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DMK PHARMACEUTICALS Corp - Quarter Report: 2008 September (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 September 30, 2008
 
 
 
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)
 
128 Grandview Road, Boyertown, PA 19512
(Address of principal executive offices, including zip code)
 
215-529-6084
(Registrant’s telephone number, including area code)

2085 Quaker Point Drive, Quakertown , Pa 18951
(Former address of principal executive offices, including zip 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, a non-accelerated filer, or a smaller reporting company. See definitions of “larger accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):   
 
 Large accelerated filer  ¨ Accelerated filer  ¨  Non-accelerated filer  ¨  Smaller reporting company   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 September 30, 2008 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
 
17
Item 4.
 
Controls and Procedures
 
17
         
PART II
 
OTHER INFORMATION
 
 
Item 1.
 
Legal Proceedings
 
17
Item 1A.
 
Risk Factors
 
18
Item 2.
 
Unregistered Sales of Equity Securities and Use of Proceeds
 
18
Item 3.
 
Defaults Upon Senior Securities
 
18
Item 4.
 
Submission of Matters to a Vote of Security Holders
 
18
Item 5.
 
Other Information
 
18
Item 6.
 
Exhibits
 
18
 
 
Signatures
 
19
 

 
PART I   -   FINANCIAL INFORMATION
 
ITEM 1: Financial Statements

Cellegy Pharmaceuticals, Inc.
Condensed Consolidated Balance Sheets
(Amounts in thousands)
(Unaudited)
 
   
September 30, 2008
 
December 31, 2007
 
Assets
             
Current assets:
             
Cash and cash equivalents
 
$
361
 
$
1,827
 
Prepaid expenses and other current assets
   
43
   
267
 
Total current assets
   
404
   
2,094
 
Note receivable
   
500
   
 
Interest receivable
   
32
   
 
Total assets
 
$
936
 
$
2,094
 
               
Liabilities and Stockholders' Equity (Deficiency)
             
Current liabilities:
             
Accounts payable
 
$
49
 
$
 
Accrued expenses and other current liabilities
   
175
   
396
 
Total current liabilities
   
224
   
396
 
Note payable
   
713
   
507
 
Derivative instruments
   
1
   
1
 
Total liabilities
   
938
   
904
 
               
Stockholders' equity (deficiency):
             
Common stock
   
3
   
3
 
Additional paid-in capital
   
125,770
   
125,753
 
Accumulated deficit
   
(125,775
)
 
(124,566
)
Total stockholders' equity (deficiency)
   
(2
)
 
1,190
 
Total liabilities and stockholders' equity
 
$
936
 
$
2,094
 
 
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
 
Nine Months Ended
 
   
September 30,
 
September 30,
 
   
2008
 
2007
 
2008
 
2007
 
Costs and expenses:
                         
Research and development
 
$
 
$
2
 
$
3
 
$
23
 
Selling, general and administrative
   
262
   
404
   
1,060
   
1,345
 
Total costs and expenses
   
262
   
406
   
1,063
   
1,368
 
Operating loss
   
(262
)
 
(406
)
 
(1,063
)
 
(1,368
)
Other income (expenses):
                         
Interest and other income
   
17
   
147
   
60
   
203
 
Interest and other expense
   
(76
)
 
(67
)
 
(206
)
 
(161
)
Derivative revaluation
   
   
5
   
   
1
 
Total other income (expenses)
   
(59
)
 
85
   
(146
)
 
43
 
                           
Net loss
 
$
(321
)
$
(321
)
$
(1,209
)
$
(1,325
)
                           
Earnings per common share:
                         
Loss per common share:
 
$
(0.01
)
$
(0.01
)
$
(0.04
)
$
(0.04
)
                           
Weighted average number of common shares used in per share calculations:
   
29,835
   
29,835
   
29,835
   
29,835
 
 
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)
 
   
Nine Months Ended September 30,
 
   
2008
 
2007
 
Operating activities
             
Net loss
 
$
(1,209
)
$
(1,325
)
Adjustments to reconcile net loss from continuing operations to net cash used in operating activites:
             
Equity compensation expense
   
17
   
40
 
Derivative revaluation
   
   
(2
)
Interest accretion on notes payable
   
206
   
131
 
Interest on long term note receivable
   
(32
)
 
 
Forgiveness of debt
   
   
(5
)
Changes in operating assets and liabilitites:
             
