SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 12 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 31, 2004
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
Commission file number 0-11550
Pharmos Corporation
(Exact name of registrant as specified in its charter)
Nevada 36-3207413
(State or other jurisdiction of (IRS Employer Id. No.)
incorporation or organization)
99 Wood Avenue South, Suite 311
Iselin, NJ 08830
(Address of principal executive offices)
Registrant's telephone number, including area code: (732) 452-9556
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes |X| No |_|.
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |X| No |_|
As of May 6, 2004 the Registrant had outstanding 87,950,878 shares of its
$.03 par value Common Stock.
Part I. Financial Information
Item 1 Financial Statements
Pharmos Corporation
(Unaudited)
Consolidated Balance Sheets
March 31, December 31,
2004 2003
============= =============
Assets
Cash and cash equivalents $ 46,587,961 $ 49,369,250
Research and development grants receivable 1,218,524 681,245
Restricted cash 16,073,617 11,192,312
Debt issuance costs 579,688 967,402
Prepaid expenses and other current assets 470,812 585,020
------------- -------------
Total current assets 64,930,602 62,795,229
Fixed assets, net 1,158,255 1,255,096
Restricted cash -- 4,907,686
Other assets 18,946 20,589
Debt issuance costs -- 29,471
------------- -------------
Total assets $ 66,107,803 $ 69,008,071
============= =============
Liabilities and Shareholders' Equity
Accounts payable $ 2,219,645 $ 3,005,461
Accrued expenses 1,859,834 1,751,200
Warrant liability 990,112 823,029
Accrued wages and other compensation 995,240 1,486,529
Convertible debentures, net 16,181,501 13,702,412
------------- -------------
Total current liabilities 22,246,332 20,768,631
Other liability 10,000 10,000
Convertible debentures, net -- 4,773,339
------------- -------------
Total liabilities 22,256,332 25,551,970
------------- -------------
Commitments and contingencies
Shareholders' equity
Preferred stock, $.03 par value, 1,250,000 shares authorized,
none issued and outstanding -- --
Common stock, $.03 par value; 110,000,000 shares authorized,
87,932,996 and 85,554,016 issued
(excluding $426 (14,189 shares in 2004 and 2003), held in 2,637,990 2,566,621
Treasury) in 2004 and 2003, respectively
Deferred compensation (122,628) (66,660)
Paid in capital 168,280,829 161,960,059
Accumulated deficit (126,944,720) (121,003,919)
------------- -------------
Total shareholders' equity 43,851,471 43,456,101
------------- -------------
Total liabilities and shareholders' equity $ 66,107,803 $ 69,008,071
============= =============
The accompanying notes are an integral part of these consolidated
financial statements.
2
Pharmos Corporation
(Unaudited)
Consolidated Statements of Operations
Three Months Ended March 31,
2004 2003
------------ ------------
Expenses
Research and development, net of grants $ 3,300,930 $ 4,039,065
Selling, general and administrative 1,037,711 852,899
Depreciation and amortization 149,794 171,616
------------ ------------
Total operating expenses 4,488,435 5,063,580
------------ ------------
Loss from operations (4,488,435) (5,063,580)
Other (expense) income
Interest income 163,947 846,511
Other expense (5,291) (18,516)
Derivative (loss)/gain (167,083) 43,365
Interest expense (1,443,939) (306,985)
------------ ------------
Other (expense) income, net (1,452,366) 564,375
------------ ------------
Net loss ($ 5,940,801) ($ 4,499,205)
============ ============
Net loss per share
- basic and diluted ($ .07) ($ .08)
============ ============
Weighted average shares outstanding - basic and diluted 87,522,955 58,303,145
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
3
Pharmos Corporation
(Unaudited)
Consolidated Statements of Cash Flows
Three Months Ended March 31,
2004 2003
------------ ------------
Cash flows from operating activities
Net loss ($ 5,940,801) ($ 4,499,205)
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization 149,794 171,616
Interest expense on convertible debentures converted into
common stock 10,555 --
Reversal of beneficial conversion feature -- (786,000)
Change in the value of warrants 167,083 (43,365)
Amortization of debt discount and issuance costs 1,239,639 53,342
Amortization of fair value of change in convertible debt -- 68,808
Stock options issuances below fair market value 18,032 13,332
Option issuance - consultant compensation 8,823 1,837
Changes in operating assets and liabilities
Research and development grants receivable (537,279) (10,951)
Prepaid expenses and other current assets 114,208 (72,822)
Other assets 1,643 --
Accounts payable (785,816) 26,263
Accrued expenses 108,634 (738,483)
Accrued wages and other compensation (491,289) (3,338)
------------ ------------
Net cash used in operating activities (5,936,774) (5,818,966)
------------ ------------
Cash flows from investing activities
Purchases of fixed assets (52,953) (14,006)
Decrease in restricted cash 26,381 2,199,999
------------ ------------
Net cash (used in) provided by investing activities (26,572) 2,185,993
------------ ------------
Cash flows from financing activities
Proceeds from issuance of common stock
and exercise of options and warrants, net 4,566,673 4,154,086
Repayment of convertible debentures (1,384,616) (3,500,000)
------------ ------------
Net cash provided by financing activities 3,182,057 654,086
------------ ------------
Net decrease in cash and cash equivalents (2,781,289) (2,978,887)
Cash and cash equivalents at beginning of year 49,369,250 19,579,287
------------ ------------
Cash and cash equivalents at end of period $ 46,587,961 $ 16,600,400
============ ============
Supplemental information:
Interest paid $ 192,111 $ 525,448
Supplemental disclosure of non-cash financing activities:
Conversion of convertible debt $ 2,000,000 $ --
Issuance of warrants in connection with the private placement $ -- $ 393,707
The accompanying notes are an integral part of these consolidated
financial statements.
