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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 September 30, 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 November 1, 2004 the Registrant had outstanding 94,304,001 shares of its
$.03 par value Common Stock.
Part I. Financial Information
Item 1 Financial Statements
Pharmos Corporation
(Unaudited)
Consolidated Balance Sheets
================================================================================
September 30, December 31,
2004 2003
============= =============
Assets
Cash and cash equivalents $ 51,486,553 $ 49,369,250
Restricted cash 9,369,679 11,192,312
Research and development grants receivable 1,750,626 681,245
Debt issuance costs 152,799 967,402
Prepaid expenses and other current assets 535,960 585,020
------------- -------------
Total current assets 63,295,617 62,795,229
Fixed assets, net 1,050,397 1,255,096
Restricted cash -- 4,907,686
Other assets 18,944 20,589
Debt issuance costs -- 29,471
------------- -------------
Total assets $ 64,364,958 $ 69,008,071
============= =============
Liabilities and Shareholders' Equity
Accounts payable $ 2,210,915 $ 3,005,461
Accrued expenses 1,628,906 1,751,200
Warrant liability 679,451 823,029
Accrued wages and other compensation 1,310,648 1,486,529
Convertible debentures, net 8,955,556 13,702,412
------------- -------------
Total current liabilities 14,785,476 20,768,631
Other liability 32,978 10,000
Convertible debentures, net -- 4,773,339
------------- -------------
Total liabilities 14,818,454 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; 150,000,000 shares authorized,
94,149,001 and 85,568,205 issued, in 2004 and 2003, respectively 2,824,471 2,567,047
Deferred compensation (1,994,813) (66,660)
Paid in capital 186,890,202 161,960,059
Accumulated deficit (138,172,930) (121,003,919)
Treasury stock, at cost 14,189 shares in 2004 and 2003, respectively (426) (426)
------------- -------------
Total shareholders' equity 49,546,504 43,456,101
------------- -------------
Total liabilities and shareholders' equity $ 64,364,958 $ 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 September 30,
2004 2003
------------ ------------
Expenses
Research and development, net of grants $3,778,934 $2,598,758
Selling, general and administrative 1,739,679 931,066
Depreciation and amortization 143,300 165,293
------------ ------------
Total operating expenses 5,661,913 3,695,117
------------ ------------
Loss from operations (5,661,913) (3,695,117)
Other expense
Interest income 147,294 52,629
Other expense, net (16,770) (19,625)
Derivative gain (loss) 345,284 (457,090)
Interest expense (756,804) (69,813)
------------ ------------
Other expense, net (280,996) (493,899)
------------ ------------
Net loss ($5,942,909) ($4,189,016)
============ ============
Net loss per share
- basic and diluted ($.07) ($.06)
============ ============
Weighted average shares outstanding - basic and diluted 90,754,695 71,083,346
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
3
Pharmos Corporation
(Unaudited)
Consolidated Statements of Operations
- --------------------------------------------------------------------------------
Nine Months Ended September 30,
2004 2003
------------ ------------
Expenses
Research and development, net of grants $9,576,872 $8,955,387
Selling, general and administrative 4,490,024 2,535,997
Depreciation and amortization 443,370 505,486
------------ ------------
Total operating expenses 14,510,266 11,996,870
------------ ------------
Loss from operations (14,510,266) (11,996,870)
Other expense
Interest income 450,143 948,045
Other expense, net (8,086) (44,346)
Derivative gain (loss) 143,577 (1,529,636)
Interest expense (3,244,379) (379,533)
------------ ------------
Other expense, net (2,658,745) (1,005,470)
------------ ------------
Net loss ($17,169,011) ($13,002,340)
============ ============
Net loss per share
- basic and diluted ($.19) ($.20)
============ ============
Weighted average shares outstanding - basic and diluted 88,772,297 64,789,797
============ ============
The accompanying notes are an integral part of these consolidated
financial statements.
