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DMK PHARMACEUTICALS Corp - Quarter Report: 2007 June (Form 10-Q)

Unassociated Document
SECURITIES AND EXCHANGE COMMISSION
Washington, DC  20549
 
FORM 10-Q
 
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
 
 
For the quarterly period ended June 30, 2007
     
 
 
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
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
 
2085B Quaker Pointe Drive, Quakertown, PA 18951
(Address of principal executive offices, including zip code)
 
215-529-6084
(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    x    No   o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
 Large accelerated filer    ¨
Accelerated filer    ¨
Non-accelerated filer    x 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes    o    No    x
 
The number of shares outstanding of the registrant’s common stock at July 31, 2007 was 29,834,796.
 


CELLEGY PHARMACEUTICALS, INC.
 
CONTENTS OF QUARTERLY REPORT ON FORM 10-Q
 
 
 
Page
PART I
FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements:
 
 
 
 
 
Condensed Consolidated Balance Sheets
3
 
 
 
 
Condensed Consolidated Statements of Operations
4
 
 
 
 
Condensed Consolidated Statements of Cash Flows
5
 
 
 
 
Notes to Condensed Consolidated Financial Statements
6
     
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
13
 
 
 
Item 3.
Quantitative and Qualitative Disclosure of Market Risk
16
 
 
 
Item 4.
Controls and Procedures
16
 
 
 
PART II
OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
17
     
Item 1A.
Risk Factors
17
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
23
 
 
 
Item 3.
Defaults Upon Senior Securities
23
 
 
 
Item 4.
Submission of Matters to a Vote of Security Holders
23
 
 
 
Item 5.
Other Information
23
 
 
 
Item 6.
Exhibits
23
     
 
Signatures
24
 
 
 

2


PART I   -   FINANCIAL INFORMATION
 
ITEM 1: Financial Statements

Cellegy Pharmaceuticals, Inc.
Condensed Consolidated Balance Sheets
(Amounts in thousands)
(Unaudited)

   
 June 30, 2007 
 
 December 31, 2006
 
Assets
             
Current assets:
             
Cash and cash equivalents
 
$
2,521
 
$
3,804
 
Accounts receivable
   
19
   
77
 
Prepaid expenses and other current assets
   
95
   
264
 
Total current assets
   
2,635
   
4,145
 
Total assets
 
$
2,635
 
$
4,145
 
 
             
Liabilities and Stockholders' Equity
             
Current liabilities:
             
Accounts payable
 
$
13
 
$
175
 
Accrued expenses and other current liabilities
   
128
   
536
 
Current portion of notes payable
   
-
   
45
 
Total current liabilities
   
141
   
756
 
Notes payable
   
404
   
322
 
Derivative instruments
   
7
   
4
 
Total liabilities
   
552
   
1,082
 
 
             
Stockholders' equity:
             
Common stock
   
3
   
3
 
Additional paid-in capital
   
125,723
   
125,699
 
Accumulated deficit
   
(123,643
)
 
(122,639
)
Total stockholders' equity
   
2,083
   
3,063
 
Total liabilities and stockholders' equity
 
$
2,635
 
$
4,145
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

3


Cellegy Pharmaceuticals, Inc
Condensed Consolidated Statements of Operations
(Amounts in thousands, except per share data)
(Unaudited)
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
 
2007
 
2006
 
2007
 
2006
 
Revenues:
                 
Licensing, milestone and development funding
 
$
-
 
$
315
 
$
-
 
$
379
 
Grants
   
-
   
912
   
-
   
1,827
 
Product sales
   
-
   
-
   
-
   
257
 
Total revenues
   
-
   
1,227
   
-
   
2,463
 
Costs and expenses:
                 
Cost of product sales
   
-
   
-
   
-
   
257
 
Research and development
   
15
   
800
   
21
   
1,906
 
Selling, general and administrative
   
426
   
1,472
   
942
   
3,571
 
Total costs and expenses
   
441
   
2,272
   
963
   
5,734
 
Operating loss
   
(441
)
 
(1,045
)
 
(963
)
 
(3,271
)
Other income (expenses):
                 
Interest and other income
   
23
   
7
   
56
   
15
 
Interest and other expense
   
(51
)
 
(224
)
 
(94
)
 
(437
)
Derivative revaluation
   
3
   
80
   
(3
)
 
25
 
Total other income (expenses)
   
(25
)
 
(137
)
 
(41
)
 
(397
)
Net loss from continuing operations applicable to common stockholders
   
(466
)
 
(1,182
)
 
(1,004
)
 
(3,668
)
Income (loss) from discontinued operations
   
-
   
(69
)
 
-
   
7
 
Net loss applicable to common stockholders
 
$
(466
)
$
(1,251
)
$
(1,004
)
$
(3,661
)
 
                 
Earnings per common share:
                 
From continuing operations
 
$
(0.02
)
$
(0.04
)
$
(0.03
)
$
(0.12
)
From discontinued operations
   
-
   
-
   
-
   
-
 
Basic loss per common share:
 
$
(0.02
)
$
(0.04
)
$
(0.03
)
$
(0.12
)
 
                 
From continuing operations
 
$
(0.02
)
$
(0.04
)
$
(0.03
)
$
(0.12
)
From discontinued operations
   
-
   
-
   
-
   
-
 
Diluted loss per common share:
 
$
(0.02
)
$
(0.04
)
$
(0.03
)
$
(0.12
)
 
                 
Weighted average number of common shares used in per share calculations:
                 
Basic
   
29,835
   
29,833
   
29,835
   
29,832
 
Diluted
   
29,835
   
29,833
   
29,835
   
29,832
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

4


Cellegy Pharmaceuticals, Inc.
Condensed Consolidated Statements of Cash Flows
(Amounts in thousands)
(Unaudited)

 
 
Six Months Ended June 30,
 
 
 
2007
2006
 
Operating activities
         
Net loss
 
$
(1,004
)
$
(3,661
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activites:
         
Bad debt expense & other non-cash items
   
-
   
37
 
Depreciation expense
   
-
   
81
 
Intangible assets amortization
   
-
   
196
 
Loss on sale of fixed assets
   
-
   
77
 
Equity compensation expense
   
24
   
83
 
Derivative re-evaluation
   
3
   
(26
)
Interest accretion on notes payable
   
82
   
384
 
MPI Note debt forgiveness
   
(5
)
 
-
 
Changes in operating assets and liabilitites:
         
Prepaid expenses and other current assets
   
169
   
2,251
 
Accounts receivable
   
58
   
365
 
Other assets
   
-
   
(1,012
)
Accounts payable
   
(162
)
 
(159
)
Accrued expenses and other current liabilities
   
(408
)
 
(1,071
)
Other long term liabilities
   
-
   
46
 
Deferred revenue
   
-
   
(128
)
Net cash used in operating activities
   
(1,243
)
 
(2,537
)
Investing activities:
         
Sale of investments
   
-
   
11
 
Proceeds from sale of subsidiary
   
-
   
1,012
 
Net cash provided by (used in) investing activities
   
-
   
1,023
 
Financing activities:
         
Repayment of notes payable
   
(40
)
 
(209
)
Net cash provided by (used in) financing activities
   
(40
)
 
(209
)
 
         
Effect of exchange rate changes on cash
   
-
   
123
 
 
         
Net decrease in cash and cash equivalents
   
(1,283
)
 
(1,600
)
Cash and cash equivalents, beginning of period
   
3,804
   
2,251
 
Cash and cash equivalents, end of period
 
$
2,521
 
$
651
 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.