Prepaid expenses and other current assets
   
224
   
(15
)
Accounts receivable
   
   
77
 
Accounts payable
   
49
   
(159
)
Accrued expenses and other current liabilities
   
(221
)
 
(371
)
Net cash used in operating activities
   
(966
)
 
(1,629
)
Investing activity:
             
Issuance of long term note receivable
   
(500
)
 
 
Net cash used in investing activity
   
(500
)
 
 
Financing activity:
             
Repayment of note payable
   
   
(40
)
Net cash used in financing activity
   
   
(40
)
               
Net decrease in cash and cash equivalents
   
(1,466
)
 
(1,669
)
Cash and cash equivalents, beginning of period
   
1,827
   
3,804
 
Cash and cash equivalents, end of period
 
$
361
 
$
2,135
 
 
 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 Pharmaceuticals, Inc. (“Cellegy” or “the Company”) 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, 2007.
 
Liquidity and Capital Resources
 
On February 12, 2008, Cellegy entered into a definitive merger agreement (as amended, the “Merger Agreement”) providing for the acquisition of Cellegy by Adamis Pharmaceuticals Corporation (“Adamis”). Adamis is a privately held specialty pharmaceuticals company that is engaged in the research, development and commercialization of products for the prevention of viral infections, including influenza. Adamis currently markets and sells a line of prescription products for a variety of allergy, respiratory disease and pediatric conditions. The transaction was unanimously approved by the boards of directors of both companies. The closing of the transaction is subject to several closing conditions, including the filing of a registration statement and proxy statement with the Securities and Exchange Commission (“SEC”), the approval of Adamis’ and Cellegy’s respective stockholders at stockholder meetings following distribution of a definitive proxy statement, and other customary closing conditions. Holders of approximately 40% of Cellegy’s outstanding common stock have entered into voting agreements pursuant to which they agreed to vote their shares in favor of the transaction. The combined company expects to continue to be publicly traded after completion of the merger, although under a different corporate name. On November 13, 2008, Cellegy filed a Form S-4 registration statement, which includes a preliminary proxy statement, with the SEC relating to the merger transaction with Adamis and certain related matters.

If the merger is consummated, each Adamis stockholder will receive, in exchange for each share of Adamis common stock held by such stockholder immediately before the closing, one (post-reverse stock split) share of Cellegy common stock (excluding in all cases dissenting shares). If the transaction is approved by Cellegy’s stockholders, before the closing Cellegy will implement a reverse stock split of its common stock so that the outstanding Cellegy shares will be converted into a number of shares equal to the sum of (i) 3,000,000 plus (ii) the amount of Cellegy’s net working capital as of the end of the month immediately preceding the month in which the closing occurs divided by .50. Based on several assumptions that are subject to change, including, without limitation, the number of shares of Cellegy common stock outstanding immediately before the merger and the amount of Cellegy’s current assets and liabilities as of the end of the month immediately prior to the closing, Cellegy estimates that the reverse stock split ratio will be approximately 1:9.9. The actual amounts and percentages will depend on many factors, and actual amounts and percentage could be higher or lower.

In addition, the Merger Agreement contains certain termination rights for both Cellegy and Adamis, and further provides that, upon termination of the merger agreement under specified circumstances, either party may be required to pay the other party a termination fee of $150,000. Both parties have the right to terminate the Merger Agreement if the merger is not consummated by December 31, 2008, so long as the terminating party is not in breach of the Merger Agreement and such breach is a principal failure of the merger to occur by such date.
 
6

 
In connection with the signing of the Merger Agreement, Cellegy also issued to Adamis an unsecured convertible promissory note (the “Promissory Note”) pursuant to which Cellegy agreed to lend Adamis $500,000 to provide additional funds to Adamis during the pendency of the merger transaction. Any principal outstanding under the Promissory Note accrues interest at 10% per annum. The Promissory Note becomes immediately due and payable in the event that the Merger Agreement is terminated by Adamis or Cellegy for certain specified reasons or on the later of (i) the sixteen month anniversary of the issue date of the Promissory Note or (ii) the date that is two business days following the first date on which certain other notes issued by Adamis to a third party have been repaid in full. If the Promissory Note is outstanding as of the closing of the merger transaction, the Promissory Note will not be repaid, but will convert into shares of Adamis stock and these shares will be immediately cancelled. Cellegy will receive no additional shares. The terms of the Promissory Note provide Cellegy with no collateralized interest in the assets of Adamis. In the event the merger is not consummated with Adamis, Cellegy bears the risk of collecting the Promissory Note and therefore is subject to the risks and uncertainties of being in the position of an unsecured creditor. While the Company feels that it is more likely than not that the merger will be consummated, in the event it is not, the Cellegy will have no ability to attach a claim to Adamis’ assets.

