Human Pheromone Sciences (EROX) 10-Q 2008 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

(MARK ONE)

[X]

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

For the quarterly period endedSeptember 30, 2008

[   ]

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

Commission file number000-23544

HUMAN PHEROMONE SCIENCES, INC.

(Exact name of registrant as specified in its charter)

California	94-3107202
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
84 West Santa Clara Street, San Jose, California	95113
(Address of principal executive offices)	(Zip code)

 Registrant’s telephone number:  (408) 938-3030

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  [X]  No  [   ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [   ] Accelerated filer [   ] Non-accelerated filer [   ] Smaller Reporting Company [X]

Indicate by a checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes  [   ]   No  [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 4,151,954 shares of Common Stock as of November 11, 2008.

HUMAN PHEROMONE SCIENCES, INC.

INDEX

Page

PART I

FINANCIAL INFORMATION

Item 1.Financial Statements

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

PART II

OTHER INFORMATION

PART I

FINANCIAL INFORMATION

Item 1.  Financial Statements

Human Pheromone Sciences, Inc.

Balance Sheets

		September 30,		December 31,
(in thousands except share data)		2008		2007
		(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	1,082	$	1,437
Accounts receivable		91		194
Inventories		50		25
Other current assets		34		40
Total current assets		1,257		1,696
Property and equipment, net		2		3
Total assets	$	1,259	$	1,699
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable	$	31	$	28
Current portion of deferred revenue		384		518
Accrued professional fees		85		95
Accrued employee benefits		34		39
Accrued income taxes		-		1
Other accrued expenses		19		6
Total current liabilities		553		687
Non-current liabilities
Deferred revenue		375		566
Total liabilities		928		1,253
Commitments and Contingencies
Shareholders' equity:
Common stock, no par value, 13,333,333 shares authorized,
4,151,954 shares issued and outstanding at each date		21,029		20,963
Accumulated deficit		(20,698)		(20,517)
Total shareholders' equity		331		446
Total liabilities and shareholders’ equity	$	1,259	$	1,699
See accompanying notes to financial statements.

3

Human Pheromone Sciences, Inc.

Statements of Operations

(unaudited)

		Three months Ended September 30,				Nine months ended September 30,
(in thousands except per share data)		2008		2007		2008		2007
Net revenues	$	262	$	239	$	764	$	902
Cost of goods sold		86		94		240		277
Gross profit		176		145		524		625
Operating Expenses:
Research and development		10		10		33		38
Selling, general and administrative		203		240		696		686
Total operating expenses		213		250		729		724
Loss from operations		(37)		(105)		(205)		(99)
Other income
Interest income, net		7		16		25		50
Total other income		7		16		25		50
Net loss  before provision for income taxes		(30)		(89)		(180)		(49)
Provision for income taxes		-		4		1		5
Net loss	$	(30)	$	(93)	$	(181)	$	(54)
Net income (loss) per common share
Basic	$	(0.01)	$	(0.02)	$	(0.04)	$	(0.01)
Diluted	$	(0.01)	$	(0.02)	$	(0.04)	$	(0.01)
Weighted average common shares outstanding
Basic		4,152		4,152		4,152		4,152
Diluted		4,152		4,152		4,152		4,152
See accompanying notes to financial statements

.

4

Human Pheromone Sciences, Inc.

Statements of Cash Flows

(unaudited)

		Nine months ended September 30
(in thousands)		2008		2007
Cash flows from operating activities
Net loss	$	(181)	$	(54)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization		1		3
Stock option compensation		66		69
Changes in operating assets and liabilities:
Accounts receivable		103		(21)
Inventories		(25)		(2)
Other current assets		6		(17)
Accounts payable and accrued liabilities		-		10
Deferred revenue		(325)		(378)
Net cash used in operating activities		(355)		(390)
Cash flows used in investing activities
		-		(1)
Net cash used in investing activities		-		(1)
Cash flows used in financing activities
		-		-
Net cash used in financing activities		-		-
Net decrease in cash and cash equivalents		(355)		(391)
Cash and cash equivalents at beginning of period		1,437		1,941
Cash and cash equivalents at end of period	$	1,082	$	1,550
See accompanying notes to financial statements

5

Human Pheromone Sciences, Inc.

Notes to Financial Statements

(unaudited)

September 30, 2008

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Nature of Operations

The Company, a California corporation, was founded in 1989 as EROX Corporation to develop and market a broad range of consumer products containing human pheromones as a component.  On May 29, 1998, the shareholders of the Company voted to change the name of the Company to Human Pheromone Sciences, Inc.  Human Pheromone Sciences, Inc. is alternatively referred to in this report as “we,” “us,” “our,” “HPS” or the “Company”.