5


Cellegy Pharmaceuticals, Inc.
 Notes to Condensed Consolidated Financial Statements
(Unaudited)
 
Note 1:  Basis of Presentation
 
The accompanying unaudited interim condensed consolidated financial statements have been prepared 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, certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted. In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements reflect all adjustments (including normal recurring adjustments and the elimination of intercompany accounts) considered necessary for a fair statement 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 interim 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, 2006.
 
Liquidity and Capital Resources
 
We prepared the condensed consolidated financial statements assuming that we will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities during the normal course of business. In preparing these condensed consolidated financial statements, consideration was given to the Company’s future business alternatives as described below, which may preclude the Company from realizing the value of certain assets during their future course of business. At June 30, 2007, the Company had cash and cash equivalents of approximately $2.5 million.

In 2006, the Company eliminated its direct research activities and the Company sold a material portion of its intellectual property. The Company’s operations currently relate primarily to the intellectual property of its Biosyn subsidiary and the evaluation of its remaining options and alternatives with respect to its future course of business. While the Savvy Phase 3 contraception trial in the United States is ongoing, the Company is not directly involved with the conduct and funding thereof and it is uncertain whether Savvy will be commercialized or whether the Company will ever realize revenues therefrom. We therefore expect negative cash flows to continue for the foreseeable future. The Company presently has enough financial resources to continue operations as they currently exist for the near term, however, it does not have the technological nor the financial assets necessary to fund the expenditures that would be required to conduct the future clinical and regulatory work necessary to commercialize Savvy without additional funding. Alternatives with respect to the Company’s remaining business and assets might include seeking to merge or combine with another third party with greater resources and infrastructure necessary to conduct development programs and to commercialize technology. If a suitable candidate cannot be found, the Company may choose to liquidate or voluntarily file bankruptcy proceedings. Due to the uncertainty of the cash flow necessary to explore or implement these alternatives, there can be no assurance that the Company will have adequate resources to continue operations for longer than twelve (12) months.

These factors raise substantial doubt about our ability to continue as a going concern. There is no assurance that any of the above options will be implemented on a timely basis or that we will be able to sell our remaining technology or find suitable candidates for a business combination or other transaction, if at all. We may be required to accept less than favorable commercial terms in any such future arrangements. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Any failure to dispel any continuing doubts about our ability to continue as a going concern could adversely affect our ability to enter into any business combination or other agreements, therefore making it more difficult to obtain required financing on favorable terms or at all. Such an outcome may negatively affect the market price of our common stock and could otherwise have a material adverse effect on our business, financial condition and results of operations.
 
6


Note 2: Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss generally represents all changes in stockholders’ equity except those resulting from investments or contributions by stockholders. The Company’s unrealized foreign currency translation (“FCT”) adjustments represent the only components of accumulated other comprehensive loss that are excluded from the Company’s net loss.

Total comprehensive income during three and six months ended June 30, 2007 and 2006 consisted of (in thousands):
 
 
 
Three Months Ended June 30,
 
  Six Months Ended June 30,
 
 
 
2007  
 
2006
 
  2007
 
  2006
 
Net loss after discontinued operations
 
$
(466
)
$
(1,251
)
$
(1,004
)
$
(3,661
)
Change in FCT adjustments
   
-
   
157
   
-
   
123
 
Comprehensive loss
 
$
(466
)
$
(1,094
)
$
(1,004
)
$
(3,538
)

  
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 that had their impact excluded was (in thousands):
 
 
 
Three Months Ended June 30,
 
  Six Months Ended June 30,
 
 
 
2007
 
  2006
 
  2007
 
  2006
 
Options
   
1,363
   
3,659
   
1,363
   
3,289
 
Warrants
   
2,115
   
2,375
   
2,115
   
2,375
 
Total number of shares excluded
   
3,478
   
6,034
   
3,478
   
5,664
 

2006 share amounts exclude 2,121,212 shares that would have been issuable upon conversion of the $3.5 million nonnegotiable senior convertible debenture due PDI, Inc. (“PDI”). This note was settled in September, 2006.
 
Note 4: Stock-Based Compensation
 
In the condensed consolidated statement of operations in the second quarter of 2007 and 2006, the Company recorded stock based compensation expenses of $22,971 and $39,844, respectively.

2005 Equity Incentive Plan (“2005 Plan”)

Options Outstanding
 
Weighted
Average
Number of
Options
 
  Weighted
Average
Remaining
Contractual Life
 
Weighted
Average
Exercise
Price  
 
Aggregate
Intrinsic
Value
 
48,000
   
8.25 years
 
$
1.34
 
$
-
 
 
There were no grants, cancellations or exercises of options under the 2005 Plan during the quarter ended June 30, 2007. None of the options vested in the quarter ended June 30, 2007.
 
7


1995 Equity Incentive Plan (“Prior Plan”)


Options Outstanding
   
  Options Exercisable
 
Weighted
Average
Number of
Options
 
  Weighted
Average
Remaining
Contractual Life  
 
Weighted
Average
Exercise
Price  
   
Aggregate
Intrinsic
Value
   
  Weighted
Average
Number of
Options  
 
Weighted
Average Remaining Contractual Life  
 
Weighted
Average
Exercise
Price  
   
Aggregate
Intrinsic
Value
 
222,944
 
  6.43 years  
 
3.12  
  $
 
-  
  172,236  
 
6.18 years  
 
3.37  
  $
 -
 
 
There were no cancellations or exercises of options under the Prior Plan during the quarter ended June 30, 2007. No future options may be granted under the Prior Plan. The total fair value of the options vesting in the quarter ended June 30, 2007 was $300.

Directors’ Stock Option Plan

Options Outstanding and Exercisable
 
Weighted
Average
Number of
Options
 
  Weighted
Average
Remaining
Contractual Life  
 
Weighted
Average
Exercise
Price  
 
Aggregate
Intrinsic
Value
 
92,000
 
 
5.33 years
 
 
4.45
 
$
-
 
 
During the quarter ended June 30, 2007, 1,000 options expired and no options were exercised. As of June 30, 2007, there were no options available for future grants under the Directors’ Plan. The total fair value of the options vesting in the quarter ended June 30, 2007 was $583.