4
Pharmos Corporation
(Unaudited)
Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------
Nine Months Ended September 30,
2004 2003
------------ ------------
Cash flows from operating activities
Net loss ($17,169,011) ($13,002,340)
Adjustments to reconcile net loss to net:
cash used in operating activities:
Depreciation and amortization 443,370 505,486
Interest expense on convertible debentures converted into
common stock 10,555 --
Reversal of beneficial conversion feature -- (786,000)
Change in the value of warrants (143,577) 1,529,636
Amortization of debt discount and issuance costs 2,748,274 111,929
Amortization of fair value of change in convertible debt -- 68,808
Amortization of stock options issuances below fair market
value 53,936 39,996
Option expense - consultant compensation 558,206 32,472
Amortization of restricted shares issuance 91,913 --
Changes in operating assets and liabilities:
Research and development grants receivable (1,069,381) 193,701
Prepaid expenses and other current assets 49,060 (3,952)
Other assets 1,645 (10,250)
Accounts payable (794,546) (1,327,866)
Accrued expenses (122,294) 167,577
Accrued wages and other compensation (175,881) 4,581
Other liabilities 22,978 --
------------ ------------
Net cash used in operating activities (15,494,753) (12,476,222)
------------ ------------
Cash flows from investing activities
Purchases of fixed assets (238,671) (56,698)
Decrease (increase) in restricted cash 6,730,319 (18,800,001)
------------ ------------
Net cash provided by (used in) investing activities 6,491,648 (18,856,699)
------------ ------------
Cash flows from financing activities
Proceeds from issuance of common stock
and exercise of options and warrants, net of issuance costs 20,812,716 12,080,090
Proceeds from issuance of convertible debentures
and warrants, net of issuance costs -- 19,620,936
Repayment of convertible debentures (9,692,308) (3,500,000)
------------ ------------
Net cash provided by financing activities 11,120,408 28,201,026
------------ ------------
Net increase (decrease) in cash and cash equivalents 2,117,303 (3,131,895)
Cash and cash equivalents at beginning of year 49,369,250 19,579,287
------------ ------------
Cash and cash equivalents at end of period $51,486,553 $16,447,392
============ ============
Supplemental information:
Interest paid $479,828 $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.
5
Pharmos Corporation
Unaudited Notes to Consolidated Financial Statements
Basis of Presentation
The accompanying unaudited 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 and cash flows for the three month and nine
month periods ended September 30, 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 in clinical trials and 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
three quarters of 2004. During 2001, the Company recorded net income due
to the nonrecurring sale of its ophthalmic product line. At September 30,
2004, the Company has an accumulated deficit of $138.2 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, grants from the Chief Scientist of Israel, research contracts, the
sale of a portion of our New Jersey net operating loss carryforwards, and
interest income. Management believes that the current cash and cash
equivalents, excluding restricted cash, of $51.5 million, as of September
30, 2004, will be sufficient to support the Company's continuing
operations beyond September 30, 2005.
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. A requirement by the FDA for further
significant clinical testing after the completion of the current pivotal
Phase III clinical trial (such as could be detailed in an approvable
letter) or a rejection of our NDA (such as a either a non acceptance of
filing or a non approvable letter) could have a material adverse effect on
Pharmos and its operations.
3. Significant Accounting Policies
Reclassifications
Certain amounts in the consolidated financial statements of prior periods
have been reclassified to conform to the current period presentation for
comparative purposes.
Research and development grants receivable
As of September 30, 2004 and December 31, 2003, research and development
grant receivables consist of grants for research and development relating
to certain projects. Research and development grants are recognized as a
reduction of research and development expenses.
6
Pharmos Corporation
Unaudited Notes to Consolidated Financial Statements
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 escrow 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 converted into common shares or in
connection with the repayment of the debt that began in March 2004. The
terms of the debentures further stipulate 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. In addition, the Company repaid the debenture holders
approximately $9.7 million from its cash and cash equivalents account
during the nine months ended September 30, 2004. The escrow agreement
stipulates that the Company repay the debenture holders the first $5.0
million from its cash and cash equivalents.
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 its 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 (as amended
by SFAS 148) has been applied to these transactions. Options issued to
non-employees are valued using the fair value methodology under SFAS 123.
7
Pharmos Corporation
Unaudited Notes to Consolidated Financial Statements
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.