4
Pharmos Corporation
Notes to Condensed Consolidated Financial Statements
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting
principles for interim financial information pursuant to the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the
opinion of management, all adjustments, consisting of normal recurring
accrual adjustments, considered necessary for a fair presentation have
been included. Operating results for the three-month period ended March
31, 2004, are not necessarily indicative of the results that may be
expected for the year ended December 31, 2004.
1. The Company
Pharmos Corporation (the Company or Pharmos) is a bio-pharmaceutical
company that discovers and develops new drugs to treat a range of
neuro-inflammatory disorders. The Company has a portfolio of drug
candidates under development, as well as discovery, preclinical and
clinical capabilities. The Company has executive offices in Iselin, New
Jersey and conducts research and development through its wholly owned
subsidiary, Pharmos, Ltd., in Rehovot, Israel.
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, 2003 and the first
quarter of 2004. During 2001, the Company recorded net income due to the
nonrecurring sale of its ophthalmic product line. At March 31, 2004, the
Company has an accumulated deficit of $126.9 million. Such losses have
resulted principally from costs incurred in research and development and
from general and administrative expenses. 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, and interest
income. Management believes that the current cash and cash equivalents of
$46.6 million as of March 31, 2004, will be sufficient to support the
Company's continuing operations beyond December 31, 2004.
The Company is continuing to actively pursue various funding options,
including additional equity offerings, strategic corporate alliances,
business combinations and the establishment of product related research
and development limited partnerships, to obtain additional financing to
continue the development of its products and bring them to commercial
markets. Should the Company be unable to raise adequate financing or
generate revenue in the future, long-term operations will need to be
scaled back or discontinued.
3. Significant Accounting Policies
Reclassifications
Certain amounts in the consolidated financial statements of the prior
period have been reclassified to conform to the current period
presentation for comparative purposes.
Research and development grants receivable
As of March 31, 2004 and December 31, 2003, other receivables consist
primarily of grants for research and development relating to certain
projects. Participations and grants in respect of research and development
expenses are recognized as a reduction of research and development
expenses as the related costs are incurred.
Restricted cash
In connection with the September 2003 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 generally in proportion
to the amount of Convertible Debentures
5
Pharmos Corporation
Notes to Condensed Consolidated Financial Statements
converted into common shares or in connection with the repayment of the
debt beginning March 2004. The terms of the debentures further stipulates
that the restricted cash can only be used to fund acquisitions upon the
approval of the investors. The short-term balance represents debt
repayment due within 12 months. During the first quarter of 2004, one of
the investors converted a total of $2 million plus interest into shares of
common stock. As part of the escrow agreement, $2 million of restricted
cash was released to the Company during April 2004.
Impairment of Long-Lived Assets
The Company reviews long-lived assets for impairment whenever events or
changes in business circumstances indicate that the carrying amount of the
assets may not be fully recoverable or that the useful lives of these
assets are no longer appropriate. Each impairment test is based on a
comparison of the undiscounted cash flow to the recorded value of the
asset. Subsequent impairment assessments could result in future impairment
charges. Any impairment charge would result in the reduction in the
carrying value of long-lived assets to its fair market value and would
reduce our operating results in the period in which the charge arose.
Equity based compensation
The Company accounts for its employee stock option plans in accordance
with the provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees", and related interpretations.
As such, compensation expense related to employee stock options is
recorded if, on the date of grant, the fair value of the underlying stock
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 has been
applied to these transactions. Options issued to non-employees are valued
using the fair value methodology under SFAS 123.
The following table illustrates the effect on net loss and net loss per
share if the Company had applied the fair value recognition provisions of
SFAS No. 123 to stock-based employee compensation. The estimated fair
value of each option is calculated using the Black-Scholes option-pricing
model.