There is no assurance that the Company will be able to close the transaction with Adamis. If the proposed merger transaction with Adamis is still pending and Cellegy requires additional cash resources to complete the transaction, Cellegy and Adamis are engaged in discussions concerning an agreement for Adamis to provide funding sufficient to permit the merger to be completed, although there can be no assurance that such funding will be available.

If the merger with Adamis is not completed, Cellegy’s board of directors will be required to explore alternatives for Cellegy’s business and assets. These alternatives might include seeking the dissolution and liquidation of Cellegy, merging or combining with another company, or initiating bankruptcy proceedings. There can be no assurance that any third party will be interested in merging with Cellegy or acquiring the remaining assets of Cellegy. Although Cellegy may try to pursue an alternative strategic transaction, it will likely have very limited cash resources, and will likely be forced to file for federal bankruptcy protection. If Cellegy files for bankruptcy protection, Cellegy will most likely not be able to raise any type of funding from any source. In that event, the creditors of Cellegy would have first claim on the value of the assets of Cellegy which, other than remaining cash, would most likely be liquidated in a bankruptcy sale. Cellegy can give no assurance as to the magnitude of the net proceeds of such sale and whether such proceeds would be sufficient to satisfy Cellegy’s obligations to its creditors, let alone to permit any distribution to its equity holders. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. These factors raise substantial doubt about our ability to continue as a going concern.
  
Note 2: Loss per Common Share
 
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 condensed consolidated statements of operations, because all options and warrants are anti-dilutive. The total number of shares that had their impact excluded was (in thousands):
 
   
Three and Nine Months Ended
 
   
September 30,
 
   
2008
 
2007
 
Options
   
1,333
   
1,363
 
Warrants
   
2,115
   
2,115
 
Total number of shares excluded
   
3,448
   
3,478
 
 
7

 
Note 3: Stock-Based Compensation
 
In the condensed consolidated statement of operations for the third quarters of 2008 and 2007, the Company recorded stock based compensation expenses of $2,902 and $16,154, respectively.

2005 Equity Incentive Plan (“2005 Plan”)
 
Options Outstanding and Exercisable
Number of Options
 
Weighted Average Remaining Contractual Life
 
Weighted Average Exercise Price
 
Aggregate Intrinsic Value
48,000
 
7.00 Years
 
$ 1.34
 
$ —
 
There were no grants, cancellations, or exercises of options under the 2005 Plan during the quarter ended September 30, 2008 and 16,000 options vested in the quarter ended September 30, 2008.

1995 Equity Incentive Plan (“Prior Plan”)
 
Options Outstanding and Exercisable
Number of Options
 
Weighted Average Remaining Contractual Life
 
Weighted Average Exercise Price
 
Aggregate Intrinsic Value
204,944
 
5.67 Years
 
$ 2.66
 
$ —
 
There were no grants, cancellations, exercises or vestings of options under the Prior Plan during the quarter ended September 30, 2008. No future options may be granted under the Prior Plan.

Directors’ Stock Option Plan (“Director’s Plan”)
 
Options Outstanding and Exercisable
Number of Options
 
Weighted Average Remaining Contractual Life
 
Weighted Average Exercise Price
 
Aggregate Intrinsic Value
84,000
 
4.50 Years
 
$ 4.35
 
$ —
 
There were no grants, cancellations, exercises or vestings of options during the quarter ended September 30, 2008. No future options may be granted under the Directors’ Plan.

Non-Plan Options

In November 2003, the Company granted an initial stock option to Mr. Richard C. Williams, upon his appointment as 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 options were 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 as director within certain future time periods. As of September 30, 2008 none of these options have been exercised and none are subject to cancellation.
 