Non-Plan Options

In November 2003, the Company granted an initial stock option to Mr. Richard C. Williams, on his appointment to become Chairman of the Board, to purchase 1,000,000 shares of common stock. 400,000 and 600,000 options have exercise prices of $2.89 and $5.00 per share, respectively. The option was vested and exercisable in full on the grant date, although a portion of the option covering up to 600,000 shares initially and declining over time is subject to cancellation if they have not been exercised in the event that Mr. Williams voluntarily resigns as Chairman and a director within certain future time periods. As of June 30, 2007, none of these options have been exercised.

Biosyn Options

In October 2004, in conjunction with its acquisition of Biosyn, Cellegy issued stock options to certain Biosyn option holders to purchase 236,635 shares of Cellegy common stock. All options issued were immediately vested and exercisable.

During the quarter ended June 30, 2007, there were no cancellations or exercises under Biosyn options plan. The following table summarizes information about stock options outstanding and exercisable related to Biosyn option grants at June 30, 2007:

Options Outstanding and Exercisable
 
Weighted
Average
Number of
Options
 
  Weighted
Average
Remaining
Contractual Life  
 
Weighted
Average
Exercise
Price  
 
Aggregate
Intrinsic
Value
 
4,797
 
 
6.56 years
 
 
0.29
 
$
-
 
 
8


Shares Reserved

As of June 30, 2007, the Company has reserved shares of common stock for issuance as follows:

Biosyn options
   
4,797
 
Director's Plan
   
92,000
 
Warrants
   
2,114,593
 
Nonplan options
   
1,000,000
 
1995 Equity Incentive Plan
   
222,944
 
2005 Equity Incentive Plan
   
998,500
 
Total
   
4,432,834
 

As of June 30, 2007, there was $48,335 of total unrecognized compensation cost related to non-vested options, which is expected to be recognized over a remaining weighted-average vesting period of approximately 0.72 years.

Warrants
 
 
 
  Warrant
Shares
 
Exercise
Price Per
Share
 
  Date Issued  
 
Expiration Date
 
June 2004 PIPE
   
604,000
 
$
4.62
   
July 27, 2004
   
July 27, 2009
 
Biosyn warrants
   
81,869
   
5.84-17.52
   
October 22, 2004
   
2008 - 2014
 
May 2005 PIPE
                 
Series A
   
714,362
   
2.25
   
May 13, 2005
   
May 13, 2010
 
Series B
   
714,362
   
2.50
   
May 13, 2005
   
May 13, 2010
 
Total
   
2,114,593
             
 
Note 5: Segment Reporting
 
All revenues during the three and six months ended June 30, 2006, were derived from the Company’s pharmaceutical segment.

Revenues from external sources by major geographic area are as follows (in thousands):

 
 
Three Months Ended June 30,
 
  Six Months Ended June 30,
 
 
 
 
2007
 
 
2006
 
 
2007
 
 
2006
 
Revenues 
                         
North America
                 
Pharmaceuticals
 
$
-
 
$
912
 
$
-
 
$
1,827
 
Europe
                 
Pharmaceuticals
   
-
   
315
   
-
   
636
 
Revenues from continuing operations
 
$
-
 
$
1,227
 
$
-
 
$
2,463
 

Cellegy allocates its revenues and operating expenses to each business segment. Management regularly assesses segment operating performance and makes decisions on how resources are allocated based upon segment performance, with the segment measurement of profitability being net income. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.
 
9


Operating loss by geographic region is as follows (in thousands):

 
 
Three Months Ended June 30,
 
  Six Months Ended June 30,
 
 
 
2007
 
2006
 
  2007
 
  2006
 
Operating Loss 
                         
North America
                 
Pharmaceuticals
 
$
(466
)
$
(879
)
$
(1,004
)
$
(2,721
)
Europe
                 
Pharmaceuticals
   
-
   
(303
)
 
-
   
(947
)
Net loss from continuing operations
 
$
(466
)
$
(1,182
)
$
(1,004
)
$
(3,668
)
All of the Company’s assets are related to the pharmaceutical segment and are located in the United States. Assets by major geographic region are as follows (in thousands):

   
June 30,
2007
 
December 31,
2006
 
Assets
         
North America
 
$
2,635
 
$
4,145
 
 
Note 6: Recent Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes how a company should recognize, measure, present and disclose uncertain income tax positions. A “tax position” is a position taken on a previously filed tax return, or expected to be taken in a future tax return that is reflected in the measurement of current or deferred tax assets or liabilities for interim or annual periods. A tax position can result in a permanent reduction of income taxes payable, a deferral of income taxes to future periods, or a change in the expected ability to realize deferred tax assets. A change in net assets that results from the adoption of FIN 48 is recorded as an adjustment to retained earnings in the period of adoption. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the effect that the adoption of FIN 48 will have on its results of operations and financial position. The adoption of FIN 48 is not expected to have a material impact on the Company’s financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.”  SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value.  SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  We do not expect our adoption of this new standard to have a material impact on the Company’s financial statements.

The Emerging Issues Task Force (“EITF”) has two issues currently under consideration that may impact the Company. EITF 07-01, “Accounting for Collaboration Arrangements Related to the Development and Commercialization of Intellectual Property” , is focused on how the parties to a collaborative agreement should account for costs incurred and revenue generated on sales to third parties, how sharing payments pursuant to a collaboration agreement should be presented in the income statement and certain related disclosure questions. EITF 07-3, “Accounting for Non-Refundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities”, is focused on whether non-refundable advance payments for goods that will be used or services that will be performed in future research and development activities should be accounted for as research and development costs or deferred and capitalized until the goods have been delivered or the related services have been rendered. The Company will continue to monitor the development of these EITF’s and evaluate the effects on its financial statements and disclosures.

10


Note 7: Accounts Receivable

Accounts receivable consists of the following (in thousands):

   
 
June 30,
2007
 
 December 31,
2006
 
Grant receivables
 
$
-
 
$
63
 
Other receivables
   
19
   
14
 
 
 
$
19
 
$
77
 

Note 8: Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following (in thousands):

   
 
June 30,
2007
 
December 31,
2006
 
Prepaid insurance
 
$
86
 
$
237
 
Security deposits
   
8
   
18
 
Other
   
1
   
9
 
 
 
$
95
 
$
264
 

Note 9: Accrued Expenses and Other Current Liabilities
 
The Company accrues for goods and services received but for which billings have not been received. Accrued expenses and other current liabilities consist of the following (in thousands):

   
 
June 30,
2007
 
December 31,
2006
 
Accrued legal fees
 
$
-
 
$
22
 
Accrued retention and severance
   
59
   
100
 
Accrued accounting and consulting fees
   
15
   
175
 
Insurance payable
   
3
   
164
 
Other
   
51
   
75
 
Total
 
$
128
 
$
536
 
 
Note 10: Notes Payable
 
 Ben Franklin Note
 
Biosyn issued a note to Ben Franklin Technology Center of Southeastern Pennsylvania (“Ben Franklin Note”) in October 1992, in connection with funding the development of a compound to prevent the transmission of Acquired Immunodeficiency Disease (“AIDS”). 
 