Quarter End March 31,
2004 2003
---- ----
Net (loss) as reported ($5,940,801) ($4,499,205)
Add: Stock-based employee
compensation expense included in
reported net loss 18,032 13,332
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards ($ 353,102) ($ 237,749)
----------- -----------
Pro forma net (loss) ($6,275,871) ($4,723,622)
=========== ===========
Earnings per share:
Basic and diluted- as reported ($ 0.07) ($ 0.08)
Basic and diluted - pro forma ($ 0.07) ($ 0.08)
For disclosure purposes under SFAS No. 123, the fair value of each option
grant was estimated on the date of grant using the Black-Scholes option
valuation model with the following weighted-average assumption:
Quarter Ended March 31,
2004 2003
---- ----
Risk-free interest rate 3.07 - 3.36 % 2.88 %
Expected lives (in years) 5 5
Dividend yield 0 % 0 %
Expected volatility 88 % 75 %
6
Pharmos Corporation
Notes to Condensed Consolidated Financial Statements
4. Net Loss Per Common Share
Basic and diluted net loss per common share was computed by dividing the
net loss for the period by the weighted average number of shares of common
stock issued and outstanding. In accordance with the requirements of
Statement of Financial Accounting Standards No. 128, common stock
equivalents have been excluded from the calculation of diluted net loss
per common share, as their inclusion would be antidilutive.
The following table summarized the equivalent number of common shares
assuming the related securities that were outstanding as of March 31, 2004
and 2003 had been converted.
2004 2003
---------- ---------
Stock options 4,801,487 4,020,205
Warrants 7,485,234 2,787,693
Shares issuable upon exercise of convertible debt 4,360,243 --
---------- ---------
Total potential dilutive securities not included
in loss per share 16,646,964 6,807,898
========== =========
5. Collaborative Agreements
In June 1995, the Company entered into a marketing agreement (the
Marketing Agreement) with Bausch & Lomb Pharmaceuticals, Inc. (Bausch &
Lomb), a shareholder of the Company, to market Lotemax(R) and Alrex(R), on
an exclusive basis in the United States following receipt of FDA approval.
The Marketing Agreement also covered the Company's other loteprednol
etabonate based product, LE-T. Under the Marketing Agreement, Bausch &
Lomb purchased the active drug substance (loteprednol etabonate) from the
Company. A second agreement, covering Europe, Canada and other selected
countries, was signed in December 1996 (the New Territories Agreement). In
October 2001, the Company sold its ophthalmic product line, including the
Company's rights under the above agreements to Bausch & Lomb.
Sale of Ophthalmic Product line
In October 2001, Bausch & Lomb purchased all rights to the Company's
loteprednol etabonate (LE) ophthalmic product line for cash and assumption
of certain ongoing obligations. The Company received gross proceeds of
approximately $25 million in cash for its rights to Lotemax(R) and
Alrex(R), prescription products that were manufactured and marketed by
Bausch & Lomb under a 1995 Marketing Agreement with the Company. Bausch &
Lomb also acquired future extensions of LE formulations including LE-T, a
product candidate that was submitted to the FDA for marketing approval in
September 2003. 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) 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). Since the Triggering Event
had not occurred as of March 31, 2004, 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 of LE-T
will be obtained. 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 netted against any additional gain recorded.
Under the terms of the October 2001 agreement, which is subject to
renegotiation, upon FDA approval the Company may receive a milestone
payment 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
7
Pharmos Corporation
Notes to Condensed Consolidated Financial Statements
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 payment.
Pharmos agreed to pay up to $3.75 million of the costs of developing LE-T,
of which $600,000 was deducted from the purchase price paid by Bausch &
Lomb in October 2001. Another $1.59 million was paid to Bausch & Lomb in
October 2003, leaving an additional $1.56 million as Pharmos' share of
these research and development related LE-T expenses. This amount is
included in accounts payable at March 31, 2004 and December 31, 2003 and
represents the maximum amount Pharmos owes Bausch & Lomb for their project
development under the terms of the 2001 agreement.
6. Common Stock Transactions
In the first quarter of 2004, the Company issued 8,493 shares of common
stock with gross proceeds of $26,160 pursuant to the Pharmos Corporation
2001 Employee Stock Purchase Plan.
In the first quarter of 2004, the Company issued 86,061 of common stock
with gross proceeds of $172,497 from the exercise of options by employees
and former employees.
In December 2003, the Company completed a public offering. Pharmos sold
10,500,000 common shares at a purchase price of $2.75 per share for gross
proceeds of $28,875,000. The stock was offered in a firm commitment
underwriting pursuant to an existing shelf registration statement. The net
proceeds of this offering to Pharmos were approximately $26.9 million.
During January 2004, the underwriters exercised their over-allotment
option in full to purchase an aggregate of 1,575,000 shares of Pharmos'
common stock at a purchase price of $2.75 per share, less the underwriting
discount. Total net proceeds from the offering, including $4.07 million
from the exercise of the over-allotment option, were approximately $31.0
million.
