SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

 

 

ý                  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended September 30, 2004

 

OR

 

o                  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                                                                           to

 

Commission File Number: 0-26372

 

 

CELLEGY PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware		82-0429727
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification Number)

 

349 Oyster Point Boulevard, Suite 200, South San Francisco, California 94080

(Address of principal executive offices, including zip code)

 

(650) 616-2200

 (Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 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  ý              No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12-b under the Securities Exchange Act of 1934). Yes  o        No  ý

 

The number of shares outstanding of the registrant’s common stock at November 3, 2004 was 26,014,038.

CELLEGY PHARMACEUTICALS, INC.

 

INDEX TO FORM 10-Q

 

PARTI	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003
	Condensed Consolidated Statements of Operations for the three months and nine months ended September 30, 2004 and 2003, and the period from June 26, 1989 (inception) to September 30, 2004
	Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003, and the period from June 26, 1989 (inception) to September 30, 2004
	Notes to Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosure of Market Risk
Item 4.	Controls and Procedures
PARTII	OTHER INFORMATION
Item 1.	Legal Proceedings
Item 2.	Changes in Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits
Signatures
Certifications

 

 

PART I — FINANCIAL INFORMATION

 

Item 1.    Financial Statements

 

Cellegy Pharmaceuticals, Inc.

(a development stage company)

 

Condensed Consolidated Balance Sheets

(Unaudited) (Amounts in thousands)

 

		September 30, 2004			December 31, 2003
Assets
Current assets:
Cash and cash equivalents		$	13,359		$	7,650
Short-term investments		—			3,687
Prepaid expenses and other current assets		254			508
Total current assets		13,613			11,845
Restricted cash		502			227
Property and equipment, net		1,597			1,892
Goodwill		963			1,010
Intangible assets related to acquisition		183			257
Other assets		92			100
Total assets		$	16,950		$	15,331
Liabilities and Stockholders’ Deficit
Current liabilities:
Accounts payable and accrued liabilities		$	1,831		$	1,908
Accrued compensation and related expenses		156			112
Current portion of deferred revenue		882			832
Total current liabilities		2,869			2,852
Other long-term liabilities		660			724
Derivative instrument		642			—
Deferred revenue		13,147			13,335
Total liabilities		17,318			16,911
Contingencies (Note 5)
Stockholders’ deficit:
Common stock		2			97,294
Additional paid-in-capital		107,467			—
Accumulated other comprehensive income		221			275
Deficit accumulated during the development stage		(108,058		)	(99,149		)
Total stockholders’ deficit		(368		)	(1,580		)
Total liabilities and stockholders’ deficit		$	16,950		$	15,331

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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Cellegy Pharmaceuticals, Inc.

(a development stage company)

 

Condensed Consolidated Statements of Operations

 

(Unaudited)

(Amounts in thousands, except per share data)

 

																		Period from June 26, 1989 (inception) to September 30, 2004
		Three Months Ended September 30,								Nine Months Ended September 30,
		2004				2003				2004				2003
Revenues:
Contract revenue		$	222			$		208		$	638			$	625			$	4,169
Government grants		—				—				—				13				568
Product sales		261				206				613				431				6,482
Total revenues		483				414				1,251				1,069				11,219
Costs and expenses:
Cost of product sales		55				46				131				86				1,638
Research and development		2,529				2,349				6,876				7,732				79,051
Selling, general and administrative		1,093				820				3,520				3,564				35,239
Acquired in-process technology		—				—				—				—				7,350
Total costs and expenses		3,677				3,215				10,527				11,382				123,278
Operating loss		(3,194			)	(2,801			)	(9,276			)	(10,313			)	(112,059			)
Interest and other income		69				134				208				368				6,794
Interest and other expense		—				(3			)	—				(3			)	(1,504			)
Derivative revaluation		(18			)	—				159				—				159
Net loss		(3,143			)	(2,670			)	(8,909			)	(9,948			)	(106,610			)
Non-cash preferred dividends		—				—				—				—				1,448
Net loss applicable to common stockholders		$	(3,143		)	$	(2,670		)	$		(8,909	)	$		(9,948	)	$		(108,058	)
Basic and diluted net loss per common share		$		(0.14	)	$	(0.13		)	$		(0.43	)	$		(0.50	)
Weighted average common shares used in computing basic and diluted net loss per common share		22,396				20,018				20,874				19,941

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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Cellegy Pharmaceuticals, Inc.

(a development stage company)

 

Condensed Consolidated Statements of Cash Flows

 

(Unaudited)

(Amounts in thousands)

 

		Nine Months Ended September  30,						Period from June 26, 1989 (inception) to September 30, 2004
		2004			2003
Operating activities
Net loss		$	(8,909	)	$	(9,948	)	$	(106,610	)
Other operating activities		491			185			32,299
Net cash used in operating activities		(8,418		)	(9,763		)	(74,311		)
Investing activities
Purchases of property and equipment		(12		)	(202		)	(5,212		)
Purchases of investments		—			(11,135		)	(98,910		)
Sales and maturities of investments		3,687			7,395			98,815
Proceeds from sale of property and equipment		—			48			238
Costs related to Biosyn acquisition		(92		)	—			(92		)
Cash used in escrow for Biosyn acquisition		(275		)	—			(275		)
Cash used in acquisition of Vaxis and Quay		—			—			(512		)
Net cash provided by (used in) investing activities		3,308			(3,894		)	(5,948		)
Financing activities
Proceeds from notes payable		—			—			8,047
Repayment of notes payable		—			—			(6,611		)
Proceeds from restricted cash		—			—			386
Other assets		—			—			(614		)
Net proceeds from issuance of common stock		10,873			477			80,511
Issuance of convertible preferred stock, net of issuance costs		—			—			11,678
Net cash provided by financing activities		10,873			477			93,397
Effect of exchange rate changes on cash		(54		)	52			221
Net (decrease) increase in cash and cash equivalents		5,709			(13,128		)	13,359
Cash and cash equivalents, beginning of period		7,650			21,629			—
Cash and cash equivalents, end of period		$	13,359		$	8,501		$	13,359

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5

Cellegy Pharmaceuticals, Inc.