8

 
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 September 30, 2008, there were no grants, cancellations, or exercises under Biosyn options plan. The following table summarizes information about stock options outstanding and exercisable related to Biosyn option grants at September 30, 2008:
 
Options Outstanding and Exercisable
Number of Options
 
Weighted Average Remaining Contractual Life
 
Weighted Average Exercise Price
 
Aggregate Intrinsic Value
4,283
 
5.31 Years
 
$ 0.29
 
$ —
 
Shares Reserved

As of September 30, 2008, the Company has reserved shares of common stock for issuance upon exercise as follows:
 
Biosyn options
   
4,283
 
Director's Plan
   
84,000
 
Warrants
   
2,114,593
 
Nonplan options
   
1,000,000
 
1995 Equity Incentive Plan
   
204,944
 
2005 Equity Incentive Plan
   
1,000,000
 
Total
   
4,407,820
 
 
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
                   
 
9

 
Note 4: Recent Accounting Pronouncements

SFAS No. 157, Fair Value Measurements 

 In September 2006, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 157, “Fair Value Measurements"(“SFAS 157”). SFAS 157 provides enhanced guidance for using fair value to measure assets and liabilities and expands disclosure with respect to fair value measurements. This statement was originally effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FSP No. 157-2 which allows companies to elect a one year deferral of adoption of SFAS 157 for non-financial assets and non-financial liabilities that are recognized or disclosed at fair value in the financial statements on a non-recurring basis. On January 1, 2008, the Company adopted the provisions of SFAS 157 for financial assets and liabilities. As permitted by FSP No.157-2, the Company elected to defer the adoption of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until January 1, 2009. SFAS 157 provides a framework for measuring fair value under U.S. GAAP and requires expanded disclosures regarding fair value measurements. SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available, and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
 
 
Level 1 
 
Quoted prices in active markets for identical assets or liabilities. Our Level 1 assets and liabilities include investments in marketable securities and cash equivalents.
 
 
 
 
 
Level 2 
 
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
 
 
 
 
Level 3 
 
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
 
There was no impact upon the Company’s consolidated financial statements resulting from the adoption of this pronouncement.
 
SFAS No. 141 (Revised 2007), Business Combinations

On December 4, 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS 141R”). Under SFAS 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition date fair value with limited exceptions. SFAS 141R will change the accounting treatment for certain specific items including:

 
·
acquisition costs will be generally expensed as incurred;
     
 
·
non-controlling interests will be valued at fair value at the acquisition date;
     
 
·
acquired contingent liabilities will be recorded at fair value at the acquisition date and subsequently measured at either the higher of such amount or the amount determined under existing guidance for non-acquired contingencies;
     
 
·
in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date until the completion or abandonment of the associated research and development efforts;
     
 
·
restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and
     
 
·
changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense.
 
10

 
SFAS 141R also includes a substantial number of new disclosure requirements. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company will adopt this statement in 2009.

SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51”

  On December 4, 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, this statement requires the recognition of a non-controlling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the non-controlling interest will be included in consolidated net income on the face of the income statement. SFAS 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the non-controlling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its non-controlling interest. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company believes that this pronouncement will have no effect on its financial statements.

SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”), which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of non-governmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States. The effective date of SFAS 162 is yet to be determined; it will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. SFAS 162 is not expected to have a significant impact on the Company’s consolidated financial statements.

Note 5: Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consist of the following (in thousands):
 
   
September 30,
 
December 31,
 
   
2008
 
2007
 
Prepaid insurance
 
$
43
 
$
134
 
Security deposits
   
   
8
 
Retention compensation
   
   
120
 
Other
   
   
5
 
   
$
43
 
$
267
 
 
11


Note 6: 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):
 
   
September 30,
 
December 31,
 
   
2008
 
2007
 
Accrued legal fees
 
$
18
 
$
29
 
Accrued compensation
   
71
   
30
 
Accrued retention
   
   
139
 
Accrued accounting and consulting fees
   
33
   
125
 
Insurance payable
   
11
   
13
 
Other
   
42
   
60
 
Total
 
$
175
 
$
396
 
 
Accrued retention represents the unamortized portion of approximately $139,000 in retention payments offered and accepted by employees in 2007. The retention payments were to be paid if the employee maintained his or her employment with the Company through the retention period indicated in the individual’s retention agreement. The retention payment was in lieu of all other severance or similar payments that the Company may have been obligated to make under any other existing agreement, arrangement or understanding, but would be in addition to any accrued salary and vacation earned through the end of the respective retention period. As of September 30 2008, the retention periods were satisfied and all retention payments have been made.

Note 7: Note 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 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 September 30, 2008, the outstanding balance of the note is $712,600.
 