The Company believes that in human pheromone and other naturally-occurring compounds research funded by the Company presents an opportunity to create and market an entirely new category of fragrances, toiletry and consumer products, as well as other types of consumer products that do not require FDA approval as a pharmaceutical product.  The Company believes that its related patents provide it a proprietary position in developing, licensing and marketing such products.

Basis of Presentation

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the three and nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2008. For further information, refer to the financial statements and footnotes thereto included in the Company’s annual report on Form 10-KSB for the year ended December 31, 2007.  

Revenue Recognition

Revenue is recorded at the time of merchandise shipment, net of provisions for returns.  The Company records revenue from sales initiated by sales agents, net of the sales commissions earned following the interpretative guidance provided by FASB Emerging Issue Task Force (EITF) No. 99-19Reporting Revenue Gross as a Principal versus Net as an Agent. License fees are earned over the license period according to the terms of the license agreement and interpretative guidance provided by Staff Accounting Bulletin (SAB) No. 101Revenue Recognition in Financial Statementsand SAB No. 104Revenue Recognition.  The Company records multiple-element arrangements in accordance with EITF 00-21Revenue Arrangements with Multiple Deliverables.  

Multiple-element arrangements are assessed to determine whether they can be separated into more than one unit of accounting.  A multiple-element arrangement is separated into more than one unit of accounting if all of the following criteria are met.

● The delivered items or service has value to the customer on a stand alone basis.

● There is objective and reliable evidence of the fair value of the undelivered items or service.

● The delivery or performance of the undelivered items or service is considered probable and substantially in our control.

If these criteria are not met, then revenues are deferred until such criteria are met or until the period(s) over which the last undelivered element is delivered.  If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the consideration is allocated to the separate units of accounting based on each unit’s relative fair value.

6

Our agreement with Personal Products Company (hereinafter referred to as “PPC”) represents a multiple-element arrangement and includes post signing consulting support to PPC as needed to assist them in claims development and manufacturing processes, an exclusive right of first discussion for new compounds that the Company develops and documents supportable claims of effectiveness, and an exclusive right to our existing patented compounds in specific consumer product fields.  A portion of the initial payment received as part of the PPC agreement is being recognized as the Company incurs expenses and resources towards fulfilling the obligations to PPC, based on interpretative guidance provided by EITF 00-21.  

The PPC agreement was entered into on August 18, 2006 and will expire when the initial patents on the licensed technology expire, in March 2012.  For the services and rights granted in the agreement, the Company received an initial payment of $1,750,000 in September 2006 and will earn royalties on products developed and sold by PPC until the patents expire.  The Company records revenue for the consulting services and right of first discussions as the Company incurs expenses and resources towards fulfilling its obligations to PPC.  License revenue is being recognized on a straight-line basis over the life of the agreement of sixty-seven months and when periodic direct costs are incurred to maintain the license.  The Company began recognizing revenue from all three units during the quarter ending September 30, 2006.

A summary of the revenue recognized for these multiple units of accounting follows (in thousands):

	Three months ending September 30,				Nine months ending  September 30,
	2008		2007		2008		2007
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Right of first discussion	$	81	$	86	$	149	$	240
Exclusive license		36		37		126		112
Consulting services		2		18		45		43
Total	$	119	$	141	$	320	$	395

The deferred revenue from the PPC license agreement as of September 30, 2008 was $748,000.

The Company granted Schwarzkopf & Henkel a non-exclusive license for the development, manufacture, sale and distribution of certain licensed hair styling products using the Company’s patented technology.   Schwarzkopf & Henkel paid a license fee of $20,000 plus royalties based on net sales of licensed products in specified countries.  The license was effective May 1, 2007 and expires on April 30, 2010.  The license was amended on February 15, 2008 to include other hair care products on a non-exclusive basis.

The $20,000 license fee is being recognized on a straight-line basis over the life of the license of thirty-six months.  There is no discernable service to be provided by the Company to warrant an alternative revenue recognition method.

A summary of the revenue recognized for Schwarzkopf & Henkel a non-exclusive license follows (in thousands):

	Three months ending September 30,				Nine months ending  September 30,
	2008		2007		2008		2007
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Royalty revenues	$	33	$	14	$	91	$	14
License fee		2		2		5		3
Total	$	35	$	16	$	96	$	17

The deferred revenue from the Schwarzkopf & Henkel license as of September 30, 2008 was $11,000.

7

Inventories

Inventories are stated at the lower of cost (first in - first out method) or market.  A summary of inventories follows (in thousands):

	September 30, 2008
	(unaudited)		December 31, 2007
Components (raw materials)	$	18	$	31
Finished goods		56		22
Reserve for shrinkage and obsolescence		(24)		(28)
	$	50	$	25

Earnings (Loss) Per Share

The Company follows the provisions of SFAS No. 128,Earnings Per Share.  SFAS No. 128 provides for the calculation of “Basic” and “Diluted” earnings per share.  Basic earnings (loss) per share is computed using the weighted-average number of common shares outstanding. Diluted earnings (loss) per share is computed using the weighted-average number of common shares and dilutive common shares outstanding during the period.  For the three months ended September 30, 2008 and 2007, options to purchase 723,000 and 700,000 shares of common stock were excluded from the computation of diluted earnings per share since their effect would be antidilutive, respectively.  For the nine months ended September 30, 2008 and 2007, options to purchase 754,000 and 661,000 shares of common stock were excluded from the computation of diluted earnings per share since their effect would be antidilutive, respectiv ely.