The Ben Franklin Note was recorded at its estimated fair value of $205,000 and was assumed by Cellegy in connection with its acquisition of Biosyn in 2004. The repayment terms of the non-interest bearing obligation include the remittance of an annual fixed percentage of 3% applied to future revenues of Biosyn, if any, until the principal balance of $777,902 is satisfied. Under the terms of the obligation, revenues are defined to exclude the value of unrestricted research and development funding received by Biosyn from nonprofit sources. There is no obligation to repay the amounts in the absence of future Biosyn revenues. The Company is accreting the discount of $572,902 against earnings using the interest rate method over the discount period of five years, which was estimated in connection with the note’s valuation at the time of the acquisition. At June 30, 2007, the outstanding balance of the note is $404,153.
 
11


PDI Notes
 
In connection with a settlement agreement dated April 11, 2005, PDI issued two non-interest bearing notes; a $3.0 million secured promissory note payable on October 12, 2006, and a $3.5 million nonnegotiable senior convertible debenture with a maturity date of April 11, 2008 (the “PDI Notes”). The PDI Notes were settled for $3.0 million in September 2006.
 
MPI Note

In 2004, the Company settled a dispute with MPI, Inc. (“MPI”) and agreed to pay $60,000 as full and final settlement (the “MPI note”). The MPI note had no stated interest rate. The settlement agreement allowed the Company to take certain credits against the MPI note based upon the cumulative amount of contracts entered into by the Company with MPI over a thirty-month period ending in January 2007, at which time the remaining balance was payable. During that period, MPI credited the Company $15,300 under this provision of the agreement. The MPI note was settled in March 2007, for $40,000 and the remaining balance of $4,700 was forgiven and recorded as other income.
 
Note 11:  Derivative Instruments.
 
 The warrants from the May 2005 PIPE financing and Kingsbridge SSO are revalued at the end of each reporting period as long as they remain outstanding. The estimated fair value of all warrants, using the Black-Scholes valuation model, recorded as derivative liability at June 30, 2007 and December 31, 2006 was $6,987 and $3,987. The changes in the estimated fair value of the warrants have been recorded as other income and expense in the condensed consolidated statement of operations. For the three and six months ended June 30, 2007, the Company recognized expense of $2,707 and income of $3,173, respectively from derivative revaluation. The Kingsbridge warrants were cancelled January 12, 2007.
 
Note 12: Discontinued Operations

On April 11, 2006, Epsilon Pharmaceuticals (“Epsilon”) purchased all of the shares of Cellegy Australia Pty, Ltd (“Cellegy Australia”). The subsidiary was part of the Pharmaceutical Segment for the Australian and Pacific Rim geographic areas. The purchase price for the shares was $1.0 million plus amounts equal to the liquidated value of Cellegy Australia's cash, accounts receivable and inventory. The total amount received was approximately $1.3 million. Below is a summary of the assets and liabilities included in the sale:

Cash
 
$
185,554
 
Inventory
   
69,427
 
Accounts Receivable
   
52,305
 
Goodwill
   
955,415
 
Current liabilities
   
262,000
 
 
Cellegy's discontinued operations reflect the operating results for the disposal group through the date of disposition and recognize the subsidiary's foreign currency translation balance as income in the current period pursuant to SFAS No. 52, Foreign Currency Translation. Below is a summary of those results:

12


   
 
Three Months
Ended
June 30,
2006
 
Six Months
Ended
June 30,
2006
 
Net revenue
 
$
-
 
$
166
 
Cost of revenues
   
-
   
27
 
Gross profit
   
-
   
139
 
Selling general and administrative expenses
   
-
   
65
 
Operating income
   
-
   
74
 
Interest income
   
-
   
2
 
Loss on disposal
   
(69
)
 
(69
)
Income (loss) from discontinued operations
 
$
(69
)
$
7
 
 
ITEM 2.          Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes to those statements included elsewhere in this Quarterly Report on Form 10-Q and our most recent audited financial statements included in our Annual Report on Form 10-K previously filed with the SEC. This discussion may contain forward-looking statements 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. 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. Actual events or results may also differ materially from those discussed in this Quarterly Report on Form 10-Q. These risks and uncertainties include those described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Affect Future Operating Results” and elsewhere in this Quarterly Report on Form 10-Q. Except as required by law, we undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may arise after the date of this Quarterly Report on Form 10-Q.
 
General
 
Cellegy Pharmaceuticals is a specialty biopharmaceutical company. Following the Company’s decision to eliminate its direct research activities and the sale of its assets to ProStrakan in late 2006, the Company’s operations currently relate primarily to the ownership of its intellectual property rights relating to the Biosyn product candidates and the evaluation of its remaining options and alternatives with respect to its future course of business.

Results of Operations
 
Revenues.  The Company had no revenues for the three and six month periods ended June 30, 2007 and had revenues of approximately $1,227,000 and $2,463,000 for the three and six month periods ended June 30, 2006, respectively.  Six-month 2006 period-to-date revenues consist of licensing, product sales and grant revenues.

Licensing revenues. The Company had no licensing revenues for the three and six month periods ended June 30, 2007. The Company recorded licensing revenues for the three and six month periods ended June 30, 2006 of approximately $315,000 and $379,000, respectively. Licensing revenues consist primarily of amortization of upfront payments received from licensees in connection with the Company’s existing licensing agreements. We expect to recognize no licensing revenues in the foreseeable future.
 

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Grant Revenues. The Company had no grant revenues for the three and six month periods ending June 30, 2007. Grant revenues were approximately $912,000 and $1,827,000 for the three and six month periods ended June 30, 2006 and related primarily to the CVN and UC-781 product candidates. The Company has discontinued its grant funding in connection with the elimination of its direct research activities in 2006 and does not expect to record grant revenues in 2007.
 
In addition to the grants funding above, Biosyn benefits indirectly from agency funding paid to third party contractors in support of its ongoing Phase 3 clinical trials. These payments from the funding agencies are made directly to the service providers, not to Biosyn. Under the terms of certain of its funding agreements, Biosyn has been granted the right to commercialize products supported by the funding in developed and developing countries, and is obligated to make its commercialized products, if any, available in developing countries, as well as to public sector agencies in developed countries at prices reasonably above cost or at a reasonable royalty rate.