Note 8:  Derivative Instrument
 
 The warrants issued in connection with the May 2005 PIPE financing 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 instruments liability at September 30, 2008 and December 31, 2007 was approximately $1,200. Any change in the estimated fair value of the warrants has been recorded as other income and expense in the condensed consolidated statement of operations. For the three and nine months ended September 30, 2008, the Company recognized no income or expense related to derivative revaluation. For the three and nine months ended September 30, 2007, the Company recognized expense of approximately $5,000 and income of approximately $1,000, respectively, from derivative revaluation. 

Note 9:  Note Receivable

In connection with the signing of the Merger Agreement with Adamis, Cellegy issued to Adamis an unsecured convertible promissory note in the amount of $500,000 to provide additional funds to Adamis during the pendency of the merger transaction. Principal outstanding under the Promissory Note accrues interest at 10% per annum. The Promissory Note becomes immediately due and payable in the event that the Merger Agreement is terminated by Adamis or Cellegy for certain specified reasons or on the later of (i) the sixteen month anniversary of the issue date of the Promissory Note or (ii) the date that is two business days following the first date on which certain other notes issued by Adamis to a third party have been repaid in full. If the Promissory Note is outstanding as of the closing of the merger transaction, the Promissory Note will not be repaid, but will convert into shares of Adamis stock, and these shares will be immediately cancelled. Cellegy will receive no additional shares. Due to the uncertainty surrounding the timing of closing the merger transaction with Adamis, if the transaction closes at all, the Company has shown the Promissory Note and its related interest income accrual as long term.
 
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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. Cellegy has intellectual property relating to a portfolio of proprietary product candidates known as microbicides. The product candidates, which include both contraceptive and non-contraceptive microbicides, are used intravaginally. Cellegy’s product candidates include Savvy, which was the subject of Phase 3 clinical trials in Ghana and Nigeria for reduction in the transmission of Human Immunodeficiency Virus (HIV)/Acquired Immunodeficiency Disease (IAIDS), both of which were suspended in 2005 and 2006 and terminated before completion, and which is currently in a Phase 3 contraception trial in the United States.
 
The Company’s operations currently relate primarily to the ownership of its intellectual property rights relating to the Savvy product candidate. Cellegy’s intellectual property consists primarily of commercialization and territorial marketing rights for its Savvy compounds as well as related patents, trademarks, license agreements, manufacturing and formulation technologies, past research, and out-license arrangements with certain philanthropic and governmental organizations. Cellegy also monitors the progress of the Savvy Phase 3 contraceptive trial in the United States and provides regulatory support for both the current contraception trial and the suspended HIV trials.
 
Results of Operations
 
Revenues.  The Company had no revenues for the three and nine month periods ended September 30, 2008 and 2007 and does not expect to recognize revenue in the foreseeable future.

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.

Research and Development Expenses.  Cellegy incurred no research and development expenses in the three month period ended September 30, 2008. For the nine month period ending September 30, 2008, the Company incurred research and development expenses of approximately $3,000.

In the three and nine month periods ending September 30, 2007, the Company incurred research and development expenses of approximately $2,000 and $23,000, respectively. The Company does not expect to incur significant research and development expenses in 2008.
 
Selling, General and Administrative Expenses.  Selling, general and administrative expenses for the three and nine month periods ending September 30, 2008 were approximately $262,000 and $1,060,000, respectively. Selling, general and administrative expenses for the three and nine month periods ending September 30, 2007 were approximately $404,000 and $1,345,000. Selling, general and administrative expenses consist primarily of legal fees, accounting and audit fees, regulatory expenses and salaries. The reduction in 2008 expense levels compared to the comparable periods in 2007 is primarily a result of reduced levels of operations.
 
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Other Income (Expenses).  Interest and other income for the three and nine month periods ending September 30, 2008 was approximately $17,000 and $60,000, respectively, as compared to approximately $147,000 and $203,000 for the comparable periods in 2007. Interest and other income consists primarily of interest income earned in connection with bank deposits and the note receivable with Adamis. The decrease in interest income was primarily due to the decline in the Company’s cash deposits.

Interest and other expense for the three and nine month periods ending September 30, 2008 was approximately $76,000 and $206,000, respectively, as compared to approximately $67,000 and $161,000 for the comparable periods in 2007. The increase in interest and other expense in the current period is due primarily to the increased interest accretion of the note payable to Ben Franklin.