As of September 30, 2008 and 2007, the unaudited components of basic and diluted earnings per share are as follows (in thousands):

		Three months ending September 30,				Nine months ending September 30,
		2008		2007		2008		2007
Net income (loss) available to common shareholders (unaudited)	$	(30)	$	(93)	$	(181)	$	(54)
Weighted-average common shares outstanding during the period (unaudited)		4,152		4,152		4,152		4,152

Capital Stock and Stock Options

During the three months ended September 30, 2008, no common stock or preferred stock was issued.  During the quarter ended September 30, 2008, no options to purchase shares of common stock were granted under the 2003 Non-Employee Directors Stock Option Plan, options to purchase 70,000 shares of common stock were granted to an officer pursuant to the Nonstatutory Stock Option Agreement issued outside of the Company’s equity incentive plans.  No issued options were exercised during the three months ended September 30, 2008; and no stock options expired under the expired 1990 Stock Option Plan.

The Company adopted SFAS 123 (R) “Share-Based Payment”, for accounting for its stock options effective with the fiscal year beginning January 1, 2006.   The fair value of each option granted is estimated on the date of the grant using the Black-Scholes option-pricing model.  The Black-Scholes pricing model has assumptions for the risk free interest rates, dividends, stock volatility and expected life of an option grant.  The risk free interest rate is based on the U.S. Treasury Bill rate with a maturity based on the expected life of the options and on the closest day to an individual stock option grant.  Dividend rates are based on the Company’s dividend history.  The stock volatility factor is based on the past seven years of market prices of the Company’s common stock.  The expected life of an option grant is based on various factors including historical exercise and expiration experience rates in addition to the life of the option.  The Company adjusts the compensation expense by a forfeiture factor based on historical experience.  The fair value of each option grant is recognized as compensation expense over the vesting period of the option on a straight line basis.

8

The Company does not record the stock compensation expense net of taxes since there was no material provision for income taxes for the period ended September 30, 2008 and 2007 as the Company incurred net operating losses for which no benefit was recognized, or utilized tax loss carryforwards.  The tax benefit is a component of the deferred tax asset disclosed in the income taxes footnote.

Stock Option Grants	2008 Option Grants	2007 Option Grants
Weighted average interest rates	3.4% to 3.5 %	4.7 %
Dividend yield	0.0 %	0.0 %
Volatility factor of the Company’s common stock	143.0 %	246.0 %
Forfeiture factor – Nonstatutory Stock Option Agreements	3.9%	-
Forfeiture factor – 2003 Non-Employee Directors Stock Option Plan	-	-
Weighted average expected life	7 years	7 years

The Company recorded $4,000 and $10,000 of employee and non-employee compensation expense for stock options during the three months ended September 30, 2008, respectively, and $13,000 and $16,000 of employee and non-employee compensation expense for stock options during the three months ended September 30, 2007, respectively.  At September 30, 2008, there was $36,000 of unrecognized compensation costs related to non-vested share-based compensation under the 2003 Non-Employee Directors’ Stock Option Plan and employee Nonstatutory Stock Option grants.  This cost is expected to be recognized over the following twenty one months.

Nonstatutory Stock Option Agreements

In July 2008, the Company’s Board of Directors granted nonstatutory stock options to a Company’s officer covering a total of 70,000 shares of common stock pursuant to the Nonstatutory Stock Option Agreements. The Board of Directors had set terms and conditions of these stock options.  Options were granted at the fair value at the date of the grant as determined by the average closing price of the Company’s common stock on the day of the grant.

A summary of the activity under the Nonstatutory Stock Option Agreements is as follows (in thousands except per share data):   

Nonstatutory Stock Option Agreements	Three months ending September 30, 2008			Nine months ending September 30, 2008
	Shares	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
Outstanding, beginning of period	330	$	0.32	330	$	0.32
Options Granted	70	$	0.45	70	$	0.45
Canceled or Expired	-		-	-		-
Outstanding, September 30, 2008	400	$	0.34	400	$	0.34

A summary of the non-vested options activity under the Nonstatutory Stock Option Agreements is as follows (in thousands except per share data):

Nonstatutory Stock Options Non-vested Options	Three months ending September 30, 2008			Nine months ending September 30, 2008
	Shares	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
Outstanding, beginning of period	-	$	0.00	69	$	0.32
Options Granted	70	$	0.45	70	$	0.45
Vested	(9)	$	0.45	(78)	$	0.32
Outstanding, September 30, 2008	61	$	0.45	61	$	0.45

9

Non-Employee Directors’ Stock Option Plan (Directors’ Plan)

In June 1993, the Company’s Board of Directors adopted a Non-Employee Directors’ Stock Option Plan (Directors’ Plan) covering a total of 158,333 shares of common stock, which provides for a one-time automatic grant of options to purchase 8,333 shares of common stock and annual grants thereafter of options to purchase 3,333 shares of common stock to each non-employee director at an exercise price equal to the fair market value of the stock on the date of grant.  This plan has expired, but stock options issued under this plan are still outstanding.

