operations (2,656,628) (2,162,653) (1,784,305) (4,155,853)
Other Income (Expense), net (93,475) (204,092) (212,741) 16,089,569*
Net income (loss) applicable to
common shareholders $ (2,750,103) $ (2,366,745) $ (1,997,046) $ 12,159,749*
Net income (loss)
per share - basic & diluted $ (.05) $ (.04) $ (.04) $ .22
* Other Income (Expense), net and the Net Loss for the fourth quarter of
2001 include the gain from the sale of the ophthalmic product line to
Bausch & Lomb in October 2001.
** As a result of the sale to Bausch & Lomb in October 2001, there was no
revenue or gross margin during the fourth quarter of 2001.
19. Subsequent events
At the February 2003 Board of Directors' meeting, an aggregate of 950,000
incentive stock options were granted to the Company's employees at an
exercise price of $1.02.
On March 4, 2003, the Company raised $4.3 million from the placement of
common stock and warrants. The private placement offering was completed by
issuing 5,058,827 shares of common stock at a price of $0.85 per share and
approximately 1.1 million warrants at an exercise price of $1.25 per
share. Additionally, the remaining balance of the September 2000
Convertible Debenture offering was redeemed for cash. The original face
amount of $3.5 million was redeemed for approximately $4.0 million, which
included accrued and unpaid interest. The Convertible Debenture was due to
mature in June 2003. The Convertible Debenture holders participated in the
private placement at a price that was below the conversion price of the
convertible debt. The Company is evaluating the effects of the
transactions above and may record a charge in the first quarter of 2003.
This charge may be material.
F-25