(a development stage company)

 

Condensed Consolidated Statements of Cash Flows (Continued)

 

(Unaudited)

(Amounts in thousands)

 

		Nine Months Ended September 30,						Period from June 26, 1989 (inception) to September 30, 2004
		2004			2003
Supplemental cash flow information
Interest paid		$	—		$	—		$	640
Supplemental disclosure of non-cash transactions:
Issuance of common stock in connection with acquired-in-process technology		—			—			7,350
Conversion of preferred stock to common stock								14,715
Issuance of common stock for notes payable		—			—			227
Issuance of warrants in connection with Kingsbridge SSO financing and July 2004 Private Placement		2,082			—			2,082
Issuance of warrants in connection with notes payable financing		—			—			487
Issuance of convertible preferred stock for notes payable		—			—			1,268
Issuance of common stock for milestone payments		—			—			750

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

6

Cellegy Pharmaceuticals, Inc.

(a development stage company)

 

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Note 1.  —  Basis of Presentation

The accompanying unaudited interim condensed consolidated financial statements have been prepared by Cellegy Pharmaceuticals, Inc. (the “Company”) in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated by the Securities and Exchange Commission.  Accordingly, they do not include all of the information and footnote disclosures required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments, including the elimination of intercompany accounts) considered necessary for a fair presentation of all periods presented. The results of Cellegy’s operations for any interim periods are not necessarily indicative of the results of operations for any other interim period or for a full fiscal year. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in Cellegy’s Annual Report on Form 10-K for the year ended December 31, 2003.

Liquidity and Capital Resources

At September 30, 2004, the Company had a deficit accumulated during the development stage of $108.1 million. It expects negative cash flow from operations to continue for about the next two years, with the need to continue or expand its development programs and to comercialize products once regulatory approvals have been obtained. The Company’s management believes that its existing cash balances, including proceeds from a private placement financing completed in July 2004 and funding available through the Kingsbridge Structured Secondary Offering facility, will be sufficient to meet its capital and operating requirements through September 30, 2005, assuming no material adverse financial impact associated with the PDI litigation and any subsequent legal proceedings.

Expenditures required to achieve the Company’s growth and profitability in the long term may be greater than projected or the cash flow generated from operations may be less than projected. As a result, its near and long-term capital needs may require additional funding through equity or debt financing, corporate collaborations or other related arrangements, bank financing and other sources. There can be no assurance that the Company will be able to obtain additional debt or equity financing on terms it deems acceptable to it, or at all. If the United States Food and Drug Administration approves Cellegesic in January 2005 and adequate funds are not available, the Company could be required to delay development or commercialization of Cellegesic and other products, to outlicense commercial rights to certain products that Cellegy would otherwise seek to commercialize internally or to reduce resources devoted to product development. Accordingly, the Company’s failure to obtain sufficient funds on acceptable terms, when needed, could have a material adverse effect on Cellegy’s ability to achieve its business objectives.

Reclassification

Certain prior year balances have been reclassified for comparative purposes.

Note 2.  —  Comprehensive Loss

Comprehensive loss generally represents all changes in stockholders’ deficit except those resulting from investments or contributions by stockholders. The Company’s unrealized gains and losses on available-for-sale securities and foreign currency translation adjustments represent the only components of comprehensive loss that are excluded from the Company’s net loss.  Total comprehensive loss during the three and nine months ended September 30, 2004 and 2003 consisted of (in thousands):

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		Three Months Ended September 30,						Nine Months Ended September 30,
		2004			2003			2004			2003
Net loss		$	(3,143	)	$	(2,670	)	$	(8,909	)	$	(9,948	)
Change in translation adjustments		62			(36		)	(54		)	(33		)
Change in unrealized gain (loss)		—			(59		)	—			(9		)
Comprehensive loss		$	(3,081	)	$	(2,765	)	$	(8,963	)	$	(9,990	)

 

Note 3.  —  Basic and Diluted Net Loss per Common Share

Basic net loss per common share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per common share incorporates the incremental shares issued upon the assumed exercise of stock options and warrants, when dilutive. There is no difference between basic and diluted net loss per common share, as presented in the statement of operations, because all options and warrants are anti-dilutive. The total number of shares excluded consisted of (in thousands):

 

Note 4.  —  Employee Stock Compensation

The Company accounts for its stock option grants in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations. The Company has elected to follow the disclosure-only alternative prescribed by Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148 “Accounting for Stock-Based Compensation-Transition and Disclosure”. Under APB 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Under APB Opinion No. 25, if the exercise price of the Company’s stock options is equal to the market price of the underlying stock on the date of grant, no compensation expense is recognized related to employee or director grants. Compensation for options granted to non-employees has been determined in accordance with SFAS No. 123 and Emerging Issues Task Force (“EITF”) No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services,” at the fair value of the equity instruments issued.