A summary of the activity under the Directors’ Plan is as follows (in thousands except per share data):

Directors’ Plan	Three months ending September 30, 2008			Nine months ending September 30, 2008
	Shares	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
Outstanding, beginning of period	40	$	0.91	50	$	1.13
Options Granted	-		-	-		-
Canceled or Expired	-		-	(10)	$	2.02
Outstanding, September 30, 2008	40	$	0.91	40	$	0.91

At September 30, 2008, no shares of the Company’s common stock were reserved for future grants under the Directors’ Plan, and options to purchase 40,000 shares were exercisable, at a weighted average exercise price of $0.91.

2003 Non-Employee Directors’ Stock Option Plan

On June 25, 2003, the Board of Directors adopted the 2003 Non-Employee Directors’ Stock Option Plan (the “2003  Plan”) of Human Pheromone Sciences, Inc.  On June 20, 2007 the Board increased the maximum number of authorized shares of common stock which may be issued on exercise of the options granted pursuant to the 2003 Plan from 300,000 shares to 600,000 shares.  The 2003 Plan will expire on June 24, 2010.  This plan replaces the Directors’ Plan which expired on June 13, 2003.  The 2003 Plan provides for annual grants of options to purchase 20,000 shares of common stock to each non-employee director at an exercise price equal to the fair market value of the stock on the date of the grant.

A summary of the activity under the 2003 Option Plan is as follows (in thousands except per share data):

2003 Plan	Three months ending September 30, 2008			Nine months ending September 30, 2008
	Shares	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
Outstanding, beginning of period	400	$	0.48	320	$	0.48
Options Granted	-		-	80	$	0.51
Canceled or Expired	-		-	-		-
Outstanding, September 30, 2008	400	$	0.48	400	$	0.48

At September 30, 2008, 200,000 shares of the Company’s common stock were reserved for future grants under the 2003 Plan, and options to purchase 387,000 shares were exercisable, at a weighted average exercise price of $0.48.

10

A summary of the non-vested options activity under the 2003 Plan  is as follows (in thousands except per share data):

2003 Plan Non-vested Options	Three months ending September 30, 2008			Nine months ending September 30, 2008
	Shares	Weighted Average Exercise Price		Shares	Weighted Average Exercise Price
Outstanding, beginning of period	73	$	0.51	33	$	0.82
Options Granted	-		-	80	$	0.51
Vested	(20)	$	0.52	(60)	$	0.68
Outstanding, September 30, 2008	53	$	0.51	53	$	0.51

INCOME TAXES

A provision for income taxes for the nine month period ended September 30, 2008 was recorded for minimum tax liabilities incurred.

The Company believes that all of its tax positions are sustainable and that no significant adjustment to its unrecognized tax benefits is expected.  The majority of the unrecognized tax benefits relates to positions where only the timing of a deduction item is in question. Such liabilities are offset by deferred tax assets and the only effect on the Company's statements of operations relates to the interest accrued on such liabilities.

2.  SEGMENT INFORMATION

Sales by geographic markets for the three and nine months ended September 30, 2008 and 2007 were as follows (in thousands):

		Three months ending September 30,				Nine months ending September 30,
		2008		2007		2008		2007
		(unaudited)		(unaudited)		(unaudited)		(unaudited)
Markets:
U.S markets	$	93	$	7	$	245	$	330
International markets		15		75		103		160
Net product revenue		108		82		348		490
License revenue (worldwide)		154		157		416		412
Net revenues	$	262	$	239	$	764	$	902

3.  NEW ACCOUNTING PRONOUNCEMENTS

The Company adopted Financial Accounting Standards Board statement No. 157,Fair Value Measurements (“SFAS 157”) on January 1, 2008, which did not have a material impact on its financial condition and results of operations. In September 2006, the Financial Accounting Standards Board issued SFAS 157 which defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007, with earlier application encouraged. In February 2008, the Financial Accounting Standards Board issued FASB Staff Position No. FAS 157-2 “Effective Date of FASB Statement No. 157” (“FSP 157-2”), which delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, excep t for items that are recognized or disclosed at fair value in the financial statements on a recurring basis, at least annually to fiscal years beginning after November 15, 2008.