On May 30, 2003, the Company completed a private placement to sell common
shares and warrants to ten investors, generating total gross proceeds of
$8.0 million. The Company filed a registration statement with the
Securities and Exchange Commission to permit resales of the common stock
by the investors. The private placement offering was completed by issuing
9,411,765 shares of common stock at a price of $0.85 per share
(representing an approximate 20% discount to a ten-day trailing average of
the closing price of the stock ending May 28, 2003) and 3,264,706 warrants
at an exercise price of $1.40 per share, which includes 441,177 placement
agent warrants. Issuance costs of approximately $525,000 in cash and
$240,000 for the value of the placement agent warrants were recorded as a
debit to additional paid in capital. The Company calculated the value of
the warrants, including the placement agent warrants, being approximately
$1,773,000 under the Black-Scholes option pricing method (assumption:
volatility 75%, risk free rate 3.15% and zero dividend yield). In the
first quarter of 2004, one investor exercised 211,764 warrants to purchase
the Company's common stock, resulting in approximately $296,000 gross
proceeds to the Company. As of March 31, 2004, seven of the twelve warrant
holders (ten investors and two placement agents) have exercised 1,911,764
warrants totaling approximately $2,676,000.
On March 4, 2003, the Company completed a private placement to sell common
shares and warrants to eight investors, generating total gross proceeds of
$4.3 million under a shelf registration. The private placement offering
was completed by issuing 5,058,827 shares of common stock at a price of
$0.85 per share (the fair market value on March 4, 2003) and 1,141,182
warrants at an exercise price of $1.25 per share, which includes 129,412
placement agent warrants. Issuance costs of approximately $127,000 in cash
and $45,000 for the value of the placement agent warrants were recorded as
a debit to additional paid in capital. As of March 31, 2004, five of the
nine warrant holders (eight investors and one placement agent) have
exercised 823,533 warrants totaling approximately $1,029,416. According to
EITF 00-19, the issued warrants meet the requirements of and will be
accounted for as a liability since registered shares must be delivered
upon settlement. Initially, the Company calculated the value of the
warrants, including the placement agent warrants, to be approximately
$394,000 under the Black-Scholes option-pricing method (assumption:
volatility 75%, risk free rate 2.88% and zero dividend yield). The value
of the warrants will be marked to market each reporting period until
exercised or expiration and amounted to $990,112 at March 31, 2004. Upon
exercise of each of the warrants, the related liability is reclassified to
additional paid-in-capital. A total of $936,156 was recorded as a credit
to additional paid-in-capital since inception as a result of exercises and
the recording of the initial value of the warrants.
8
Pharmos Corporation
Notes to Condensed Consolidated Financial Statements
7. Private Placement
On September 26, 2003, the Company completed a private placement of
convertible debentures and warrants to six institutional investors,
generating total gross proceeds of $21.0 million. Five million dollars of
the proceeds will be used for working capital purposes, and $16.0 million
will be available to fund acquisitions upon the approval of the investors.
The convertible debentures are convertible into common stock of the
Company at a fixed price of $4.04, 205% above the closing bid price of the
stock for the five days preceding the closing date. The debentures, which
bear an interest rate of 4%, will be redeemed in 13 substantially equal
monthly increments beginning March 31, 2004. In general, amounts converted
into shares of Pharmos common stock will reduce the monthly redemption
amount proportionately. The $16.0 million earmarked for acquisition
activity will be held in escrow until used or repaid. In connection with
the financing, the Company also issued 5,514,705 three-year warrants
(including 514,705 placement agent warrants) to purchase 5,514,705 shares
of common stock at an exercise price of $2.04 per share. Total issuance
costs related to the financing were approximately $1,229,000 in cash and
$434,000 for the value of the placement agent warrants. The issuance costs
allocated to the warrants were recorded as a debit to additional paid in
capital. The placement agent warrants were capitalized and are being
amortized over the life of the debt. The Company calculated the value of
the warrants at the date of the transaction, including the placement agent
warrants, being approximately $4,652,877 under the Black-Scholes
option-pricing method (assumption: volatility 75%, risk free rate 1.59%
and zero dividend yield). The Company allocated the $19.34 million in net
proceeds between the convertible debentures and the warrants based on
their fair values. The Company is reporting the debt discount of
approximately $3.5 million as a direct reduction to the face amount of the
debt in accordance with APB 21. The discount will accrete over the life of
the outstanding debentures. Total accretion of the debt discount in 2004
was approximately $914,721. The issuance costs allocated to the
convertible debentures of approximately $1.4 million are being deferred
and amortized to interest expense over the life of the debt. During the
first quarter of 2004, one of the investors converted a total of $2
million plus interest into 497,662 shares of common stock. As of March 31,
2004, approximately $3.4 million has been either repaid or converted into
common stock of the Company. In conjunction with this conversion, the
relating unamortized debt discount and issuance costs totaling $267,912
were reclassified to additional paid in capital.