Pro forma information regarding net loss and net loss per common share is required by SFAS No. 123, which requires that the information be determined as if the Company has accounted for its common stock options granted under the fair market value method. The fair market value of options granted has been estimated at the date of the grant using a Black-Scholes option pricing model. Had compensation cost for the Company’s stock-based compensation plans been determined in a manner consistent with the fair value approach described in SFAS No. 123, the Company’s net loss and net loss per common share as reported would have been increased to the pro forma amounts indicated below (in thousands):

8

		Three Months Ended September 30,							Nine Months Ended September 30,
		2004			2003				2004				2003
Net loss as reported		$	(3,143	)	$		(2,670	)	$	(8,909		)	$	(9,948		)
Add: Stock based employee costs included in the determination of net loss, as reported		—			8				70				23
Deduct: Stock-based employee compensation costs that would have been included in the determination of net loss if the fair value method had been applied to all awards		(186		)	(351			)	(712			)	(1,189			)
Net loss, pro forma		$	(3,329	)	$	(3,013		)	$		(9,551	)	$		(11,114	)
Basic and diluted net loss per common share, as reported		$	(0.14	)	$	(0.13		)	$	(0.43		)	$		(0.50	)
Pro forma basic and diluted net loss per common share		$	(0.15	)	$	(0.15		)	$	(0.46		)	$		(0.56	)

 

The Company values its options on the date of grant using the Black-Scholes valuation model. The Company did not issue any options during the third quarter of 2004 and therefore, no valuations were required.

 

 

 

Note 5.  —  Contingencies

In December 2002, Cellegy entered into an exclusive license agreement with PDI, Inc. (“PDI”) to commercialize Fortigel in North American markets. Under the terms of the agreement, PDI’s Pharmaceutical Products Group is responsible for the marketing and sale of Fortigel, if approved, utilizing its existing sales and marketing infrastructure. Cellegy received a payment of $15.0 million upon signing the agreement and is entitled to receive a milestone payment of $10.0 million on United States Food and Drug Administration, or FDA, approval and royalties following a successful product launch. Cellegy is responsible for supplying finished product to PDI through Cellegy’s contract manufacturer. In July 2003, the FDA issued a Not Approvable letter relating to the Fortigel New Drug Application, or NDA.

In October 2003, Cellegy announced that it received a mediation notice from PDI. The dispute resolution provisions of the license agreement require non-binding mediation before either party may initiate further legal proceedings. The communication asserted several claims relating to the agreement, including Cellegy’s breach of several provisions of the agreement and failure to disclose relevant facts. PDI claimed several kinds of alleged damages, including return of the initial license fee that PDI paid to Cellegy when the agreement was signed. The parties subsequently conducted mediation as contemplated by the agreement but did not reach any resolution of the claims.

In December 2003, Cellegy and PDI both initiated legal proceedings against each other relating to the agreement. Cellegy filed a declaratory judgment action in federal district court in San Francisco against PDI, and PDI initiated an action in federal district court in New York against Cellegy. In its action, Cellegy seeks, among other things, a declaration that it has fully complied with the license agreement and that PDI’s claims are without merit. The federal court in New York decided that the cases would be consolidated in the Northern District of

9

California and that future proceedings would be held in that jurisdiction. There can be no assurances regarding the outcome of the litigation, which will likely take at least several more months to resolve. The court currently has scheduled a trial date sometime at the end of the first quarter in 2005, although the date is subject to change. The Company could be required to devote significant time and resources to the proceedings and an unfavorable outcome could have a material adverse impact on our business and financial position. Such potential loss is not estimable at this time.

Note 6.  —  Equity Financing and Issuances

In January 2004, the Company entered into a Structured Secondary Offering (“SSO”) facility agreement with Kingsbridge Capital Limited (“Kingsbridge”).  The facility requires Kingsbridge to purchase up to 3.74 million shares of newly issued common stock at times and in amounts selected by Cellegy over a period of up to two years, subject to certain restrictions.  The Company filed a registration statement with the SEC which was subsequently amended and declared effective on June 1, 2004. The SSO agreement does not prohibit additional debt or equity financings, including Private Investment in Public Equity (“PIPEs”), shelf offerings, secondary offerings or any other non-fixed or future priced securities. If the common stock falls below $1.25 per share, Cellegy will not be able to conduct draw downs on the SSO, and Cellegy could be required to find additional sources of funding to continue to operate under the current plan.  Cellegy initiated a first draw down beginning on June 17, 2004 and ending on July 8, 2004. Through September 30, 2004, the Company issued 141,946 common shares and received proceeds of $533,000.

The timing and amount of any draw downs are at Cellegy’s sole discretion, subject to certain timing conditions, and are limited to certain maximum amounts depending in part on the then current market capitalization of the Company.  Kingsbridge is not obligated to purchase shares if Cellegy’s stock price is below $1.25 per share.  The purchase price of the common stock will be at discounts ranging from 8% to 12% of the average market price of the common stock prior to each future draw down.  The lower discount applies to higher stock prices.  In connection with the agreement, Cellegy issued warrants to Kingsbridge to purchase 260,000 common shares at an exercise price of $5.27 per share. Cellegy can, at its discretion and based on its cash needs, determine how much, if any, of the equity line it will draw down in the future, subject to the other conditions in the agreement.

The warrants issued in connection with the SSO facility qualify as a derivative instrument, due to liquidating damages provisions included in the warrant agreement in the event the Company fails to maintain an effective registration statement. This derivate instrument has been valued based on a Black-Scholes model. The factors used to perform Black-Scholes calculation were the following: volatility of 94%, risk free interest rate of 2.86%, dividend yield of 0% and the closing stock price of $4.39 at January 21, 2004, the date of the agreement. The fair value of $800,800 was recorded as a liability upon the warrants issuance in January 2004.  The derivative instrument will be revalued quarterly, as long as it remains outstanding, with the changes in the estimated fair value recorded in other income or expense in the income statement. For the three and nine months ended September 30, 2004, $18,000 was recorded as a derivative revaluation expense and $159,000 was recorded as derivative revaluation income in the income statement, respectively, related to changes in the valuation of the warrants.