11

In March 2008, the FASB released FAS No. 161,Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133. FAS No. 161 requires enhanced disclosures about an entity’s derivative instruments and hedging activities and thereby improves the transparency of financial reporting.  This statement is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.  Management does not believe the adoption of FAS No. 161 will have a material impact on the Company's financial position or results of operations.

In May 2008, the FASB released FAS No. 162,The Hierarchy of Generally Accepted Accounting Principles. FAS No. 162 identifies the sources of accounting principles and framework for selecting principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP Hierarchy).  This statement is effective sixty days following the SEC’s approval of Public Company Accounting Oversight Board amendments to AU Section 411.  Management does not believe the adoption of FAS No. 162 will have a material impact on the Company's financial position or results of operations.

In May 2008, the FASB released FAS No. 163,Accounting for Financial Guarantee Insurance Contracts – an interpretation of FASB Statement No. 60. The scope of FAS No. 163 is limited to financial guarantee insurance contracts focusing on the recognition and measurement of claim liabilities.  This statement is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008.  Management does not believe the adoption of FAS No. 163 will have any impact on the Company as the scope of the FAS is outside the Company’s business activities.

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

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Except for the historical information contained in this discussion and analysis of financial condition and results of operations, the matters discussed herein are forward-looking statements.  These forward-looking statements include but are not limited to the Company’s plans for sales growth and expansion into new channels of trade, expectations of gross margin, expenses, new product introduction, and the Company’s liquidity and capital needs.  These matters involve risks and uncertainties that could cause actual results to differ materially from the statements made.  These risks and uncertainties may include consumer trends, business cycles, scientific developments, changes in governmental policy and regulation, currency fluctuations, economic trends in the United States and inflation.  These and other factors may cause actual results to differ materially from those anticipated in forward-looking statements.  Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.

CRITICAL ACCOUNTING POLICIES

The Company’s discussion and analysis of its financial conditions and results of operations are based upon financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses and disclosures on the date of the financial statements.  On an on-going basis, we evaluate our estimates, including, but not limited to, those related to revenue recognition and license fees.  We use authoritative pronouncements, historical experience and other assumptions as the basis for making judgments.  Actual results could differ from those estimates.  We believe that the following critical accounting policies affect our more significant judgments and estimates in the preparation of our financial statements.

Stock Option Policy

The Company adopted SFAS 123 (R) “Share-Based Payment”, for accounting for its stock options effective with the fiscal year beginning January 1, 2006.   The fair value of each option granted is estimated on the date of the grant using the Black-Scholes option-pricing model.  The Black-Scholes pricing model has assumptions for the risk free interest rates, dividends, stock volatility and expected life of an option grant.  The risk free interest rate is based on the U.S. Treasury Bill rate with a maturity based on the expected life of the options and on the closest day to an individual stock option grant.  Dividend rates are based on the Company’s dividend history.  The stock volatility factor is based on the past seven years of market prices of the Company’s common stock.  The expected life of an option grant is based on various factors including historical exercise rates in addit ion to the life of the stock option.  The Company adjusts compensation expense by a forfeiture factor based on historical experience. The fair value of each option grant is recognized as compensation expense over the vesting period of the option on a straight line basis.

12

The Company did not record the stock compensation expense net of taxes since there was no material provision for income taxes for the period ended September 30, 2008 as the Company incurred net operating losses for which no benefit was recognized, or utilized tax loss carryforwards.  The tax benefit is a component of the deferred tax asset disclosed under the heading “Income Taxes” below.

Use of Estimates

The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.

Revenue Recognition

Revenue is recorded at the time of merchandise shipment, net of provisions for returns.  The Company records revenue from sales initiated by sales agents, net of the sales commissions earned following the interpretative guidance provided by FASB Emerging Issue Task Force (EITF) No. 99-19Reporting Revenue Gross as a Principal versus Net as an Agent. License fees are earned over the license period according to the terms of the license agreement and interpretative guidance provided by Staff Accounting Bulletin (SAB) No. 101Revenue Recognition in Financial Statementsand SAB No. 104Revenue Recognition.  The Company records multiple-element arrangements in accordance with EITF 00-21Revenue Arrangements with Multiple Deliverables.  

Multiple-element arrangements are assessed to determine whether they can be separated into more than one unit of accounting.  A multiple-element arrangement is separated into more than one unit of accounting if all of the following criteria are met.

● The delivered items or service has value to the customer on a stand alone basis.

● There is objective and reliable evidence of the fair value of the undelivered items or service.

● The delivery or performance of the undelivered items or service is considered probable and substantially in our control.

If these criteria are not met, then revenues are deferred until such criteria are met or until the period(s) over which the last undelivered element is delivered.  If there is objective and reliable evidence of fair value for all units of accounting in an arrangement, the consideration is allocated to the separate units of accounting based on each unit’s relative fair value.