As of March 31, 2004, the Convertible Debenture repayment schedule was as
follows:
2004 2005 Total
---- ---- -----
Principal $ 12,769,231 $ 4,846,154 $ 17,615,385
Applicable Discount: (1,365,460) (68,424) (1,433,884)
------------ ------------ ------------
Total, net $ 11,403,771 $ 4,777,730 $ 16,181,501
============ ============ ============
Emerging Issues Task Force Issue No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios, required the Company to compute the Beneficial
Conversion Feature (BCF) of the convertible debt from the private
placement of September 2000. The BCF must be capitalized and amortized
from the closing date until the earliest date that the investors have the
right to convert the debt into common shares. The BCF in 2000 was computed
at approximately $1.8 million, all of which has been amortized and
included as interest expense in the year ending December 31, 2000. Two of
the eight investors of the March 2003 private placement were also holders
of the remaining $3.5 million September 2000 Convertible Debenture
offering, which was ultimately redeemed for approximately $4.0 million,
which includes unpaid and accrued interest. The Convertible Debenture
holders chose not to convert the existing debt to common equity. Instead,
the Convertible Debenture holders opted to be repaid early and participate
in a new round of financing. For the two investors, the sale of the common
stock and warrants reduced the conversion price of the outstanding debt,
which resulted in an additional BCF charge of approximately $2.7 million
during the first quarter ending March 31, 2003. The total related BCF
charge since inception of the debt of $3.5 million was redeemed in the
first quarter of 2003 as a result of the debt being repaid. The impact of
the reversal of the total BCF charge since inception of the debt resulted
in a net credit of $786,000 recorded as interest income during the first
quarter ending March 31, 2003. This accounting treatment in accordance
with EITF 00-27.
9
Pharmos Corporation
Notes to Condensed Consolidated Financial Statements
8. Segment and Geographic Information
The Company is active in one business segment: designing, developing,
selling and marketing pharmaceutical products. The Company maintains
development operations in the United States and Israel. The Company's
selling operations are maintained in the United States.
Geographic information for the three months ending March 31, 2004 and 2003
are as follows:
2004 2003
---- ----
Net loss
United States ($5,824,199) ($3,830,023)
Israel (116,602) (669,182)
----------- -----------
($5,940,801) ($4,499,205)
=========== ===========
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion and analysis of our financial condition and results of
operations contains forward-looking statements that involve risks and
uncertainties. The Company has based these forward-looking statements on our
current expectations and projections of future events. Such statements reflect
our current views with respect to future events and are subject to unknown
risks, uncertainty and other factors that may cause results to differ materially
from those contemplated in such forward looking statements. In addition, the
following discussion should be read in conjunction with the consolidated
financial statements and the related notes thereto included elsewhere in this
report.
Through the end of the third quarter of 2001, the Company generated revenues
from product sales but continues to be dependent upon external financing,
interest income, and research and development contracts to pursue its intended
business activities. The Company had not been profitable from inception through
2000, was not profitable in 2002, 2003, and the first quarter of 2004, and has
incurred a cumulative net loss of $126.9 million through March 31, 2004. In
2001, the Company recorded a profit due to 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."
In mid-March 2004, the Company completed enrollment of U.S. and international
TBI patients in its pivotal, Phase III clinical trial of dexanabinol.
Approximately six months after the completion of enrollment, Pharmos anticipates
completing the clinical trial, as the trial protocol requires periodic
examinations and testing of patients enrolled in the trials during the six
months following their initial treatment. Several months after the completion of
the last patient last follow-up visit, Pharmos plans to unblind the study and
announce the main study results around yearend.
In March 2003, the Company initiated a double-blinded placebo controlled Phase
II trial of dexanabinol as a preventive agent against the cognitive impairment
(CI) that can follow coronary surgery involving cardiopulmonary bypass (CS-CPB)
operations. This trial is being conducted at five leading medical centers in
Israel. The enrollment of up to 200 CS-CPB patients in this trial is expected to
be completed around the end of the second quarter of 2004. The clinical protocol
calls for a final follow-up examination of each patient three months after
enrollment. Allowing time for completion of patient records and preparation of
the database, Pharmos expects to unblind the data and announce the study results
during the fourth quarter of 2004.
Pharmos is advancing the lead candidate from its proprietary platform of
CB2-selective compounds through advanced stages of preclinical development.
Pending successful completion of ongoing preclinical studies, the Company plans
to initiate human testing of PRS-211,375 around year-end by studying its
potential to treat pain in cancer patients.
Results of Operations
Quarters ended March 31, 2004 and 2003
Total operating expenses decreased by $575,145 or 11%, from $5,063,580 in 2003
to $4,488,435 in 2004. In mid-March 2004, the Company completed enrollment of
U.S. and international traumatic brain injury patients in its pivotal, Phase III
clinical trial of dexanabinol. During February 2003, the FDA accepted the
Company's Investigational New Drug application, which allowed the Company to
begin U.S. patient enrollment in the
11
trial. Last year at this time, the Company incurred a significant amount of
resources to commence the clinical trial in the U.S. and to further support
international sites. The decrease in the clinical trial expenses offset higher
salaries and benefits, consultant and professional fees. Consultant fees
increased in 2004 due to expenditures related to the scale up of dexanabinol
synthesis. Also, the Company incurred higher expenses in connection with an
increase in the accrual of accounting fees and legal services in 2004.