On July 27, 2004, Cellegy completed a private placement financing, primarily with existing institutional stockholders, issuing 3,020,000 common shares and warrants to purchase 604,000 shares of common stock, resulting in gross proceeds of $10,327,000. The offering price of the common stock sold was $3.42 per share and the exercise price of the warrants is $4.62 per share.  These warrants are still outstanding at September 30, 2004 and expire on July 27, 2009. The Company calculated the fair value of the warrants using a Black-Scholes model and has allocated a total value of $1,281,000 to the warrants, which has been recorded as additional paid-in-capital. The factors used to perform the Black-Scholes calculation were the following: volatility of 94%, risk free interest rate of 3.45%, dividend yield of 0% and the closing stock price of $3.51 at July 27, 2004, the completion date of the private placement. The issued shares and the shares issuable upon exercise of the warrants were registered for resale on a Form S-3 Registration Statement which was declared effective by the Securities and Exchange Commission on September 29, 2004.

Note 7.  —  Delaware Reincorporation

On September 2, 2004, Cellegy Pharmaceuticals, Inc., a California corporation (“Cellegy California”), consummated a merger with and into its wholly owned subsidiary, Cellegy Pharmaceuticals, Inc., a Delaware

10

corporation (“Cellegy Delaware”) (the “Reincorporation”).  As a result of the Reincorporation, the registrant is now a Delaware corporation. As provided by the Agreement and Plan of Merger and Reincorporation, each outstanding share of Cellegy California common stock, no par value, was automatically converted into one share of Cellegy Delaware common stock, $0.0001 par value per share, at the time the Reincorporation became effective.  Each stock certificate representing issued and outstanding shares of Cellegy California common stock continues to represent the same number of shares of Cellegy Delaware common stock.  At September 30, 2004, the par value of the total outstanding shares was $2,300 as reflected on the consolidated balance sheet.

Note 8  —  Segment Reporting

The Company has two business segments: pharmaceuticals and skin care.  Pharmaceuticals include primarily research and clinical development expenses for potential prescription products to be marketed directly by Cellegy or through corporate partners.

Current pharmaceutical revenues consist primarily of Rectogesic sales in Australia, New Zealand and South Korea, in addition to the PDI and ProStrakan license revenue for Fortigel and Tostrex, respectively. The Company expects to complete other corporate collaborations in the future for a number of its potential pharmaceutical products, which may result in milestones, development funding and royalties on sales.

The skin care business segment includes development expenses for non-prescription moisturizer and anti-aging products.  The Company’s product sales are to one customer, Gryphon Development, Inc., which is selling one of the Company’s skin care products, exclusively in the United States, through a major specialty retailer.

Cellegy allocates its revenues and operating expenses to each business segment, but does not assess segment performance or allocate resources based on a segment’s assets and, therefore, asset depreciation and amortization and capital expenditures are not reported by segment.  Operating expenses for the skin care business segment only include cost of goods sold to Gryphon. The rest of the Company’s operating expenses are allocated to the pharmaceutical segment.

The following table contains information regarding revenues and loss from operating each business segment (in thousands):

 

 

All of the Company’s assets are related to the pharmaceutical segment and most of these assets are located in the United States.

Note 9.  —  Licenses and Other Agreements

In July 2004, Cellegy and ProStrakan Group Ltd (“ProStrakan”) entered into to an exclusive license agreement for the future commercialization of Tostrex^TM (testosterone gel) in Europe. Under the terms of the agreement, ProStrakan will be responsible for regulatory filings, sales, marketing and distribution of Tostrex throughout the

11

European Union (“EU”) and in certain nearby non-EU countries. Cellegy will be responsible for supplying finished product to ProStrakan through its contract manufacturer. Assuming successful commercial launch, Cellegy could receive up to $5.75 million in total payments in addition to a royalty on net sales of Tostrex.  Cellegy received a $500,000 non-refundable upfront payment in July 2004. The upfront payment has been recorded as deferred revenue and is being amortized over the ten-year estimated product life. In addition, ProStrakan has granted a right of first negotiation to Cellegy to license its oral testosterone-glucoside product, which is currently undergoing a Phase 1 clinical study in the United States.

On August 25, 2004, Cellegy was granted marketing approval of Rectogesic in the United Kingdom. Under the terms of the Asset Purchase Agreement between Cellegy and Neptune Pharmaceuticals entered into in December 1997, Cellegy was required to pay a $750,000 milestone payment in either cash or common shares. A research and development expense of $750,000 was recorded in the third quarter of 2004. Subsequent to September 30, 2004, the Company issued 204,000 common shares to Neptune Pharmaceuticals and its affiliates based on the $3.66 closing price of the common stock on August 25, 2004.