Our agreement with Personal Products Company (hereinafter referred to as “PPC”) represents a multiple-element arrangement and includes post signing consulting support to PPC as needed to assist them in claims development and manufacturing processes, an exclusive right of first discussion for new compounds that the Company develops and documents supportable claims of effectiveness, and an exclusive right to our existing patented compounds in specific consumer product fields.  A portion of the initial payment received as part of the PPC agreement is being recognized as the Company incurs expenses and resources towards fulfilling the obligations to PPC, based on interpretative guidance provided by EITF 00-21.  

The PPC agreement was entered into on August 18, 2006 and will expire when the initial patents on the licensed technology expire, in March 2012.  For the services and rights granted in the agreement, the Company received an initial payment of $1,750,000 in September 2006 and will earn royalties on products developed and sold by PPC until the patents expire.  The Company records revenue for the consulting services and right of first discussions as the Company incurs expenses and resources towards fulfilling its obligations to PPC.  License revenue is being recognized on a straight-line basis over the life of the agreement of sixty-seven months and when periodic direct costs are incurred to maintain the license.  The Company began recognizing revenue from all three units during the quarter ending September 30, 2006.

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A summary of the revenue recognized for these multiple units of accounting follows (in thousands):

	Three months ending September 30,				Nine months ending September 30,
	2008		2007		2008		2007
	(unaudited)		(unaudited)		(unaudited)		(unaudited)
Right of first discussion	$	81	$	86	$	149	$	240
Exclusive license		36		37		126		112
Consulting services		2		18		45		43
Total	$	119	$	141	$	320	$	395

The deferred revenue from the PPC license agreement as of September 30, 2008 was $748,000.

The Company granted Schwarzkopf & Henkel a non-exclusive license for the development, manufacture, sale and distribution of certain licensed hair styling products using the Company’s patented technology.   Schwarzkopf & Henkel paid a license fee of $20,000 plus royalties based on net sales of licensed products in specified countries.  The license was effective May 1, 2007 and expires on April 30, 2010.  The license was amended on February 15, 2008 to include other hair care products on a non-exclusive basis.

The $20,000 license fee is being recognized on a straight-line basis over the life of the license of thirty-six months.  There is no discernable service to be provided by the Company to warrant an alternative revenue recognition method.

A summary of the revenue recognized for Schwarzkopf & Henkel a non-exclusive license follows (in thousands):

	Three months ending September 30,					Nine months ending September 30,
	2008		2007			2008			2007
	(unaudited)		(unaudited)			(unaudited)			(unaudited)
Royalty revenues	$	33		$	14		$	91		$	14
License fee		2			2			5			3
Total	$	35		$	16		$	96		$	17

The deferred revenue from the Schwarzkopf & Henkel license as of September 30, 2008 was $11,000.

The $20,000 license fee is being recognized on a straight-line basis over the life of the license of thirty-six months.  There is no discernable service to be provided by the Company to warrant an alternative revenue recognition method.  The revenue recognized under this agreement for the three months ending September 30, 2008 was $35,000 consisting of royalties of $33,000 and amortization of the license fee of $2,000. The revenue recognized under this agreement for the three months ending September 30, 2007 was $16,000 consisting of royalties of $14,000 and amortization of the license fee of $2,000. For the nine months ending September 30, 2008 the revenues recognized under this agreement were $96,000, consisting of royalties of 91,000 and amortization of the license fee of $5,000.  The revenue recognized under this agreement for the nine months ending September 30, 2007 was $17,000 consisting r oyalties of $14,000 of amortization of the license fee of $3,000.   The deferred revenue from the Schwarzkopf & Henkel license as of September 30, 2008 was $11,000.

Inventories

Inventories are stated at the lower of cost (first in - first out method) or market.  A summary of inventories follows (in thousands):

	September 30, 2008
	(unaudited)		December 31, 2007
Components (raw materials)	$	18	$	31
Finished goods		56		22
Reserve for shrinkage and obsolescence		(24)		(28)
	$	50	$	25

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Income Taxes

The Company accounts for income taxes under SFAS 109 “Accounting for Income Taxes”.  Deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards, and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities in the Company’s financial statements and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that all or some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would ultimately be sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more-likely-than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. The evaluation of a tax position taken is considered by itself and not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

Interest and penalties associated with unrecognized tax benefits are classified as interest expense and additional income taxes in the statements of operations.

COMPANY OVERVIEW

The Company is engaged in the research, development, manufacturing and marketing of consumer products containing synthetic human pheromones and other mood enhancing compounds.  The Company initiated commercial operations in late 1994 with a line of fine fragrances and toiletries.  Licensing of the Company’s technology is currently the core business of the Company while directly managing the on-going development of identified compounds for potential new products.  The Company’s patented compounds are sold to licensed customers and included as components in their fragranced consumer products.  The Company also offers private label manufacturing services for third party consumer product licensees.