Three months ended Nine months ended
September 30, September 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net (loss) as reported ($5,942,909) ($4,189,016) ($17,169,011) ($13,002,340)
Add: Stock-based employee
compensation expense included in
reported net loss 109,865 13,332 145,849 39,996
Deduct: Total stock-based
employee compensation expense
determined under fair value based
method for all awards (466,715) (260,027) (1,172,919) (758,429)
------------ ------------ ------------ ------------
Pro forma net (loss) ($6,299,759) ($4,435,711) ($18,196,081) ($13,720,773)
============ ============ ============ ============
Earnings per share:
Basic and diluted- as reported ($.07) ($.06) ($.19) ($.20)
Basic and diluted - pro forma ($.07) ($.06) ($.20) ($.21)
For disclosure purposes under SFAS No. 123, the fair value of each option
grant was estimated on the date of grant using the Black-Scholes option
valuation model with the following weighted-average assumption:
Three months ended, September 30 Nine months ended, September 30
2004 2003 2004 2003
---- ---- ---- ----
Risk-free interest rate 3.69% 3.15% 3.07% - 3.69% 2.88 - 3.15%
Expected lives (in years) 5 5 5 5
Dividend yield 0% 0% 0% 0%
Expected volatility 87% 75% 87 - 88% 75%
New Accounting Pronouncement
In July 2004, the EITF issued a draft abstract for EITF Issue No. 04-08,
"The Effect of Contingently Convertible Debt on Diluted Earnings per
Share" ("EITF 04-08"). EITF 04-08 reflects the Task Force's conclusion
that contingently convertible debt should be included in diluted earnings
per share computations regardless of whether the market price trigger has
been met. The adoption of this statement is not expected to impact to the
Company's financial statement presentation as the Company is in a loss
position.
In March 2004, the Emerging Issues Task Force issued EITF 03-6,
"Participating Securities and the Two-Class Method under FASB Statement
No. 128". This statement provides additional guidance on the calculation
and disclosure requirements for earnings per share. The FASB concluded in
EITF 03-6 that companies with multiple classes of common stock or
participating securities, as defined by SFAS No. 128, calculate and
disclose earnings per share based on the two-class method. The adoption of
this statement does not have an impact to the Company's financial
statement presentation as the Company is in a loss position.
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.
8
Pharmos Corporation
Unaudited Notes to Consolidated Financial Statements
The following table summarized the equivalent number of common shares
assuming the related securities that were outstanding as of September 30,
2004 and 2003 had been converted.
2004 2003
---------- ----------
Stock options 5,329,967 3,960,955
Warrants 6,806,440 11,254,529
Shares issuable upon exercise of convertible debt 2,331,862 5,198,023
Restricted stock - non vested 632,912 --
---------- ----------
Total potential dilutive securities not included
in loss per share 15,101,181 20,413,507
========== ==========
5. Collaborative Agreements
In June 1995, the Company entered into a marketing agreement (the
Marketing Agreement) with Bausch & Lomb Pharmaceuticals, Inc. (Bausch &
Lomb) 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 September 30, 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 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 September 30, 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.
9
Pharmos Corporation
Unaudited Notes to Consolidated Financial Statements
6. Common Stock Transactions
In the first nine months of 2004, the Company issued 9,493 shares of
common stock with gross proceeds of $28,998 pursuant to the Pharmos
Corporation 2001 Employee Stock Purchase Plan. In the first nine months of
2004, the Company issued 288,274 shares of common stock with gross
proceeds of $460,380 from the exercise of options by employees, former
employees and consultants. In the first nine months of 2004, the Company
incurred a non-cash charge of approximately $558,000 for extending the
stock option exercise period to its former chief financial officer, in
return for consulting services and the issuance of options for certain
other consultants. During the quarter ended September 30, 2004, the
Company recorded a non-cash charge of $147,000 for the stock options.
On September 6, 2004, the Board of Directors approved the Retention Award
Agreements and Pharmos entered into Retention Award Agreements with each
of Dr. Haim Aviv, Chairman and Chief Executive Officer, and Dr. Gad
Riesenfeld, President and Chief Operating Officer. The Company granted
retention awards of $300,000 cash and 379,747 restricted stock units to
Dr. Aviv and $200,000 cash and 253,165 shares of restricted stock to Dr.
Riesenfeld (the Awards). One half of the Awards shall vest or are
scheduled to vest and become non-forfeitable on December 31, 2005, and the
balance shall vest and become non-forfeitable on June 30, 2007, subject to
certain accelerated vesting provisions. The fair value of the restricted
shares was based on the fair value of the stock on the issuance date. The
aggregate fair value of the restricted stock awards totaled $2 million.