Note 10.  —  Subsequent Events

On October 7, 2004, Cellegy announced that it has entered into a definitive agreement to acquire Biosyn, a privately-held, development stage, biopharmaceutical company. The acquisition was completed on October 22, 2004. Biosyn is a leader in the development of a contraceptive gel product for the prevention of HIV-AIDs in women. Under the terms of the agreement, Cellegy exchanged 2,462,000 shares of its common stock for 100% of Biosyn’s issued and outstanding capital stock, paid $3,154,000 in cash to satisfy certain balance sheet liabilities and assumed outstanding Biosyn options and warrants, which are exercisable, to acquire approximately 319,000 shares of Cellegy common stock. Up to an additional $15.0 million is payable in cash contingent upon future commercial launch of Biosyn’s lead product Savvy (C31G vaginal gel), in the United States and selected major overseas markets, following regulatory approvals. As of September 30, 2004, a total of $275,000 was recorded as restricted cash related to the Biosyn acquistion. This acquisition will be accounted for as an asset acquisition using the purchase method.

 

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Cellegy Pharmaceuticals is a development stage specialty biopharmaceutical company.  We were incorporated in California in 1989 and reincorporated in Delaware during the third quarter of 2004.  Upon approval by the United States Food and Drug Administration, or FDA, of one or more of our pharmaceutical products, we will exit the development stage to become a commercial company and a leader in the marketing and sales of prescription biopharmaceutical products directed toward the treatment of gastrointestinal conditions and sexual dysfunction using proprietary topical formulations and nitric oxide (“NO”) donor technologies. Key elements of our business and commercialization strategy include self-marketing to specialty physicians in the United States, acquisitions of complementary products and companies and out-licensing of product rights in major overseas markets.

We are developing several prescription drug candidates, including: Cellegesic™  (nitroglycerin ointment) for the treatment of anal fissures and hemorrhoids; two transdermal testosterone gel product candidates, Fortigel™ (testosterone gel) for the treatment of male hypogonadism, a condition that afflicts men, generally above the age of forty, and Tostrelle™ (testosterone gel), for the treatment of sexual dysfunction in menopausal women and Savvy, for female contraception and HIV-AIDs prevention. Other pipeline products include NO donors for the treatment of female sexual dysfunction, Raynaud’s Disease, restless leg syndrome and prostate cancer.  Cellegesic was approved for sale in the United Kingdom in August 2004 and a decision by the FDA on approvability for sale in the United States is expected by early January 2005.

General

In January 2004, we entered into a Structured Secondary Offering (“SSO”) facility agreement with Kingsbridge Capital Limited.  The facility requires Kingsbridge to purchase up to 3.74 million shares of newly issued common stock at times and in amounts selected by us over a period of up to two years, subject to certain restrictions.  We

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filed a registration statement with the Securities and Exchange Commission which was subsequently declared effective on June 1, 2004. The SSO agreement does not prohibit us from conducting additional debt or equity financings, including PIPEs, shelf offerings, secondary offerings or any other non-fixed or future priced securities. If our common stock falls below $1.25 per share, we will not be able to conduct draw downs on the SSO. We initiated a first draw down beginning on June 17, 2004 and ending on July 8, 2004. A total of 141,946 common shares have been issued resulting in proceeds of  $533,000.

 In January 2004, we announced results of a preliminary analysis of our third Cellegesic Phase 3 clinical trial showing a reduction in anal fissure pain compared with a placebo control during the first three weeks of the trial, the primary efficacy endpoint of the study.  The double blind, placebo controlled trial was conducted according to a Special Protocol Assessment, or SPA, that was agreed to by the Company and the FDA.  A New Drug Application  (“NDA”) was submitted to the FDA in June 2004 and the FDA granted “Priority Review” status in October 2004, with a decision on approvability now expected in January 2005.

In July 2004, Cellegy announced that the United Kingdom’s Committee on Safety of Medicines (“MHRA”) will recommend that marketing authorization be granted by the Medicines and Healthcare Products Regulatory Agency for Cellegesic^TM (branded Rectogesic^® outside the United States). In August 2004, the MHRA issued an approvable letter for Rectogesic.

In July 2004, Cellegy and ProStrakan Group Ltd (“ProStrakan”)  entered into to an exclusive license agreement for the future commercialization of Tostrex^TM (testosterone gel) in Europe. Under the terms of the agreement, ProStrakan will be responsible for regulatory filings, sales, marketing and distribution of Tostrex throughout the European Union and in certain nearby non-EU countries. Cellegy will be responsible for supplying finished product to ProStrakan through Cellegy’s contract manufacturer. Assuming successful commercial launch, Cellegy could receive up to $5.75 million in total payments in addition to a royalty on net sales of Tostrex. Cellegy received a $500,000 non-refundable upfront payment in July 2004.

On July 27, 2004, Cellegy completed a private placement financing, primarily with a small number of existing institutional stockholders, issuing 3,020,000 common shares and warrants to purchase 604,000 shares of common stock, resulting in gross proceeds of $10.3 million. The offering price of the common shares sold was $3.42 per share and the exercise price of the warrants is $4.62 per share.

On October 7, 2004, Cellegy announced that it has entered into a definitive agreement to acquire Biosyn, Inc. (“Biosyn”), a privately-held biopharmaceutical company. The acquisition was completed on October 22, 2004. Biosyn is a leader in the development of a contraceptive gel product for the prevention of HIV-AIDs in women. Under the terms of the agreement, Cellegy exchanged 2,246,000 shares of its common stock for 100% of Biosyn’s issued and outstanding capital stock, paid $3,154,000 in cash to satisfy certain balance sheet liabilities and assumed outstanding Biosyn options and warrants which are exercisable to acquire approximately 319,000 shares of Cellegy common stock. Up to an additional $15.0 million is payable in cash contingent upon future commercial launch of Biosyn’s lead product Savvy, in the United States and selected major overseas markets, following regulatory approvals.