Results of Operations

Three Months ended September 30, 2008 compared to the Three Months ended September 30, 2007

Net revenue for the quarters ended September 30, 2008 and 2007 were as follows (in thousands):

		Three months ending September 30,
		2008		2007
		(unaudited)		(unaudited)
Net product revenue by markets:
U.S. markets	$	93	$	7
International markets		15		75
Net product revenue		108		82
License revenue (worldwide)		154		157
Net Revenues	$	262	$	239

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Net revenues for the three months ended September 30, 2008 was $262,000, a $23,000 increase from the prior year’s revenue of $239,000.  Domestic sales for the three months ended September 30, 2008 were $86,000 more than the prior year, attributable to a reorders from a long standing customer. International sales for the three months ended September 30, 2008 of $15,000 were $60,000 less than sales of $75,000 for the three months ended September 30, 2007 due to decreased private label manufacturing for an Asian customer who has moved its manufacturing offshore.  Neither the domestic nor international customers’ purchasing patterns are on a seasonal or cyclical pattern which results in inconsistent revenue.   License revenue decreased by $3,000 to $154,000 for the three months ending September 30, 2008.  Increased royalties from the Schwarzkopf & Henkel license nearly offset the decreased revenue r ecognized from the PPC license.

Gross profit for the quarter ended September 30, 2008 of $176,000 is 31% more than the gross profit of $145,000 for the three months ended September 30, 2007.  As a percentage of revenue, gross profit of 67% for the third quarter of 2008 was more than gross profit of 61% for the three months ended September 30, 2007.  Gross margin on product sales increased slightly to 75% for the third quarter of 2008 from 73% for the comparable three months of 2007. The increases in both gross profit and gross margin is attributed to the increased revenues and revenues from higher margin products.  

		Three months ending September 30,
		2008		2007
		(unaudited)		(unaudited)
Gross Profit by Revenue Type:
Net product gross profit	$	81	$	60
License gross profit		95		85
Total Gross Profit	$	176	$	145

Research and development expenses for the third quarters of 2008 and 2007 were $10,000 in each period.  Research expenditures of $47,000 that were incurred for the three months ended September 30, 2008, and $49,000 incurred for the three months ended September 30,2007, to support the PPC license have been charged as cost of goods sold. The total research and development costs incurred for the quarters, including the amount recorded as cost of goods sold, were $57,000 for the three months ended September 30, 2008, which was $2,000 less than the $59,000 incurred for the three months ended September 30, 2007.  Research and development on several new compounds, in addition to the two compounds noted in the PPC license, is on-going at a reduced basic funding level.

Selling, general and administrative expenses for the three months ended September 30, 2008 of $183,000 are $34,000 less than the $217,000 incurred for the three months ended September 30, 2007.  Selling, marketing and distribution expenses were $2,000 less than the prior year as the Company continues to focus on product licensing which is less promotionally intensive.  General and administrative and facility costs decreased by $32,000, primarily a result of decreases in audit and tax fee accruals, travel and stock option compensation costs.

The Company earned $7,000 and $16,000 in net interest income during the three months ending September 30, 2008 and 2007, respectively.  The decrease in net interest income was due to decreasing interest rates and the Company’s reduction in cash balances.

The Company did not record a minimum tax provision for the quarters ended September 30, 2008 and 2007, due primarily to a valuation allowance on deferred tax assets being recorded and the expected utilization of net operating losses carried forward from prior years to offset any significant tax liability.  

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Nine Months ended September 30, 2008 as compared to the Nine Months ended September 30, 2007

Net revenue for the nine months ended September 30, 2008 and 2007 were as follows:

		Nine months ending September 30,
		2008		2007
		(unaudited)		(unaudited)
Net product revenue by markets:
U.S. markets	$	245	$	330
International markets		103		160
Net product revenue		348		490
License revenue (worldwide)		416		412
Net Revenues	$	764	$	902

Net revenue for the nine months ended September 30, 2008 was $764,000.  This was a 15% decrease from net revenue of $902,000 for the first nine months of 2007. Domestic product revenues decreased by $85,000 in 2008 due to two customers who did not order comparable amounts of product as they had in 2007.  New customer sales increased  during the first nine months of 2008, but not enough to offset the two declining customers’ purchases.  Since the Company is not always aware of its customers’ manufacturing and marketing plans, revenue fluctuations do occur between periods. International revenues of $103,000 in the nine months ended September 30, 2008, which is $57,000  less than the prior year due to an Asian market distributor that is continuing to use our compounds but is manufacturing their private label product overseas to reduce shipping and other manufacturi ng costs.  