Product Sales.  The Company had no product sales for the three and six month periods ended June 30, 2007. There were no product sales for the three month period ended June 30, 2006. Product sales for the six-month period ending June 30, 2006 of approximately $257,000 consisted primarily of in-process and other inventory purchases by ProStrakan in conjunction with its acquisition of the European marketing rights to Rectogesic in late 2005. Due to the renegotiation of its agreements with ProStrakan and the sale of the Company’s technology in 2006, Cellegy does not currently generate product sales revenue. We expect to recognize no product sales revenues in the foreseeable future.

Research and Development Expenses.  In the three and six month periods ending June 30, 2007, the Company incurred research and development expenses of approximately $15,000 and $21,000, respectively. During the corresponding periods of 2006, research and development expenses of approximately $800,000 and $1,906,000 were attributable primarily to research activities concerning the Company’s HIV product candidates. The Company discontinued its direct research activities in 2006 and does not expect to incur significant research and development expenses in 2007.
 
Selling, General and Administrative Expenses.  Selling, general and administrative expenses for the three and six month periods ending June 30, 2007 were approximately $426,000 and $942,000. Selling, general and administrative expenses for the three and six month periods ending June 30, 2006 were approximately $1,472,000 and $3,571,000, respectively.

For the three month period, the decrease of approximately $1,046,000 consists primarily of approximately $431,000 decreases in salary and related expenses due to reductions in staffing, a decrease of approximately $116,000 in rent and other office expenses and a decrease of approximately $499,000 in legal, consulting and other administrative expenses. For the six month period, the decrease of approximately $2,629,000 consists primarily of approximately $1,099,000 decreases in salary and related expenses due to reductions in staffing, decreases of approximately $996,000 in legal, consulting and other administrative expenses and decreases of approximately $534,000 in rent and other office expenses. Additionally, the first quarter of 2006 includes Kingsbridge SSO financing fees of $266,000.

Other Income (Expense).  Net other expense in the second quarters of 2007 and 2006 was approximately $25,000 and $137,000, respectively. Net other expense for the six month period ending June 30, 2007 and 2006 was approximately $41,000 and $397,000, respectively. The decrease in expense was due primarily to a reduction in interest expense due to the liquidation of the promissory notes due PDI, Inc. in the fourth quarter of 2006. Additionally, derivative expense decreased in 2007 due to the termination of the Kingsbridge SSO agreement and related warrants derivative in January 2007.

Discontinued Operations.  On April 11, 2006, Epsilon purchased all of the shares of Cellegy Australia and as a result, the Company reflected Cellegy Australia as a discontinued operation. As of April 11, 2006, income from discontinued operations was approximately $7,000.
 
14


Liquidity and Capital Resources
 
Our cash and cash equivalents were approximately $2.5 million and $3.8 million at June 30, 2007 and December 31, 2006, respectively.

Cash and cash equivalents decreased approximately $1,283,000 in the six month period ended June 30, 2007 due primarily to operating expenses.

We prepared the condensed consolidated financial statements assuming that we will continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities during the normal course of business. In preparing these condensed consolidated financial statements, consideration was given to the Company’s future business alternatives as described below, which may preclude the Company from realizing the value of certain assets during their future course of business.

In 2006, the Company eliminated its direct research activities and sold a material portion of its intellectual property. The Company’s operations currently relate primarily to the ownership of its intellectual property rights of its Biosyn subsidiary and the evaluation of its remaining options and alternatives with respect to its future course of business. While the Savvy Phase 3 contraception trial in the United States is ongoing, the Company is not directly involved with the conduct and funding thereof and it is uncertain whether Savvy will be commercialized or whether the Company will ever realize revenues therefrom. We therefore expect negative cash flows to continue for the foreseeable future. The Company presently has enough financial resources to continue operations as they currently exist for the near term, however, it does not have the technological or the financial assets necessary to fund the expenditures that would be required to conduct the future clinical and regulatory work necessary to commercialize Savvy without additional funding. Alternatives with respect to the Company’s remaining business and assets might include seeking to merge or combine with another third party with greater resources and infrastructure necessary to conduct development programs and to commercialize technology. If a suitable candidate cannot be found, the Company may chose to liquidate or voluntarily file bankruptcy proceedings. Due to the uncertainty of the cash flow necessary to explore or implement these alternatives, there can be no assurance that the Company will have adequate resources to continue operations for longer than 12 months.

These factors raise substantial doubt about our ability to continue as a going concern. There is no assurance that any of the above options will be implemented on a timely basis or that we will be able to sell or license our remaining technology or find suitable candidates for a business combination or other transaction, if at all. We may be required to accept less than favorable commercial terms in any such future arrangements. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Any failure to dispel any continuing doubts about our ability to continue as a going concern could adversely affect our ability to enter into business combination or other agreements, therefore making it more difficult to obtain required financing on favorable terms or at all. Such an outcome may negatively affect the market price of our common stock and could otherwise have a material adverse effect on our business, financial condition and results of operations.

Recent Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes how a company should recognize, measure, present and disclose uncertain income tax positions. A “tax position” is a position taken on a previously filed tax return, or expected to be taken in a future tax return that is reflected in the measurement of current or deferred tax assets or liabilities for interim or annual periods. A tax position can result in a permanent reduction of income taxes payable, a deferral of income taxes to future periods, or a change in the expected ability to realize deferred tax assets. A change in net assets that results from the adoption of FIN 48 is recorded as an adjustment to retained earnings in the period of adoption. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the effect that the adoption of FIN 48 will have on its results of operations and financial position. The adoption of FIN 48 is not expected to have a material impact on the Company’s financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.”  SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value.  Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings.  SFAS No. 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value.  SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.  We do not expect our adoption of this new standard to have a material impact on the Company’s financial statements.
 
15


The Emerging Issues Task Force (“EITF”) has two issues currently under consideration that may impact the Company. EITF 07-01, “Accounting for Collaboration Arrangements Related to the Development and Commercialization of Intellectual Property”, is focused on how the parties to a collaborative agreement should account for costs incurred and revenue generated on sales to third parties, how sharing payments pursuant to a collaboration agreement should be presented in the income statement and certain related disclosure questions. EITF 07-3, “Accounting for Non-Refundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities”, is focused on whether non-refundable advance payments for goods that will be used or services that will be performed in future research and development activities should be accounted for as research and development costs or deferred and capitalized until the goods have been delivered or the related services have been rendered. The Company will continue to monitor the development of these EITF’s and evaluate the effects on its financial statements and disclosures.