Results of Operations

Revenues. Cellegy had revenues of $483,000 and $414,000 for the three months ended September 30, 2004 and 2003, respectively.  During the three months ended September 30, 2004, revenues consisted of $172,000 in Rectogesic® (nitroglycerin ointment) sales in Australia, $90,000 in skin care product sales to Gryphon Development, the product development division of a major specialty retailer and $208,000 and $13,000 in PDI revenue and ProStrakan licensing revenue for Fortigel and Tostrex, respectively. For the same period last year, revenues consisted of $112,000 in Australian Rectogesic sales, $94,000 in skin care product sales and $208,000 in licensing revenue for Fortigel.

 

Cellegy had revenues of $1,251,000 and $1,069,000 for the nine months ended September 30, 2004 and 2003, respectively. During the nine months ended September 30, 2004, revenues consisted primary of $432,000 in Australian Rectogesic sales, $638,000 in PDI and ProStrakan licensing revenue and $181,000 in product sales to Gryphon. For the same period last year, revenues consisted of $282,000 in Australian Rectogesic sales, $625,000 in licensing revenue for Fortigel, $149,000 in product sales to Gryphon and $13,000 in Canadian government grants.

 

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The licensing revenue of $208,000 from PDI for each of the three quarters of 2004 reflected the quarterly recognition, over the term of the license agreement with PDI, associated with the $15.0 million upfront payment received from PDI in December 2002. The licensing revenue of $13,000 for Tostrex in the third quarter of 2004 reflected the quarterly recognition, over the 10 year estimated life of the product, associated with the $500,000 upfront payment received from ProStrakan in the July 2004 license agreement. We will continue to record these licensing revenues in the same manner for subsequent quarters assuming that the conditions of the license agreements with PDI and/or ProStrakan and the estimate of the lives of the products do not change.

 

Research and Development Expenses. Research and development expenses, which were primarily clinical costs, were $2,529,000 for the three months ended September 30, 2004, compared with $2,349,000 for the same period last year. Higher research and development expenses for the three months ended September 30, 2004, compared with the same period last year were due primarily to the recognition of a $750,000 milestone payment to Neptune Pharmaceuticals and its affiliates associated with the approval of Rectogesic in the United Kingdom during this year’s third quarter, offset somewhat by reduced clinical trial and regulatory activities.

During the nine months ended September 30, 2004 and 2003, research and development expenses were $6,876,000 and $7,732,000, respectively. Lower research and development expenses for the nine months ended September 30, 2004, compared with the same period last year, were primarily due to reduced clinical trial and regulatory activity this year, compared with peak clinical and regulatory spending for our Cellegesic and Fortigel product candidates last year, partially offset by the $750,000 milestone payment to Neptune Pharmaceuticals and its affiliates. Clinical expenses will increase in the first quarter of 2005 should Cellegy begin a Phase 3 clinical trial with Fortigel, currently under discussion with the FDA, and/or if planned advanced clinical studies using Tostrelle gel to treat female sexual dysfunction are initiated.

Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $1,093,000 for the three months ended September 30, 2003 or $273,000 higher than expenses of $820,000 in expenses for the same period last year.  Higher spending in 2004 was primarily due to an increase of $95,000 in legal and professional fees related to the Delaware reincorporation and an increase of approximately $178,000 in other professional and administrative fees related primarily to external reporting, investor communications and our Sarbanes-Oxley compliance program.

During the nine months ended September 30, 2004 and 2003, general and administrative expenses were $3,520,000 and $3,564,000 respectively. Expenses in the first nine months of this year compared with the same period last year were lower by $44,000. Increased expenses during this year’s nine months, included $605,000 in legal fees associated with litigation, external reporting, consulting, professional services and our Sarbanes-Oxley compliance program and approximately $95,000 in additional legal and professional fees associated with the Delaware reincorporation. These expenses were more than offset by $318,000 in compensation expenses, $320,000 write-off of capitalized tenant improvements at our South San Francisco facility and $106,000 in amortization expense relating to our Cellegy Australia acquisition during the first nine months in 2003.

 Selling, general and administrative expenses are expected to increase throughout the rest of this year and next year, primarily in support of our domestic launch of Cellegesic, assuming approval by the FDA and for additional accounting and consulting fees associated primarily with our Sarbanes-Oxley compliance program.

Interest and Other Income (Expense), Net.  For the three months ended September 30, 2004, Cellegy had net interest and other income of $51,000, comprised of $69,000 in interest and rental income and $18,000 in other derivative revaluation expense associated with the Kingsbridge warrants. For the three months ended September 30, 2003, Cellegy had net interest and other income of $131,000, comprised of $134,000 in interest and rental income and $3,000 in other expense. For the nine months ended September 30, 2004, Cellegy recorded net interest and other income of $367,000, including interest and rental income of $208,000 and $159,000 in other derivative income associated with the Kingsbridge warrants. For the nine months ended September 30, 2003, net interest and other income was $365,000, consisting of $343,000 in interest and rental income, $25,000 in other income and $3,000 in interest expense.

 

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Liquidity and Capital Resources

We have experienced net losses from operations each year since our inception. Through September 30, 2004, we incurred an accumulated deficit of $108.1 million and consumed cash from operations of $74.3 million. Cash from equity financing transactions have included $6.4 million in net proceeds from our initial public offering in August 1995, $6.8 million in net proceeds from a preferred stock financing in April 1996, $3.8 million in net proceeds from a private placement of common stock in July 1997, $13.8 million in net proceeds from a follow-on public offering in November 1997, $10.0 million in net proceeds from a private placement in July 1999, $11.6 million in net proceeds from a private placement in October 2000, $15.2 million in net proceeds from a private placement in June 2001, $5.2 million in net proceeds from a private placement in November 2002,  $533,300 in proceeds from the draw downs of the Kingsbridge SSO and $10.3 million in net proceeds from a private placement in July 2004.