For financial reporting purposes, the cash awards and the fair value of
the restricted stock awards, which totaled $2,500,000, will be expensed
pro rata over the vesting periods. During the quarter ended September 30,
2004, the Company recorded an expense of $115,000 in connection with the
Awards.
On August 20, 2004, the Company completed a private placement to sell
common shares to six investors, generating total gross proceeds of $16.75
million. An aggregate of 5,583,334 shares of common stock were issued
utilizing a shelf registration of Pharmos' securities declared effective
by the Securities and Exchange Commission in December 2003 and was priced
at $3.00 per share. Issuance costs of approximately $1,048,177 were
recorded as a reduction of additional paid in capital. Proceeds from this
offering were used to fund the Company's advanced Phase III development of
dexanabinol for traumatic brain injury, Phase II trial for prevention of
post-surgical cognitive impairment and other research and development
activities.
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 nine months of 2004, two investors exercised 247,058 warrants to
purchase the Company's common stock, resulting in approximately $345,882
gross proceeds to the Company. As of September 30, 2004, seven of the
twelve warrant holders (ten investors and two placement agents) have
exercised 1,947,058 warrants totaling approximately $2,726,000.
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
10
Pharmos Corporation
Unaudited Notes to Consolidated Financial Statements
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 totaled approximately $127,000 in
cash and $45,000 for the value of the placement agent warrants. As of
September 30, 2004, five of the nine warrant holders (eight investors and
one placement agent) have exercised 823,533 warrants totaling
approximately $1,029,416. There were no exercises during 2004. 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 $679,451 at September 30, 2004.
Upon exercise of each of the warrants, the related liability is
reclassified to additional paid-in-capital and any gain or loss is
recorded in the consolidated statement of operations. In connection with
warrant exercises to date, a total of $936,154 has been reclassified to
additional paid-in-capital.
7. Private Placement of Convertible Debt
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 reduction 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 $1,981,421. 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. In conjunction
with this conversion, the relating unamortized debt discount and issuance
costs totaling $267,912 was reclassified to additional paid in capital. As
of September 30, 2004, approximately $11.7 million has been either repaid
or converted into common stock of the Company. As of September 30, 2004,
one of the six warrant holders exercised 100,000 warrants totaling
approximately $204,000.
As of September 30, 2004, the Convertible Debenture repayment schedule was
as follows:
2004 2005 Total
----------- ----------- -----------
Principal $4,461,538 $4,846,154 $9,307,692
Applicable Discount: (283,712) (68,424) (352,136)
----------- ----------- -----------
Total, net $4,177,826 $4,777,730 $8,955,556
=========== =========== ===========
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
11
Pharmos Corporation
Unaudited Notes to Consolidated Financial Statements
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 is in accordance
with EITF 00-27.
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 and nine months ending September 30,
2004 and 2003 are as follows:
Three months ended Nine months ended
September 30, September 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Net loss
United States ($5,824,145) ($4,051,336) ($16,837,447) ($12,581,944)
Israel (118,764) (137,680) (331,564) (420,396)
------------ ------------ ------------ ------------
($5,942,909) ($4,189,016) ($17,169,011) ($13,002,340)
============ ============ ============ ============
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This discussion and analysis of our financial condition and results of
operations contains forward-looking statements that involve risks and
uncertainties. 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 three quarters of 2004,
and has incurred a cumulative net loss of $138.2 million through September 30,
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. Six months
after the completion of enrollment, Pharmos completed patient follow up, as the
trial protocol requires periodic examinations and testing of patients enrolled
in the trial during the six months following their initial treatment. Allowing
time for completion of patient records and preparation of the database, Pharmos
plans to unblind the study and announce the main study results around year-end.
The FDA Modernization Act of 1997 permits but does not obligate the FDA to
approve a drug based on data from one adequate and well-controlled trial along
with confirmatory evidence of efficacy. Because of the seriousness of traumatic
brain injury and the fact that there are no FDA-approved drugs for treatment of
TBI, our development plan of dexanabinol for TBI provides for submitting a New
Drug Application (NDA) to the FDA based on one successful pivotal study.