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 project is the development of dexanabinol for the treatment of severe
traumatic brain injury (TBI), which is currently involved in Phase III testing
in the U.S., Europe, Australia and Israel. During the first quarter of 2004, the
gross cost of the traumatic brain injury project was $2.8 million. Total costs
since the traumatic brain injury project entered Phase II development in 1996
through March 31, 2004 were $38.2 million. The principal costs of completing the
project include collection and evaluation of the data, production of the drug
substance and drug product, commercial scale-up, and management of the project.
The primary uncertainties in the completion of the project are the results of
the study upon its conclusion, and the Company's ability to produce or secure
production of finished drug product under current Good Manufacturing Practice
conditions for sale in countries in which marketing approval has been obtained,
as well as the resources required to generate sales in such countries. Should
the uncertainties delay completion of the project on the current timetable, the
Company may experience additional costs that cannot be accurately estimated. If
the Phase III trial of dexanabinol for the treatment of severe traumatic brain
injury is successfully completed, the Company can expect to begin to earn
revenues upon marketing approval as early as 2006; 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 2003, the Company initiated a Phase II trial of dexanabinol
as a preventive agent against the cognitive impairment (CI) that can follow
coronary surgery involving cardiopulmonary bypass (CS-CPB) that was approved by
Israel's Ministry of Health. Enrollment of patients undergoing CS-CPB in the
trial is expected to be complete by the second quarter of 2004. During the first
quarter of 2004, the gross cost of patients undergoing CS-CPB was $340,752.
Total costs since the CS-CPB project entered Phase II development in 2003
through March 31, 2004 were $1.2 million.
Gross expenses for other research and development projects in earlier stages of
development for the first quarters of 2004 and 2003 were $443,772 and $483,281,
respectively. Total research and development expenses, net of grants, for the
first quarters of 2004 and 2003 were $3,300,930 and $4,039,065, respectively.
The Company recorded grant receivables from the Office of the Chief Scientist of
Israel's Ministry of Industry and Trade of $816,256 and $328,637 during the
first quarters of 2004 and 2003, respectively, which reduced the research and
development expenses.
Selling, general and administrative expenses increased by $184,812, or 22%, to
$1,037,711 in 2004 from $852,899 in 2003. The increase in selling, general and
administrative expenses is due to higher salaries, professional fees, and
insurance fees by $115,887, $62,285, and $50,398, respectively, in the quarter
compared to the first quarter 2003. The higher professional fees in 2004 are
attributed to higher accounting and legal fees. The directors and officers
policy renewal rate for 2004 increased by 102% due to (generally) higher rates
throughout the insurance industry and to compensate for the insurers' perceived
risk with respect to the outcome of the Phase III TBI trial.
Depreciation and amortization expenses decreased by $21,822, or 13%, from
$171,616 in 2003 to $149,794 in 2004. The decrease is due to some fixed assets
becoming fully depreciated.
Other (expense) income, net, decreased by $2,016,741 from income of $564,375 in
2003 to an expense of $1,452,366 in 2004. Interest expense increased by
$1,136,954 to $1,443,939 in 2004 from $307,000 in 2003. During the first quarter
of 2003, the Company retired the remaining $3.5 million of the outstanding
September 2000 Convertible Debentures which were originally due to mature in
June 2003. In accordance with Emerging
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Issues Task Force Issue No. 98-5, Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios
(BCF), the Company recorded a charge of $1.8 million which was fully amortized
at December 31, 2000 in connection with the issuance of convertible debt with a
favorable conversion feature. In accordance with EITF 00-27, a net credit of
$786,000 was recorded as interest income during the first quarter of 2003 to
reverse the BCF previously recorded which was associated with the remaining
balance of the September 2000 Convertible Debenture offering with a face amount
of $3.5 million which was not converted. During the quarter, the Company
recognized royalties of $3,469 per the licensing agreement with Herbamed, Ltd, a
company controlled by Dr. Haim Aviv, the Company's CEO. Excluding the BCF which
is included in the interest income, interest income increased by $103,436, or
171%, from $60,511 in the first quarter of 2003 to $163,947 in the first quarter
of 2004 as the result of a higher average cash balance.
Liquidity and Capital Resources
While the Company recorded revenues from 1998 until the third quarter of 2001
from the sale of its approved products, it has incurred cumulative operating
losses since its inception and had an accumulated deficit of $126.9 million at
March 31, 2004. 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 Loss
carryforwards, and interest income. Should the Company be unable to raise
adequate financing or generate revenue in the future, operations will need to be
scaled back or discontinued.
The following table describes the Company's liquidity and financial position on
March 31, 2004, and on December 31, 2003:
March 31, 2004 December 31, 2003
Working capital $ 42,684,270 $ 42,026,598
Cash and cash equivalents $ 46,587,961 $ 49,369,250
Restricted cash $ 16,073,617 $ 16,099,998
Current working capital position
As of March 31, 2004, the Company had working capital of $42.7 million
consisting of current assets of $64.9 million and current liabilities of $22.2
million. This represents an increase of $0.7 million from its working capital of
$42.0 million on current assets of $62.8 million and current liabilities of
$20.8 million as of December 31, 2003.