Gross profit for the first nine months of 2008 decreased 16% to $524,000 from $625,000 in the first nine months of 2007.  Gross margin was 69% for both the nine months ended September 30, 2008 and the nine months ended September 30, 2007.  Gross margin on product sales decreased to 75% for the nine months ended September 30, 2008 from 84% for the nine months ended September 30, 2007.  The decreased product gross profit and declining gross margin on product sales is attributable to both the decreased product sales and increased sales of higher cost products.  Gross margin on license increased to 63% for the nine months ended September 30, 2008 from 52% for the nine months ended September 30, 2007. Increased license revenue from the Schwarzkopf & Henkel license has helped to increase the license gross profit and margin.

		Nine months ending September 30,
		2008		2007
		(unaudited)		(unaudited)
Gross Profit by Revenue Type:
Net product gross profit	$	261	$	411
License gross profit		263		214
Total Gross Profit	$	524	$	625

Research and development expenses for the nine months ended September 30, 2008 and 2007 were $33,000 and $38,000, respectively.  Research expenditures of $100,000 and $116,000 that were incurred in the nine months ended September 30, 2008 and 2007, respectively, to support the PPC license have been charged as cost of goods sold. The total research and development cost incurred for the first nine months of 2008 was $133,000 and $154,000 for the nine months in 2007.  The reduction in spending is the result of reduced consultant costs due to the timing of the on-going research and development requirements of the several new compounds that are under development.

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Selling, general and administrative expenses for the first nine months of 2008 were $696,000 and $686,000 for the comparable period of 2007, a $10,000 increase.  Selling, marketing and distribution expenses are $2,000 less than the prior year as the Company continues to focus on product licensing which is less capital intensive. General, administrative and facility costs increased by $8,000 primarily due to general increases in professional fees, health insurance benefits, and corporate administration.

The Company earned $25,000 and $50,000 in net interest income during the nine months ending September 30, 2008 and 2007, respectively.  The decreased earnings were due to reduced interest rates and lower cash balances.

The Company recorded a $1,000 minimum tax provision in 2008 and $5,000 in 2007, due primarily to a valuation allowance on deferred tax assets being recorded and the expected utilization of net operating losses carried forward from prior years to offset any significant tax liability.  

Off-Balance Sheet Arrangements.

None.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2008, the Company had cash of $1,082,000 with no outstanding bank borrowings and working capital of $704,000.  At December 31, 2007, the Company had cash of $1,437,000 with no outstanding bank borrowings and working capital of $1,009,000.  For the first nine months of 2008, net cash used in operating activities was $355,000 as compared to $390,000 for the same period in 2007, an improvement of $35,000.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

Not required for smaller reporting companies.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.  Based on our evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with our evaluation that occurred during the fiscal quarter ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings

The Company is not party to any pending legal proceedings.

Item 1A. Risk Factors

Not required for smaller reporting companies.

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

In December 2007, the Board of Directors approved a stock repurchase program for the Company to buy back up to 400,000 shares of the Company’s common stock.  No shares were repurchased in the quarter ended September 30, 2008.

On July 18, 2008, the Company’s Board of Directors granted nonstatutory stock options to one Company officer covering a total of 70,000 shares of common stock pursuant to the Nonstatutory Stock Option Agreements.  Options were granted at $ 0.45 per share, which was determined to be the fair value at the date of the grant as determined by the closing price of the Company’s common stock on the day of the grant.  The options were offered pursuant to exemptions from registration under Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 of Regulation D. The optionee is an “accredited investor” as such term is defined in Regulation D. A legend was placed on the option that neither it nor the underlying shares of common stock have been registered and is restricted from resale.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 5. Other Information

On July 18, 2008, the Company’s Board of Directors granted nonstatutory stock option to purchase 70,000 shares of the Company’s common stock to Gregory S. Fredrick, the Company’s Chief Financial Officer, pursuant to the Nonstatutory Stock Option Agreement, with the exercise price of $ 0.45 per share, which was determined to be the fair value at the date of the grant as determined by the closing price of the Company’s common stock on the day  of the grant.  The option will vest monthly over a period of two years, for so long as Mr. Fredrick continues to be employed by the Company; provided that the vesting shall accelerate in event of the Termination not for Cause (as defined in the Stock Option Agreement).

Item 6. Exhibits

Exhibits

Exhibit 31.1

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act

Exhibit 31.2

Certification Pursuant to Section 302 of the Sarbanes-Oxley Act

Exhibit 32

Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. 1350

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant had duly caused this Report to be signed on behalf by the undersigned thereunto duly authorized.

HUMAN PHEROMONE SCIENCES, INC.

Date:  November 12, 2008

/s/ William P. Horgan                                    

William P. Horgan

Chairman and Chief Executive Officer

(Principal Executive Officer)

Date:  November 12, 2008

/s/ Gregory S. Fredrick                                 

Gregory S. Fredrick

Chief Financial Officer

(Principal Financial Officer and Principal Accounting Officer)

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