During the third quarter of 2004, our cash and investments balance, including restricted cash, increased by $8.0 million. We received net financing proceeds of $10.6 million and $500,000 in upfront payments from ProStrakan. These additions to cash and investments, including restricted cash, were offset somewhat by cash used during the quarter of about $3.1 million. This quarterly and nine months cash usage was in line with our goal to preserve cash and focus on key clinical and product development programs. Our cash needs are expected to increase later this year and in 2005 as we prepare for the marketing launch of Cellegesic in the United States, assuming FDA approval, and to cover potential additional payments in support of Biosyn’s operating expenses not covered by various government and non-government organization grants and planned increases in clinical trial activity. Although we expect that most of clinical and operating expenses associated with the Biosyn operation will be covered by grants, Cellegy may be required to fund certain expenditures and new programs. We have disbursed $3.2 million for the Biosyn acquisition earlier in the fourth quarter. Future expenditures and capital requirements depend on numerous factors including, without limitation: the progress and focus of our research and development programs; the timing and scope of pre-clinical and clinical programs, particularly the planned Phase 3 trials for Fortigel and Tostrelle; the time and costs involved in obtaining regulatory approvals; the progress and outcome of the Cellegy/PDI litigation; the costs of filing, prosecuting, defending and enforcing patent claims, oppositions and appeals; our ability to establish new collaborative arrangements; the validation of a second contract manufacturing site; potential expenses required to support Biosyn’s operations; and the initiation of commercialization activities and working capital increases associated with the scale up, manufacture and potential launch of Cellegesic.

We expect negative cash flow from operations to continue for approximately the next two years, in order to expand our development programs and to commercialize products once regulatory approvals have been obtained. Management believes that its existing cash balances and funding available through the Kingsbridge SSO facility, will be sufficient to meet the Company’s capital and operating requirements through, at least, September 30, 2005, assuming no material adverse financial impact associated with the PDI litigation and any subsequent legal proceedings. However, failure to obtain additional funds as described in the next paragraph may affect the timing of development, clinical trials or commercialization activities relating to certain products.

 

However, our near and long term capital needs will require us to obtain additional funds through equity or debt financing, corporate collaborations, bank financing and other sources. We now have the capability to draw down funds from the Kingsbridge SSO facility up to about an additional $15.0 million but there is no assurance that we can conduct draw downs since this is dependent on our stock price and other conditions in the agreement. There can be no assurance that we will be able to obtain additional financings on terms acceptable to us, if at all. If adequate funds are not available, we could be required to delay development or commercialization of certain products, to license rights to commercialize certain products that we would otherwise seek to commercialize internally or to reduce resources devoted to product development. Accordingly, our failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our ability to achieve our near and longer term business objectives.

Critical Accounting Policies and Estimates

Our critical accounting policies and estimates were discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2003.  No changes in those policies and estimates have occurred during the three quarters of 2004, other than those noted below.

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Derivative Instruments. Cellegy accounts for the warrants issued in January 2004, in conjunction with the Kingsbridge financing, as a derivative financial instrument.  As a derivative, the fair value of the warrant is recorded as a liability in the balance sheet and changes in the fair value of the warrant are recognized as other income or expense during each period.  The fair value of the warrant is expected to change primarily in response to changes in the Company’s stock price. Significant increases in the fair value of the Company’s stock could give rise to significant expense in the period of the change.  Likewise, a reduction in the Company’s stock price could give rise to significant income in the period of the change.

Factors That May Affect Future Operating Results

This Quarterly Report on Form 10-Q includes forward-looking statements made pursuant to the safe harbor provisions of the Securities Litigation Reform Act of 1995, that involve substantial risks and uncertainties. These forward-looking statements are not historical facts, but are based on current expectations, estimates and projections about our industry, our beliefs and our assumptions. Investors are cautioned that these forward-looking statements are subject to numerous risks and uncertainties, known and unknown, which could cause actual results and developments to differ materially from those expressed or implied in such statements. Words such as “believes,” “anticipates,” “expects,” “intends” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. These forward-looking statements are not guarantees of future performance and concern matters that could subsequently differ materially from those described in the forward-looking statements.

Such risks and uncertainties relate to, among other factors, the outcome of the FDA’s review of the Cellegesic NDA. The FDA may not find that the Cellegesic trial data, the statistical analysis methodology used by Cellegy with the inclusion of post-discontinuation pain scores, the treatment of data from patients who dropped out of the study due to headaches or other sections of the NDA acceptable.  The Agency may not agree that the trial data satisfies the standards specified in the Special Protocol Assessment and may not ultimately grant marketing approval for Cellegesic. Even assuming Cellegesic approval, Cellegy may not have the resources or personnel to successfully launch the product on a timely basis. There are risks and uncertainties associated with our female clinical trial programs for Tostrelle and Savvy in that sufficient resources for clinical development of these product candidates may not be available or one or both drugs may not prove to be safe and effective by standards established by worldwide regulatory authorities. There are also risks associated with our ability to successfully manage and integrate the Biosyn operations and retain key employees related to those operations. Furthermore, there can be no assurances regarding the outcome and timing of ongoing discussions with the FDA, particularly with regard to additional clinical requirements for marketing approval of Fortigel; our ability to complete corporate partnerships relating to Cellegesic in Europe; the outcome of regulatory review in Sweden of our Tostrex product for the treatment of male hypogonadism or, even if approved in Sweden, of regulatory review in other countries; the commercial success of Cellegesic even if approved by the FDA; and the progress and outcome of the PDI litigation.