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, 2006.  No changes in those policies and estimates have occurred during the six months ended June 30, 2007.
 
ITEM 3. Quantitative and Qualitative Disclosure of Market Risk
 
Cellegy invests its excess cash in short-term, investment grade, fixed income securities under an investment policy. All of our securities owned as of June 30, 2007, were in money market funds and are classified as cash equivalents. We believe that potential near-term losses in future earnings, fair values or cash flows related to our investment portfolio are not significant. We currently do not hedge interest rate exposure. If market interest rates were to increase or decrease, the fair value of our portfolio would not be affected.
 
We are incurring market risk associated with the issuance of warrants to the May 2005 PIPE investors to purchase approximately 1.4 million 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 or expired. 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 statement of operations in future quarters.
 
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 the end of the period covered by this report, our disclosure controls and procedures were effective 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.
 
16


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.  A controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls are met, and no evaluation of controls can provide absolute assurance that all controls and instances of fraud, if any, within a company have been detected.
 
PART II   -  OTHER INFORMATION
 
ITEM 1. Legal Proceedings
 
None
 
ITEM 1A.  Risk Factors
 
We sold substantially all of our remaining assets to a third party and have drastically reduced the scope of our current operations.

In the fourth quarter of 2006, we sold a material portion of our assets, including intellectual property rights and related assets to ProStrakan. The Company’s operations currently relate primarily to the ownership of the intellectual property rights of our Biosyn subsidiary.

The Company is considering alternatives regarding future operations.

The Company’s board of directors is continuing to explore alternatives for the Company with respect to its business and assets. These alternatives might include seeking to sell remaining assets to third parties, the possible dissolution or liquidation of the Company, merging or combining with another company, bankruptcy proceedings or other alternatives. There can be no assurance that any third party will be interested in merging with the Company or acquiring the remaining assets of the Company or would agree to a price and other terms that we would deem adequate.

We have a history of losses and do not expect to achieve profitability.

We have incurred losses since our inception and negative cash flows from operations that raise substantial doubt about our ability to continue as a going concern. Without additional funds from sales of assets, intellectual property or technologies, or from a business combination or a similar transaction, we will exhaust our resources and will be unable to continue operations, and our accumulated deficit will continue to increase as we continue to incur losses. The amount of future net losses and our ability to sell our remaining assets or successfully enter a business combination transaction are highly uncertain.

In 2006, the Company eliminated its direct research activities and sold a material portion of its intellectual property. The Company’s operations currently relate primarily to the intellectual property relating to the product candidates of its Biosyn subsidiary and the evaluation of its remaining options and alternatives with respect to its future course of business. While the Savvy Phase 3 contraception trial in the United States is ongoing, the Company is not directly involved with the conduct and funding thereof and it is uncertain whether Savvy will be commercialized or whether the Company will ever realize revenues therefrom. We therefore expect negative cash flows to continue for the foreseeable future. The Company presently has enough financial resources to continue operations as they currently exist for the near term, however, it does not have the technological or the financial assets necessary to fund the expenditures that would be required to conduct the future clinical and regulatory work necessary to commercialize Savvy without additional funding. Alternatives with respect to the Company’s remaining business and assets might include seeking to merge or combine with another third party with greater resources and infrastructure necessary to conduct development programs and to commercialize technology. If a suitable candidate cannot be found, the Company may choose to liquidate or voluntarily file bankruptcy proceedings. Due to the uncertainty of the cash flow necessary to explore or implement these alternatives, there can be no assurance that the Company will have adequate resources to continue operations for longer than twelve (12) months.

17


These factors raise substantial doubt about our ability to continue as a going concern. There is no assurance that any of the above options will be implemented on a timely basis or that we will be able to sell or license our remaining technology or find suitable candidates for a business combination or other transaction, if at all. We may be required to accept less than favorable commercial terms in any such future arrangements. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Any failure to dispel any continuing doubts about our ability to continue as a going concern could adversely affect our ability to enter into business combination or other agreements, therefore making it more difficult to obtain required financing on favorable terms or at all. Such an outcome may negatively affect the market price of our common stock and could otherwise have a material adverse effect on our business, financial condition and results of operations.

We have received a “going concern” opinion from our independent registered public accounting firm, which may negatively impact our business.

Our audit opinions from our current and prior independent registered public accounting firms regarding the consolidated financial statements for the years ended December 31, 2006, 2005 and 2004 include an explanatory paragraph indicating that there is substantial doubt about the Company’s ability to continue as a going concern. Doubts concerning our ability to continue as a going concern could adversely affect our ability to enter into business combination or other agreements, therefore making it more difficult to obtain required financing on favorable terms or at all. Such an outcome may negatively affect the market price of our common stock and could otherwise have a material adverse effect on our business, financial condition and results of operations.
 
We are subject to regulation by regulatory authorities including the FDA, which could delay or prevent marketing of our products. Unexpected regulatory outcomes could adversely affect our business and stock price.

Cellegy’s remaining product candidates and our research and clinical activities are subject to extensive regulation by governmental regulatory authorities in the United States and in other countries. Before we obtain regulatory approval for the commercial sale of any potential drug products, we must demonstrate through pre-clinical studies and clinical trials that the product is safe and efficacious for use in the clinical indication for which approval is sought. The timing of NDA submissions, the outcome of reviews by the FDA and the initiation and completion of other clinical trials are subject to uncertainty, change and unforeseen delays. Under the Prescription Drug User Fee Act (“PDUFA”), the FDA establishes a target date to complete its review of an NDA. Although the FDA attempts to respond by the relevant PDUFA date to companies that file NDAs, there is no obligation on the FDA’s part to do so. In addition, extensive current pre-clinical and clinical testing requirements and the current regulatory approval process of the FDA in the United States and of certain foreign regulatory authorities, or new government regulations, could prevent or delay regulatory approval of our product candidates.

The process of developing and obtaining approval for a new pharmaceutical product within this regulatory framework requires a number of years and substantial expenditures. There can be no assurance that necessary approvals will be obtained in a timely manner, if at all. Delays in clinical trials or obtaining regulatory approvals could delay receipt of revenues from product sales, increase our expenditures relating to obtaining approvals, jeopardize corporate partnership arrangements that we might enter into with third parties regarding particular products, or cause a decline in our stock price. If we fail to comply with applicable regulatory requirements, we could be subject to a wide variety of serious administrative or judicially imposed sanctions and penalties, any of which could result in significant financial penalties that could reduce our available cash, delay introduction of products resulting in deferral or elimination of revenues from product sales, and could result in a decline in our stock price.

18


Clinical trial results are very difficult to predict in advance, and the clinical trial process is subject to delays. Failure of one or more clinical trials or delays in trial completion could adversely affect our business and our stock price.