Liquidity and Capital Resources
 
Our cash and cash equivalents were approximately $361,000 and $1,827,000 at September 30, 2008 and December 31, 2007, respectively. Cash and cash equivalents decreased approximately $1,466,000 during the nine month period ending September 30, 2008 due to our $500,000 loan to Adamis in connection with the proposed merger, related merger expenses and operating expenses incurred in connection with Cellegy’s present level of operations.
  
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 Cellegy’s future business alternatives as described below, which may preclude Cellegy from realizing the value of certain assets during their future course of business.

Cellegy’s operations currently relate primarily to the management of intellectual property rights of its Biosyn subsidiary and the administration of the clinical and regulatory affairs of its Savvy Phase 3 contraception trial. While the Savvy Phase 3 contraception trial in the United States is ongoing, Cellegy is not directly involved with the conduct and funding thereof, and it is uncertain whether Savvy will be commercialized or whether Cellegy will ever realize revenues there from. We therefore expect negative cash flows to continue for the foreseeable future. Cellegy believes that it presently has enough financial resources to continue operations as they currently exist until approximately the end of 2008, absent unforeseen significant additional expenses. If the proposed merger transaction with Adamis is still pending and Cellegy requires additional cash resources to complete the transaction, Cellegy and Adamis are engaged in discussions concerning an agreement for Adamis to provide funding sufficient to permit the merger to be completed, although there can be no assurance that such funding will be available.

On February 12, 2008, Cellegy entered into a definitive merger agreement providing for the acquisition of Cellegy by Adamis. In connection with the signing of the Merger Agreement, Cellegy issued to Adamis an unsecured convertible promissory note pursuant to which Cellegy agreed to lend Adamis $500,000 to provide additional funds to Adamis during the pendency of the merger transaction. Any principal outstanding under the Promissory Note accrues interest at 10% per annum. The Promissory Note becomes immediately due and payable in the event that the Merger Agreement is terminated by Adamis or Cellegy for certain specified reasons or on the later of (i) the sixteen month anniversary of the issue date of the Promissory Note or (ii) the date that is two business days following the first date on which certain other notes issued by Adamis to a third party have been repaid in full. If the Promissory Note is outstanding as of the closing of the merger transaction, the Promissory Note will not be repaid but will convert into shares of Adamis stock, and these shares will be immediately cancelled. Cellegy will receive no additional shares. There is no assurance that Cellegy will be able to close the transaction with Adamis.
 
If the merger with Adamis is not completed, Cellegy’s board of directors will be required to explore alternatives for Cellegy’s business and assets. These alternatives might include seeking the dissolution and liquidation of Cellegy, merging or combining with another company, or initiating bankruptcy proceedings. There can be no assurance that any third party will be interested in merging with Cellegy or acquiring the remaining assets of Cellegy. Although Cellegy may try to pursue an alternative strategic transaction, it will likely have very limited cash resources, and will likely be forced to file for federal bankruptcy protection. If Cellegy files for bankruptcy protection, Cellegy will most likely not be able to raise any type of funding from any source. In that event, the creditors of Cellegy would have first claim on the value of the assets of Cellegy which, other than remaining cash, would most likely be liquidated in a bankruptcy sale. Cellegy can give no assurance as to the magnitude of the net proceeds of such sale and whether such proceeds would be sufficient to satisfy Cellegy’s obligations to its creditors, let alone to permit any distribution to its equity holders. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. These factors raise substantial doubt about our ability to continue as a going concern.
 
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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.

On November 13, 2008, Cellegy filed a Form S-4 registration statement, which includes a preliminary proxy statement, with the SEC relating to the proposed merger transaction with Adamis and related matters and the registration statement includes additional information about the proposed merger.
 
Recent Accounting Pronouncements

SFAS No. 157, Fair Value Measurements 

 In September 2006, the Financial Accounting Standards Board (the “FASB”) issued SFAS No. 157, “Fair Value Measurements"(“SFAS 157”). SFAS 157 provides enhanced guidance for using fair value to measure assets and liabilities and expands disclosure with respect to fair value measurements. This statement was originally effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued FSP No. 157-2 which allows companies to elect a one year deferral of adoption of SFAS 157 for non-financial assets and non-financial liabilities that are recognized or disclosed at fair value in the financial statements on a non-recurring basis. On January 1, 2008, the Company adopted the provisions of SFAS 157 for financial assets and liabilities. As permitted by FSP No.157-2, the Company elected to defer the adoption of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis, until January 1, 2009. SFAS 157 provides a framework for measuring fair value under U.S. GAAP and requires expanded disclosures regarding fair value measurements. SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs, where available, and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
 
 
Level 1 
 
Quoted prices in active markets for identical assets or liabilities. Our Level 1 assets and liabilities include investments in marketable securities and cash equivalents.
 