Assuming a successful pivotal trial, such a single trial strategy could lead to
the FDA granting unconditional approval or conditional approval requiring
post-marketing testing or concluding that further clinical testing, modest or
significant in scope, would be required for approval. A requirement by the FDA
for further significant clinical testing after the completion of the current
pivotal Phase III clinical trial (such as could be detailed in an approvable
letter) or a rejection of our NDA (such as a either a non acceptance of filing
or a non approvable letter) could have a material adverse effect on Pharmos and
its operations.
In mid-July 2004, the Company completed enrollment of 202 patients in its
exploratory 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. 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 PRS-211,375 from its proprietary
platform of CB2-selective synthetic cannabinoid compounds through advanced
stages of preclinical development. The compounds were designed
13
to reduce the side effects caused by natural cannabinoids and to improve their
efficacy as analgesics to treat moderate to severe pain and as anti-inflammatory
agents for conditions like multiple sclerosis and rheumatoid arthritis. Using
both rodents and large animals, pharmacological efficacy of PRS-211,375 has been
demonstrated in animal models of a number of indications. Safety and toxicology
studies of a range of doses in monkeys are ongoing. Pending successful
completion of preclinical studies, the Company plans to initiate human testing
of PRS-211,375 during the first half of 2005 by studying its potential to treat
pain resulting from a number of sources such as cancer and inflammation.
Results of Operations
Quarters ended September 30, 2004 and 2003
Total operating expenses increased by $1,996,796 or 53%, to $5,661,913 in 2004
from $3,695,117 in 2003. With the nearing completion of the pivotal dexanabinol
trial in TBI, increasing resources have been allocated to manufacturing
activities that are required for submission in an NDA. Pre-clinical activities
for PRS,211-375 increased substantially during the current quarter over 2003 in
preparation of beginning human clinical trials in 2005. The Company incurred
higher consulting and professional fees in connection with an increase in
accounting fees, including Sarbanes-Oxley compliance, legal services,
amortization of deferred compensation from the Retention Award Agreements, and
non-cash stock option charges in 2004.
Major differences in quarterly operating expenses year-over-year include
decreased costs for the Phase II and Phase III clinical trials of dexanabinol
which were more than offset by increased costs for chemical, manufacturing and
control and scale up of dexanabinol synthesis and for late stage preclinical
development activities for PRS,211-375. Clinical trial expenditures decreased
due to completion of enrollment in mid-March and evaluation in mid-September of
U.S. and international traumatic brain injury patients in its pivotal, Phase III
clinical trial of dexanabinol. Additionally, patient enrollment was completed in
mid-July in the exploratory Phase II trial of dexanabinol as a preventative
agent against CI in CS-CPB operations.
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
lead project is the development of dexanabinol for the treatment of severe
traumatic brain injury (TBI), which has completed patient follow up in Phase III
testing in the U.S., Europe, Australia and Israel. During the third quarter of
2004, the gross cost of the TBI project was $2.0 million. Total costs since the
TBI project entered Phase II development in 1996 through September 30, 2004 were
$42.3 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 a successful
Phase III trial of dexanabinol for the treatment of severe TBI is sufficient for
approval, the Company may begin to earn revenues upon marketing approval as
early as 2006; however, should our product candidate require additional clinical
trials creating additional financial and time burdens or should the 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. Patient enrollment was completed in mid-July 2004.
During the third quarter of 2004, the gross cost of patients undergoing CS-CPB
was $512,935. Total costs since the CS-CPB project entered Phase II development
in 2003 through September 30, 2004 were $2.0 million.
14
Gross expenses for other research and development projects in early stages of
development for the third quarters of 2004 and 2003 were $1,741,596 and
$308,755, respectively. Total research and development expenses, net of grants,
for the third quarters of 2004 and 2003 were $3,778,934 and $2,598,758,
respectively. The Company recorded research and development grant receivables
from the Office of the Chief Scientist of Israel's Ministry of Industry and
Trade of $1,032,813 and $866,986 during the third quarters of 2004 and 2003,
respectively, which reduced the research and development expenses.
Selling, general and administrative expenses increased by $808,613, or 87%, to
$1,739,679 in 2004 from $931,066 in 2003. The majority of the increase in
selling, general and administrative expenses is due to higher professional fees,
consultants, and salaries by $367,524, $296,905, and $75,075, respectively, in
the quarter compared to the third quarter 2003. The increase in salaries was
attributed to an increase in headcount and the amortization of deferred
compensation from the Retention Award Agreements. The higher professional fees
in 2004 are attributed to increased accounting fees, preparation of
Sarbanes-Oxley compliance related, and personnel recruitment fees. The Company
granted stock options to certain key consultants during the current quarter
which resulted in higher consulting fees.