Current and future liquidity position
Management believes that cash and cash equivalents of $46.6 million as of March
31, 2004, will be sufficient to support the Company's continuing operations
beyond December 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.
Cash and investments
At March 31, 2004, cash and cash equivalents, including restricted cash of $16.1
million totaled $62.7 million. At December 31, 2003 cash and cash equivalent,
including restricted cash of $16.1 million totaled $65.5 million. This decrease
in cash of $2.8 million was principally due to cash used in the Company's
operations. The cash, cash equivalents and restricted cash will be used to
finance future growth, capital expenditures and
13
repayment of debt.
As part of the September 2003 financing, the Company received a total of $16.0
million of restricted cash held in escrow, which will remain in escrow until
either the Company's convertible debentures are converted into common shares of
the Company by the investor or by the Company, or such funds are repaid by the
Company or are used to fund acquisition(s) approved by the investors. To date,
approximately $3.38 million has either been converted into common shares of the
Company's stock or repaid.
Operating activities
Net cash used in operating activities for the first quarter of 2004 was $5.9
million compared to $5.8 million for the first quarter of 2003. The increase is
due principally to the higher expenses related to the completed enrollment of
U.S. and international TBI patients in its pivotal Phase III clinical trial of
dexanabinol.
Capital expenditures
Our capital expenditures for property, plant and equipment for the first three
months of 2004 and 2003 totaled approximately $53,000 and $14,000, respectively
for normal replacements and improvements.
Financing activities
During the first quarter of 2004, one of the investors from the September 2003
Convertible Debentures private placement converted a total of $2 million plus
interest into 497,662 shares of common stock of the Company. As part of the
escrow agreement, $2 million of restricted cash was released to the Company
during April 2004. As of March 31, 2004, the Company repaid approximately $1.38
million of the September 2003 Convertible Debentures. The remaining Convertible
Debenture balance of $17.6 million will be repaid in equal monthly installments
by March 2005.
Executive stock trading program
During April 2004, Pharmos Corporation's President and Chief Operating Officer,
Dr. Gad Riesenfeld, and one of its directors, Dr. Elkan Gamzu, separately
adopted pre-arranged stock trading plans in accordance with guidelines specified
by Rule 10b5-1 under the Securities Exchange Act of 1934.
Rule 10b5-1 permits officers and directors of public companies to adopt
pre-determined plans for selling specified amounts of stock. The plans may be
entered into only when the director or officer is not in possession of material,
non-public information and may be used to gradually diversify investment
portfolios over a period of time.
Dr. Riesenfeld and Dr. Gamzu have each made their first sale of stock pursuant
to their 10b5-1 plans. Dr. Riesenfeld exercised stock options and sold 12,882
shares on April 19, 2004, and Dr. Gamzu exercised stock options and sold 2,500
shares on April 15, 2004. Under the terms of Dr. Riesenfeld's plan, he may,
prior to April 19, 2005, exercise stock options and/or warrants and sell, on a
monthly basis, up to an aggregate of 154,583 shares (including the 12,882 shares
already sold), which represents approximately 23% of the total number of shares,
warrants and options he currently holds. Under the terms of Dr. Gamzu's plan, he
may, prior to April 15, 2005, exercise stock options and sell, on a monthly
basis, up to an aggregate of 75,000 shares (including the 2,500 shares already
sold), which represents approximately 65% of the total number of shares,
warrants and options he currently holds.
In October 2001, Bausch & Lomb Pharmaceuticals, Inc. (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
14
Marketing Agreement with the Company; in addition, Bausch & Lomb also acquired
future extensions of LE formulations including LE-T, a product that was
submitted to the FDA for marketing approval in September 2003. 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.
Pharmos agreed to pay up to $3.75 million of the costs of developing LE-T, of
which $600,000 was deducted from the purchase price paid by Bausch & Lomb in
October 2001. In July 2003, the Company paid Bausch & Lomb $1.59 million of its
liability for the LE-T development. As of March 31, 2004, Pharmos owes an
additional $1.56 million as its share of these research and development related
LE-T expenses. This amount is included as part of accounts payable at March 31,
2004, and represents the maximum amount Pharmos owes Bausch & Lomb. As a result
of this transaction, the Company recorded a net gain of $16.3 million during the
fourth quarter of 2001. The Company incurred transaction and royalty costs of
approximately $2 million. The Company also compensated the LE patent owner
approximately $2.7 million ($1.5 million paid upon closing and $1.2 million 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.