 
 
 
 
Level 2 
 
Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
 
 
 
 
Level 3 
 
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.
 
There was no impact upon the Company’s consolidated financial statements resulting from the adoption of this pronouncement.
 
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SFAS No. 141 (Revised 2007), Business Combinations

On December 4, 2007, the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFAS 141R”). Under SFAS 141R, an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition date fair value with limited exceptions. SFAS 141R will change the accounting treatment for certain specific items including:

 
·
acquisition costs will be generally expensed as incurred;
     
 
·
non-controlling interests will be valued at fair value at the acquisition date;
     
 
·
acquired contingent liabilities will be recorded at fair value at the acquisition date and subsequently measured at either the higher of such amount or the amount determined under existing guidance for non-acquired contingencies;
     
 
·
in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date until the completion or abandonment of the associated research and development efforts;
     
 
·
restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and
     
 
·
changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense.

SFAS 141R also includes a substantial number of new disclosure requirements. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company will adopt this statement in 2009.

SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51”

  On December 4, 2007, the FASB issued SFAS No. 160, “Non-controlling Interests in Consolidated Financial Statements — An Amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, this statement requires the recognition of a non-controlling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the non-controlling interest will be included in consolidated net income on the face of the income statement. SFAS 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the non-controlling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its non-controlling interest. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company believes that this pronouncement will have no effect on its financial statements.

SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles”

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”), which identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of non-governmental entities that are presented in conformity with generally accepted accounting principles (“GAAP”) in the United States. The effective date of SFAS 162 is yet to be determined; it will become effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles. SFAS 162 is not expected to have a significant impact on the Company’s consolidated financial statements.
 
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Critical Accounting Policies and Estimates
 
Our critical accounting policies and estimates were discussed in our Annual Report on Form 10-K for the year ended December 31, 2007.  No changes in those policies and estimates have occurred during the nine months ended September 30, 2008.

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 September 30, 2008, 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 significantly 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.
 
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
 
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ITEM 1A.  Risk Factors
 
As a smaller reporting company, Cellegy is not required under the rules of the Securities and Exchange Commission, or SEC, to provide information under this Item. Risks and uncertainties relating to the amount of Cellegy’s cash and cash equivalents at September 30, 2008, the period of time that Cellegy believes its cash will be sufficient to conduct operations, risks and uncertainties relating to the proposed Adamis merger transaction, and risks and uncertainties if the merger transaction with Adamis is not completed, are discussed above under the heading, “Liquidity and Capital Resources” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this Form 10-Q, and are incorporated herein by this reference. Other material risks and uncertainties associated with Cellegy’s business have been previously disclosed in our most recent annual report on Form 10-K for the year ended December 31, 2007, including under the heading “Risk Factors,” as modified by subsequent disclosures in our quarterly reports on Form 10-Q and other documents filed with the SEC. In addition, on November 13, 2008, Cellegy filed a registration statement on Form S-4, which includes a preliminary proxy statement, with the SEC relating to the proposed reverse stock split and subsequent issuance of Cellegy shares pursuant to the proposed merger transaction with Adamis and certain related matters. The registration statement, under the heading “Risk Factors,” identifies various risks and uncertainties relating to the proposed merger transaction, Cellegy, Adamis, and the combined company if the merger is completed, and as those disclosures have been previously reported in a filing with the SEC, they are not repeated in this Item but are incorporated herein by reference.
 
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
 
2.1
 
Agreement dated November 11, 2008, between Cellegy and Adamis Pharmaceuticals Corporation amending the Agreement and Plan of Reorganization dated February 12, 2008. (Incorporated by reference to Exhibit 2.1 to the Report on Form 8-K filed with the SEC by Cellegy on November 12, 2008.)
     
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
     
99.1
 
Risk Factors incorporated by reference from the Form S-4 registration statement filed by the Registrant with the SEC on November 13, 2008.
 
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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 14, 2008   /s/ Richard C. Williams
 
Richard C. Williams
 
Chairman and Interim Chief Executive Officer
     
 
 
 
 
 
 
Date: November 14, 2008   /s/ Robert J. Caso
 
Robert J. Caso
 
Vice President, Finance and Chief Financial Officer
 
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