 

We undertake no obligation to update or revise the statements made herein, except as specifically required by law. In addition to the factors discussed below, factors that could affect our future business and results of operations, or that could cause actual results to differ from forward-looking statements made herein, are discussed in our annual report on Form 10-K for the year ended December 31, 2003, in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Factors that May Affect Future Operating Results,” and in quarterly reports that we file with the Securities and Exchange Commission.

Item 3.    Quantitative and Qualitative Disclosure of Market Risk

 

We invest our excess cash in short-term, investment grade, fixed income securities under an investment policy.  However, during this quarter, we currently have all our excess cash in money market funds and have no short or long term investments as of September 30, 2004. We believe that potential near term losses in future earnings, fair values or cash flows related to our investment portfolio will not be significant.

We are incurring market risk associated with the issuance of warrants to Kingsbridge to purchase 260,000 shares of our common stock.  We will continue to calculate the fair value at the end of each quarter and record the difference to other income or expense until the warrants are exercised.  We are incurring risk associated with increases or decreases in the market price of our common stock, which will directly impact the fair value calculation and the non-cash charge or credit recorded to the income statement in future quarters.  For example, if our stock

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price increases by 20% during the fourth quarter of 2004 from its September 30, 2004 value, and all other inputs into the Black-Scholes model remained constant, we would record approximately $180,000 of other expense for the period ended September 30, 2004.  If our stock price decreased by 20% from its value for the same periods, we would record approximately the same amount as other income.

Item 4.    Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)).

Based upon this evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of September 30, 2004, our disclosure controls and procedures were adequate to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the United States Securities and Exchange Commission rules and forms.  The Company is in the process of reviewing, documenting and evaluating its internal controls in response to requirements set forth  under the Sarbanes-Oxley, Section 404 guidelines.

Although Cellegy’s management continues to evaluate the internal control structure and strengthen Cellegy’s controls and procedures, particularly in connection with the requirements of Section  404 of the Sarbanes-Oxley Act of 2002,  during the period covered by this report, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

PART II  —  OTHER INFORMATION

Item 1.    Legal Proceedings

In October 2003, we received a communication from PDI, Inc. invoking mediation procedures under the exclusive license agreement between PDI and Cellegy relating to Fortigel.  After mediation was completed in December 2003, both PDI and Cellegy initiated litigation proceedings against each other. Cellegy filed a declaratory judgment action in federal district court in San Francisco against PDI, and PDI initiated an action in federal district court in New York against Cellegy.  In its action, Cellegy seeks, among other things, a declaration that it has fully complied with the license agreement and that PDI’s claims are without merit. The federal court in New York decided that the case would be consolidated in the Northern District of California and that future proceeding would be held in that jurisdiction.

The Company has devoted time and resources to the litigation and will likely be required to devote significant additional time and resources to the litigation. There can be no assurances regarding the outcome of the proceedings, which will likely take at least several more months to resolve.  An unfavorable outcome could have a material adverse impact on our business and financial position.

Item 2.    Changes in Securities and Use of Proceeds

(a)                                As previously reported on a Form 8-K filed in September 2004, the Company completed its reincorporation from California to Delaware through a merger of the former California corporation into a newly formed wholly-owned Delaware subsidiary. As a result, holders of common stock of the former California corporation became holders of common stock of the successor Delaware corporation and Delaware corporate law rather California corporate law, defines the rights of holders of common stock under applicable state law. The Company’s proxy statement distributed to its shareholders in connection with the 2004 annual meeting of shareholders, at which the reincorporation was approved, includes a comparison of certain provisions of Delaware and California corporate law relating to holders of common stock.

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(b)                               As previously reported, on July 27, 2004, Cellegy completed a private placement financing, primarily to a small number of existing institutional stockholders, issuing 3,020,000 common shares and warrants to purchase 604,000 shares of common stock, resulting in gross proceeds of $10.3 million. The offering price of the common stock sold was $3.42 per share and the exercise price of warrants was $4.62 per share. The shares were issued in reliance of the exemption from registration provided by Section 4 (2) of the Securities and Exchange Act of 1933, as amended, and/or Regulation D promulgated thereunder.

Item 3.    Defaults Upon Senior Securities

None

Item 4.    Submission of Matters to a Vote of Security Holders

None

Item 5.    Other Information

None

Item 6.    Exhibits

*10.1                    Employment Agreement dated October 7, 2004, between the Company and Anne-Marie Corner.

 

*10.2       Biosyn, Inc. 1999 Stock Option Plan.

 

*10.3                    Stock Option Assumption Agreement dated October 20, 2004, between the Company and Anne-Marie Corner relating to assumed non-plan stock options.

 

*10.4                    Stock Option Assumption Agreement dated October 20, 2004, between the Company and Anne-Marie Corner relating to assumed plan stock options.

 

*10.5                    Notice of Assumption of Biosyn Options relating to Anne-Marie Corner’s assumed stock options.

 

* Represents a management contract or compensatory plan or arrangement.

 

31.1                             Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2                             Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1                             Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2                             Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

 

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.

		CELLEGY PHARMACEUTICALS, INC.
Date:  November 12, 2004		/s/ K. Michael Forrest
		K. Michael Forrest
		President and Chief Executive Officer
Date: November 12, 2004		/s/ A. Richard Juelis
		A. Richard Juelis
		Vice President, Finance and Chief Financial Officer

 

 

 

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