Results of pre-clinical studies and early clinical trials may not be good predictors of results that will be obtained in later-stage clinical trials. We cannot provide any assurance that Cellegy’s remaining clinical trial will demonstrate the results required to continue advanced trial development and allow us to seek marketing approval for our product candidate. Because of the independent and blind nature of certain human clinical testing, there will be extended periods during the testing process when we will have only limited, or no, access to information about the status or results of the tests. Cellegy and other pharmaceutical companies have believed that their products performed satisfactorily in early tests, only to find their performance in later tests, including Phase 3 clinical trials, to be inadequate or unsatisfactory, or that FDA Advisory Committees have declined to recommend approval of the drugs, or that the FDA itself refused approval, with the result that stock prices have fallen precipitously. Clinical trials can be extremely costly. Certain costs relating to the Phase 3 trials for the Savvy product for contraception and, when they were conducted, for the reduction in the transmission of HIV, and other clinical and preclinical development costs for Savvy, were funded directly by certain grant and contract commitments from several governmental and non-governmental organizations (“NGOs”). Nevertheless, current or future clinical trials could require substantial additional funding. There can be no assurance that funding from governmental agencies and NGOs will continue to be available, and any other Phase 3 trials that Cellegy may commence in the future relating to its products could involve the expenditure of several million dollars through the completion of the clinical trials. In addition, delays in the clinical trial process can be extremely costly in terms of lost sales opportunities and increased clinical trial costs. The speed with which we complete our clinical trials and our regulatory submissions, including NDAs, will depend on several factors, including the following:

 
·
the rate of patient enrollment, which is affected by the size of the patient population, the proximity of patients to clinical sites, the difficulty of the entry criteria for the study and the nature of the protocol;
 
·
the timely completion of clinical site protocol approval and obtaining informed consent from subjects;
 
·
analysis of data obtained from preclinical and clinical activities;
 
·
changes in policies or staff personnel at regulatory agencies during the lengthy drug application review; and
 
·
the availability of experienced staff to conduct and monitor clinical studies, internally or through Contract Research Organizations (“CRO”).

Adverse events in our clinical trials section may force us to stop development of our product candidates or prevent regulatory approval of our product candidates, which could materially harm our business.

Patients participating in the clinical trial of our product candidate may experience serious adverse health events. A serious adverse health event includes death, a life-threatening condition, hospitalization, disability, congenital anomaly, or a condition requiring intervention to prevent permanent impairment or damage. The occurrence of any of these events could interrupt, delay or halt clinical trials of our product candidate and could result in the FDA, or other regulatory authorities, denying approval of our product candidate for any or all targeted indications. An institutional review board or independent data safety monitoring board, the FDA, other regulatory authorities or we, may suspend or terminate clinical trials at any time. Our product candidate may prove not to be safe for human use. Any delay in the regulatory approval of our product candidate could increase our product development costs and allow our competitors additional time to develop or market competing products.

Due to our reliance on contract research organizations or other third-parties to assist us in conducting clinical trials, we are unable to directly control all aspects of our clinical trials.

We have relied on CROs and other third parties to conduct our clinical trials. As a result, we have had and will continue to have less control over the conduct of the clinical trials, the timing and completion of the trials and the management of data developed through the trial than would be the case if we were relying entirely upon our own staff. Communicating with CROs can also be challenging, potentially leading to difficulties in coordinating activities. CROs may:
 
 
·
have staffing difficulties;

19


 
·
experience regulatory compliance issues;
 
·
undergo changes in priorities or may become financially distressed; or
 
·
not be able to properly control payments to government agencies or clinical sites, particularly in less developed countries.

These factors may adversely affect their ability to conduct trials relating to our product candidates. We may experience unexpected cost increases or experience problems with the timeliness or quality of the work of the CRO. If we must replace these CROs or any other third party contractor, trials may have to be suspended until we find another CRO that offers comparable services. The time that it takes us to find alternative organizations may cause a delay in the commercialization of our product candidates or may cause us to incur significant expenses. Although we do not now intend to replace our CROs, such a change would make it difficult to find a replacement organization to conduct our trials in an acceptable manner and at an acceptable cost. Any delay in or inability to complete clinical trials could significantly compromise our ability to secure regulatory approval of product candidates, thereby limiting our ability to generate product revenue resulting in a decrease in our stock price.

The type and scope of the patent coverage we have may limit the commercial success of our products.

Cellegy’s success depends, in part, on our ability to obtain patent protection for our products and methods, both in the United States and in other countries. No assurance can be given that any additional patents will be issued to us, that the protection of any patents that may be issued in the future will be significant, or that current or future patents will be held valid if subsequently challenged.

The patent position of companies engaged in businesses such as Cellegy’s business generally is uncertain and involves complex, legal and factual questions. There is a substantial backlog of patent applications at the United States Patent and Trademark Office. Patents in the United States are issued to the party that is first to invent the claimed invention. There can be no assurance that any patent applications relating to Cellegy’s products or methods will be issued as patents, or, if issued, that the patents will not be challenged, invalidated or circumvented or that the rights granted there under will provide a competitive advantage.

In addition, many other organizations are engaged in research and product development efforts that may overlap with Cellegy’s products. Such organizations may currently have, or may obtain in the future, legally blocking proprietary rights, including patent rights, in one or more products or methods under development or consideration by Cellegy. These rights may prevent us from commercializing technology, or may require Cellegy to obtain a license from the organizations to use the technology. Cellegy may not be able to obtain any such licenses that may be required on reasonable financial terms, if at all, and cannot be sure that the patents underlying any such licenses will be valid or enforceable. Moreover, the laws of certain foreign countries do not protect intellectual property rights relating to United States patents as extensively as those rights are protected in the United States. The issuance of a patent in one country does not assure the issuance of a patent with similar claims in another country, and claim interpretation and infringement laws vary among countries; therefore, the extent of any patent protection is uncertain and may vary in different countries. As with other companies in the pharmaceutical industry, we are subject to the risk that persons located in other countries will engage in development, marketing or sales activities of products that would infringe our patent rights if such activities were conducted in the United States.

We have limited sales and marketing experience.

We may market products, if any are successfully developed and approved and if we obtain sufficient funding, through a direct sales force in the United States. Cellegy has very limited experience in sales, marketing or distribution. To market these products directly, we may seek to establish a direct sales force in the United States or obtain the assistance of a marketing partner. However, Cellegy does not presently have the financial capability or the experience to successfully establish a direct sales force, marketing or distribution operations, which could delay or prevent the successful commercialization of our products and could reduce the ultimate profitability for Cellegy of such products if we needed to rely on a third party marketing partner to commercialize the products.

20


If medical doctors do not prescribe our products or the medical profession does not accept our products, our product sales and business would be adversely affected.