As of March 31, 2004, the Company had the following contractual commitments and
long-term obligations:
Payments Due by Period
Less than 1 1 - 3 4 - 5 After
Total Year Years Years 5 Years
Operating Leases $ 533,202 $ 274,794 $ 135,539 $ 45,457 $ 77,413
Other Long-Term Obligations
(excluding debt discount) 17,615,385 17,615,385 -- -- --
R&D Commitments 1,290,631 1,290,631 -- -- --
----------- ----------- ----------- ----------- -----------
Total $19,439,219 $19,180,810 $ 135,539 $ 45,457 $ 77,413
=========== =========== =========== =========== ===========
On September 26, 2003, the Company completed a private placement of convertible
debentures and warrants with six institutional investors, generating total gross
proceeds of $21.0 million. The convertible debentures are convertible into
common stock of the Company at a fixed price of $4.04, 205% above the closing
bid price of the stock for the five days preceding the closing date. The
debentures, which bear an interest rate of 4%, will be redeemed in 13 equal
monthly increments beginning March 31, 2004. As of March 31, 2004, debentures
totaling approximately $3.4 million were either repaid or converted into common
stock of the Company.
The R&D commitments represent scheduled professional fee payments for clinical
services relating to the Phase III clinical study of dexanabinol for severe
traumatic brain injury. One of the clinical service based agreements, if fully
executed, currently totals $11.1 million and is not committed beyond 2004.
Through March 31, 2004, the Company has recorded $9.6 million as an expense.
The Company has assessed its vulnerability to certain market risks, including
interest rate risk associated with financial instruments included in cash and
cash equivalents and our convertible debentures. Due to the relatively
short-term nature of these investments the Company has determined that the risks
associated with interest rate fluctuations related to these financial
instruments do not pose a material risk to us.
15
Statements made in this document related to the development, commercialization
and market expectations of the Company's drug candidates, to the establishment
of corporate collaborations, and to the Company's operational projections are
forward-looking and are made pursuant to the safe harbor provisions of the
Securities Litigation Reform Act of 1995. Such statements involve risks and
uncertainties, which may cause results to differ materially from those set forth
in these statements. Among the factors that could result in a materially
different outcome are the inherent uncertainties accompanying new product
development, action of regulatory authorities and the results of further trials.
Additional economic, competitive, governmental, technological, marketing and
other factors identified in Pharmos' filings with the Securities and Exchange
Commission could affect such results.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Please refer to the second to last paragraph in the foregoing section,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures: An evaluation of
Pharmos' disclosure controls and procedures (as defined in
section13(a) - 14(c) of the Securities Exchange Act of 1934 (the
"Act")) was carried out under the supervision and with the
participation of Pharmos' Chief Executive Officer and Chief
Financial Officer and several other members of Pharmos' senior
management at March 31, 2004. Pharmos' Chief Executive Officer and
Chief Financial Officer concluded that Pharmos' disclosure controls
and procedures as currently in effect are effective in ensuring that
the information required to be disclosed by Pharmos in the reports
it files or submits under the Act is (i) accumulated and
communicated to Pharmos' management (including the Chief Executive
Officer and Chief Financial Officer) in a timely manner, and (ii)
recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms.
(b) Changes in Internal Controls: There were no changes in Pharmos'
internal controls or in other factors that could significantly
affect those controls subsequent to the date of their most recent
evaluation.
16
Part II
Other Information
Item 1 Legal Proceedings NONE
Item 2 Changes in Securities
On January 5, 2004, the Company announced that C.E. Unterberg, Towbin and
Harris Nesbitt Gerard, the underwriters for Pharmos' December 19, 2003 public
offering, exercised their over-allotment option in full to purchase an aggregate
of 1,575,000 shares of Pharmos' common stock at a purchase price of $2.75 per
share, less the underwriting discount. The option was offered in connection with
a previously announced firm commitment underwriting pursuant to an existing
shelf registration statement. Total net proceeds from the offering, including
$4.07 million from the exercise of the over-allotment option, were approximately
$31.1 million.
Proceeds from the offering were used to for general corporate purposes,
research and product development activities (potentially including the
acquisition of new technologies), conducting preclinical studies and clinical
trials, and for the equipping of facilities.
Item 3 Defaults upon Senior Securities NONE
Item 4 Submissions of Matters to Vote of Security Holders NONE
Item 5 Other Information NONE
Item 6 Exhibits and Reports on Form 8-K
(a) Exhibits
Number Exhibit
-------- --------
31.1 Certification of Chief Executive Officer pursuant to Exchange
Act Rules 13a-14(a) and 15(d)-14(a), adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to Exchange
Act Rules 13a-14(a) and 15(d)-14(a), adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
17
(b) Reports on Form 8-K
Current Report filed on January 5, 2004; Item 5 was reported, The
underwriters have exercised their over-allotment option in full to
purchase an aggregate of 1,575,000 shares
Current Report filed on March 25, 2004; Item 5 was reported, Resignation
of the Chief Financial Officer
Current Report filed on April 22, 2004; Item 5 was reported, Adoption of
certain pre-arranged stock trading plans in accordance with guidelines
specified by Rule10b5-1 under the Securities Exchange Act of 1934
18
SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHARMOS CORPORATION
Dated: May 7, 2004
by: /s/ Alon Michal
---------------
Alon Michal
Acting Chief Financial Officer
(Principal Accounting and
Financial Officer)
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