Depreciation and amortization expenses decreased by $21,993, or 13%, from
$165,293 in 2003 to $143,300 in 2004. The decrease is due to some fixed assets
becoming fully depreciated.
Other expense, net, decreased by $212,903 from $493,899 in 2003 to $280,996 in
2004. Interest expense increased by $686,991 to $756,804 in 2004 from $69,813 in
2003. The 2004 interest expense is based on three months of interest associated
with the remaining balance of the $21.0 million September 2003 Convertible
Debenture financing as compared to the Debentures being outstanding for only
four days in 2003. During the quarter, the Company recorded in other income
royalties of $59 per the licensing agreement with Herbamed, Ltd, a company
controlled by Dr. Haim Aviv, the Company's CEO. Interest income increased by
$94,665, or 180%, to $147,294 in 2004 from $52,629 in 2003 as a result of a
higher average cash balance.
Nine Months ended September 30, 2004 and 2003
Total operating expenses increased by $2,513,396 or 21%, to $14,510,266 in 2004
from $11,996,870 in 2003. With the nearing completion of the pivotal dexanabinol
trial in TBI, increasing resources have been allocated to manufacturing
activities that are required for submission in an NDA. Pre-clinical activities
for PRS,211-375 increased substantially in 2004 over 2003 in preparation of
beginning human clinical trials in 2005. The Company incurred higher consulting
and professional fees in connection with an increase in non-cash stock option in
2004, accounting fees, including Sarbanes-Oxley compliance, legal services, and
amortization of deferred compensation from the Retention Award Agreements which
is included in salaries. Major differences in operating expenses year-over-year
include decreased costs for the Phase II and Phase III clinical trials of
dexanabinol which were more than offset by increased costs for chemical,
manufacturing and control and scale up of dexanabinol synthesis and for late
stage preclinical development activities for PRS,211-375. Clinical trial
expenditures decreased due to completion of enrollment in mid-March and
evaluation in mid-September of U.S. and international traumatic brain injury
patients in its pivotal, Phase III clinical trial of dexanabinol. Additionally,
patient enrollment was completed in mid-July in the exploratory Phase 2 trial of
dexanabinol as a preventative agent against CI in CS-CPB operations. 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 lead
project is the development of dexanabinol for the treatment of severe TBI, which
has completed patient follow up in Phase III testing in the U.S., Europe,
Australia and Israel. During the first nine months of 2004, the gross cost of
the TBI project was $6.8 million. Total costs since the TBI project entered
Phase II development in 1996 through September 30, 2004 were $42.3 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
15
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 TBI is sufficient for approval, the Company may
begin to earn revenues upon marketing approval as early as 2006; however, should
our product candidate require additional clinical trials creating additional
financial and time burdens 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 CI that can follow coronary surgery involving
CS-CPB that was approved by Israel's Ministry of Health. Enrollment of patients
undergoing CS-CPB in the trial was completed in July 2004. During the nine
months of 2004, the gross cost of patients undergoing CS-CPB was $1,198,190.
Total costs since the CS-CPB project entered Phase II development in 2003
through September 30, 2004 were $2.0 million.
Gross expenses for other research and development projects in earlier stages of
development for the first nine months of 2004 and 2003 were $2,666,660 and
$1,174,558 respectively. Total research and development expenses, net of grants,
for the first nine months of 2004 and 2003 were $9,576,872 and $8,955,387,
respectively. The Company recorded research and development grant receivables
from the Office of the Chief Scientist of Israel's Ministry of Industry and
Trade of $2,739,958 and $2,271,838 during the first nine months of 2004 and
2003, respectively, which reduced the research and development expenses.