Our business is dependent on market acceptance of our products by physicians, healthcare providers, patients and the medical community. Medical doctors’ willingness to prescribe our products depends on many factors, including:

 
·
perceived efficacy of our products;
 
·
convenience and ease of administration;
 
·
prevalence and severity of adverse side effects in both clinical trials and commercial use;
 
·
availability of alternative treatments;
 
·
cost effectiveness;
 
·
effectiveness of our marketing strategy and the pricing of our products;
 
·
publicity concerning our products or competing products; and
 
·
our ability to obtain third-party coverage or reimbursement.

Even if we receive regulatory approval and satisfy the above criteria, physicians may not prescribe our products if we do not promote our products effectively. Factors that could affect our success in marketing our products include:

 
·
the experience, skill and effectiveness of the sales force and our sales managers;
 
·
the effectiveness of our production, distribution and marketing capabilities;
 
·
the success of competing products; and
 
·
the availability and extent of reimbursement from third-party payers.

Failure of our products or product candidates to achieve market acceptance would limit our ability to generate revenue and could harm our business.

We have very limited staffing and will continue to be dependent upon key personnel.

Our success is dependent upon the efforts of a small management team and staff. We do not have key man life insurance policies covering any of our executive officers or key employees. If key individuals leave Cellegy, we could be adversely affected if suitable replacement personnel are not quickly recruited. There is competition for qualified personnel in all functional areas, which makes it difficult to attract and retain the qualified personnel necessary for the development and growth of our business. Our future success depends upon our ability to continue to attract and retain qualified scientific, clinical and administrative personnel.

Our corporate compliance programs cannot guarantee that we are in compliance with all potentially applicable regulations.

The development, manufacturing, pricing, sales, and reimbursement of our products, together with our general operations, are subject to extensive regulation by federal, state and other authorities within the United States and numerous entities outside of the United States. We are a small company and we rely heavily on third parties to conduct many important functions. We also have significantly fewer employees than many other companies that have the same or fewer product candidates in late stage clinical development. In addition, as a publicly traded company we are subject to significant regulations, including the Sarbanes-Oxley Act of 2002, some of which have either only recently been adopted or are currently proposals subject to change. While we have developed and instituted a corporate compliance program and continue to update the program in response to newly implemented or changing regulatory requirements, we cannot assure you that we are now or will be in compliance with all such applicable laws and regulations. If we fail to comply with any of these regulations, we could be subject to a range of regulatory actions, including suspension or termination of clinical trials, restrictions on our products or manufacturing processes, withdrawal of products from the market, significant fines, or other sanctions or litigation. Failure to comply with potentially applicable laws and regulations could also lead to the imposition of fines, cause the value of our common stock to decline, and impede our ability to raise capital or lead to the de-listing of our stock.

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We are evaluating our internal controls over financial reporting to allow management to report on, and our independent registered public accounting firm to attest to, our internal controls, as required by the Sarbanes-Oxley Act. We will be performing the system and process evaluation and testing (and any necessary remediation) required to comply with the management certification and auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act (“Section 404”). Cellegy is considered a non-accelerated filer, and as such is required to comply with the Section 404 requirements for its fiscal year ending December 31, 2007. While we anticipate being able to fully implement the requirements relating to internal controls and all other aspects of Section 404 by our compliance deadline, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations. If we are not able to implement the requirements of Section 404 in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities, including the SEC. In addition, we may be required to incur a substantial financial investment to improve our internal systems and the hiring of additional personnel or consultants.

Risks Relating to Our Industry

We face intense competition from larger companies, and in the future Cellegy may not have the resources required to develop innovative products. Cellegy’s products are subject to competition from existing products.

The pharmaceutical industry is subject to rapid and significant technological change. Cellegy is much smaller in terms of size and resources than many of its competitors in the United States and abroad, which include, among others, major pharmaceutical, chemical, consumer product, specialty pharmaceutical and biotechnology companies, universities and other research institutions. Cellegy’s competitors may succeed in developing technologies and products that are safer and more effective than any product or product candidates that we may develop and could render Cellegy’s technology and potential products obsolete and noncompetitive. Many of these competitors have substantially greater financial and technical resources, clinical production and marketing capabilities and regulatory experience. In addition, any Cellegy products will likely be subject to competition from existing products. As a result, any future Cellegy products may never be able to compete successfully with existing products or with innovative products under development by other organizations.

We are subject to the risk of clinical trial and product liability lawsuits.

The testing of human health care product candidates entails an inherent risk of allegations of clinical trial liability, while the marketing and sale of approved products entails an inherent risk of allegations of product liability. We are subject to the risk that substantial liability claims from the testing or marketing of pharmaceutical products could be asserted against us in the future. Cellegy has obtained clinical trial insurance coverage relating to our clinical trials in an aggregate amount of $3 million. If any of our product candidates are approved for marketing, we may seek additional coverage.

There can be no assurance that Cellegy will be able to obtain or maintain insurance on acceptable terms, particularly in overseas locations, for clinical and commercial activities or that any insurance obtained will provide adequate protection against potential liabilities. Moreover, our current and future coverages may not be adequate to protect us from all of the liabilities that we may incur. If losses from liability claims exceed our insurance coverage, we may incur substantial liabilities that exceed our financial resources. In addition, a product or clinical trial liability action against us would be expensive and time-consuming to defend, even if we ultimately prevail. If we are required to pay a claim, we may not have sufficient financial resources and our business and results of operations may be harmed.

Our stock price could be volatile.
 
Our stock price has from time to time experienced significant price and volume fluctuations. Since becoming a public company, our stock price has fluctuated due to overall market conditions and due to matters or events more specific to Cellegy. Events or announcements that could significantly impact our stock price include:

 
·
Publicity or announcements regarding regulatory developments relating to our products;

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·
Clinical trial results, particularly the outcome of more advanced studies; or negative responses from both domestic and foreign regulatory authorities with regard to the approvability of our products;
 
·
Period-to-period fluctuations in our financial results, including our cash and cash equivalents balance, operating expenses, cash burn rate or revenue levels;
 
·
Common stock sales in the public market by one or more of our larger stockholders, officers or directors;
 
·
A negative outcome in any litigation or potential legal proceedings; or
 
·
Other potentially negative financial announcements including: a review of any of our filings by the SEC, changes in accounting treatment or restatement of previously reported financial results or delays in our filings with the SEC.
 
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
 
None
 
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
 
a) Exhibits

   
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:  July 31, 2007
/s/ Richard C. Williams  
 
Richard C. Williams
 
Chairman and Interim Chief Executive Officer
 
 
 
 
Date:  July 31, 2007
/s/ Robert J. Caso  
 
Robert J. Caso
 
Vice President, Finance and Chief Financial Officer
 
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