Selling, general and administrative expenses increased by $1,954,027, or 77%, to
$4,490,024 in 2004 from $2,535,997 in 2003. The Company recorded non-cash
charges, which are reflected in the numbers below, of approximately $494,000 of
stock options and $92,000 for the Retention Award Agreements. The majority of
the increase in selling, general and administrative expenses is due to higher
consultant fees, professional fees, salaries, and insurance fees by $700,538,
$545,134, $329,541, and $149,787, respectively, in the first nine months
compared to the same period in 2003. The higher consulting fees in 2004 are
attributed to the Company incurring a non-cash charge of approximately $423,000
for extending the stock option exercise period to the Company's former chief
financial officer. The higher professional fees in 2004 are attributed to
increased legal, accounting, Sarbanes-Oxley compliance, and personnel
recruitment fees. The increase in salaries was attributed to an increase in
headcount and the amortization of deferred compensation from the Retention Award
Agreements. Insurance renewals were higher reflecting insurance industry trends
and increased coverage.
Depreciation and amortization expenses decreased by $62,116, or 12%, from
$505,486 in 2003 to $443,370 in 2004. The decrease is due to some fixed assets
becoming fully depreciated.
Other expense, net, increased by $1,653,275 from $1,005,470 in 2003 to
$2,658,745 in 2004. Interest expense increased by $2,864,846 to $3,244,379 in
2004 from $379,533 in 2003. The 2004 interest expense is based on nine months of
interest associated with the remaining balance of the $21.0 million September
2003 Convertible Debenture financing as compared to three months of interest
expense on the remaining $3.5 million September 2000 Convertible Debentures,
which were ultimately retired during the first quarter of 2003. In accordance
with Emerging Issues Task Force Issue No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios (BCF), the Company recorded a charge of $1.8 million which was
fully amortized at December 31, 2000 in connection with the issuance of
convertible debt with a favorable conversion feature. In accordance with EITF
00-27, a net credit of $786,000 was recorded as interest income during the first
quarter 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 first nine
months of 2004, the Company recorded as other income royalties of $4,813 per the
licensing agreement with Herbamed, Ltd, a company controlled by Dr. Haim Aviv,
the Company's CEO. Interest income decreased by $497,902, or 53%, from $948,045
in 2003
16
to $450,143 in 2004 due to the impact of the BCF of $786,000 in 2003 partially
offset by the interest generated from higher cash balances in 2004.
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 $138.2 million at
September 30, 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, grants from the Chief Scientist of
Israel, research contracts, 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
September 30, 2004, and on December 31, 2003:
September30, 2004 December 31, 2003
Working capital $48,510,141 $42,026,598
Cash and cash equivalents $51,486,553 $49,369,250
Short-term convertible debentures, net $ 8,955,556 $13,702,412
Long-term convertible debentures, net $ 0 $ 4,773,339
Current working capital position
As of September 30, 2004, the Company had working capital of $48.5 million
consisting of current assets of $63.3 million and current liabilities of $14.8
million. This represents an increase of $6.5 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. This increase in working capital of $6.5
million was principally due to the cash raised from the common stock private
placement of $16.75 million in August less debt repayment of $9.7 million.
Current and future liquidity position
Management believes that cash and cash equivalents of $51.5 million as of
September 30, 2004, will be sufficient to support the Company's continuing
operations beyond September 2005. 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.
Cash
At September 30, 2004, cash and cash equivalents totaled $51.5 million. At
December 31, 2003 cash and cash equivalents totaled $49.4 million. This net
increase in cash of $2.1 million was principally due to the cash raised through
the August 2004 private placement which was offset by the cash used in the
Company's operations and repayment of the September 2003 Convertible Debentures.
The cash, equivalents and restricted cash will be used to finance future growth,
capital expenditures and 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
17
or are used to fund acquisition(s) approved by the investors. To date,
approximately $9.7 million of the original $21.0 million in convertible
debentures have been repaid. An additional $2 million has been converted into
common shares of the Company's stock.
Operating activities
Net cash used in operating activities for the first three quarters of 2004 was
$15.5 million compared to $12.5 million for the first three quarters of 2003.
The increase is primarily due to the expenditures associated with scale up of
dexanabinol synthesis, preclinical studies on PRS-211,375 and the compliance
costs associated with the Sarbanes-Oxley Act.
Capital expenditures
Our capital expenditures for property, plant and equipment for the first nine
months of 2004 and 2003 totaled approximately $239,000 and $57,000, respectively
for normal replacements and improvements.
Financing activities
During the third quarter of 2004, the Company completed a private placement to
sell common shares to six investors generating gross proceeds of $16.75 million.
An aggregate of 5,583,334 shares of common stock were issued.
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 September 30, 2004, the Company repaid or converted
approximately $11.7 million of the September 2003 Convertible Debentures. The
remaining Convertible Debenture balance of $9.3 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 as of April 19, 2004, which he held. 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 as of April 19, 2004, which he held.
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
18
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 that was submitted to the FDA for marketing approval in September
2003. In July 2004, Bausch & Lomb received from the FDA an "approvable letter
for LE-T", meaning that the FDA expects to approve LE-T provided certain
conditions in such letter were met to the satisfaction of the FDA. The Company
had no product sales beginning in the fourth quarter of 2001. 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 September 30, 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. 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 September 30, 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 September 30, 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 September 30, 2004, the Company had the following contractual commitments
and long-term obligations:
Payments Due by Period
Less than 1 - 3 4 - 5 After
Total 1 Year Years Years 5 Years
Operating Leases $ 1,203,195 $ 256,186 $ 459,551 $ 54,524 $ 432,934
Convertible
Debentures* 9,420,726 9,420,726 -- -- --
R&D 572,206 572,206 -- -- --
Commitments
Other Liability** 500,000 -- 500,000 -- --
----------- ----------- ----------- ----------- -----------
Total $11,696,127 $10,249,118 $ 959,551 $ 54,524 $ 432,934
=========== =========== =========== =========== ===========
* Includes interest expense to be paid in cash and excludes the debt
discount
** Represents cash retention bonus given to the CEO and President. $22,978
has accrued through September 30, 2004. See Footnote 6.
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 September 30, 2004,
19
debentures totaling approximately $11.7 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 TBI
and expenditures associated with scale up of dexanabinol synthesis. One of the
clinical service based agreements, if fully utilized, currently totals $11.1
million and is not committed beyond 2004. From inception through September 30,
2004, the Company has recorded $10.6 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, currency impact in Israel, 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. The value of the
warrant liability is based upon the Company's stock price.
New accounting pronouncements
In July 2004, the EITF issued a draft abstract for EITF Issue No. 04-08, "The
Effect of Contingently Convertible Debt on Diluted Earnings per Share" ("EITF
04-08"). EITF 04-08 reflects the Task Force's conclusion that contingently
convertible debt should be included in diluted earnings per share computations
regardless of whether the market price trigger has been met. The adoption of
this statement is not expected to impact to the Company's financial statement
presentation as the Company is in a loss position.
In March 2004, the Emerging Issues Task Force issued EITF 03-6, "Participating
Securities and the Two-Class Method under FASB Statement No. 128". This
statement provides additional guidance on the calculation and disclosure
requirements for earnings per share. The FASB concluded in EITF 03-6 that
companies with multiple classes of common stock or participating securities, as
defined by SFAS No. 128, calculate and disclose earnings per share based on the
two-class method. The adoption of this statement does not have an impact to the
Company's financial statement presentation as the Company is in a loss position.
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 September 30, 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.
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(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.
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Part II
Other Information
Item 1 Legal Proceedings NONE
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds NONE
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
Number Exhibit
------ -------
10.1 Employment Agreement between Pharmos Corporation
and James A. Meer, dated as of July 12, 2004.
10.2 Letter Agreement dated as of August 20, 2004
between Rodman & Renshaw, Inc., and Harris Nesbitt
Corp., as placement agents, and Pharmos
Corporation (incorporated by reference to Exhibit
99.1 to the registrant's Current Report on Form
8-K filed August 23, 2004).
10.3 Retention Award Agreement, dated as of September
6, 2004, by and between Pharmos Corporation and
Dr. Haim Aviv (incorporated by reference to
Exhibit 10.1 to the registrant's Current Report on
Form 8-K filed September 10, 2004).
10.4 Retention Award Agreement, dated as of September
6, 2004, by and between Pharmos Corporation and
Gad Riesenfeld (incorporated by reference to
Exhibit 10.2 to the registrant's Current Report on
Form 8-K filed September 10, 2004).
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.
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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.
23
SIGNATURE PAGE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PHARMOS CORPORATION
Dated: November 2, 2004
by: /s/ James A. Meer
---------------------------
James A. Meer
Vice President and
Chief Financial Officer
(Principal Accounting and
Financial Officer)
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