UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(MARK ONE)
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarter ended June 30, 2003
[ ] TRANSITION REPORT UNDER SECTION 13 OR A5(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (no fee required)
Commission file number 0-23544
HUMAN PHEROMONE SCIENCES, INC.
(Name of small business issuer in its charter)
California 94-3107202
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. employee
incorporation or organization) Identification No.)
84 West Santa Clara Street, San Jose, California 95113
- ------------------------------------------------ ----------
(Address of principal executive offices) (Zip code)
Issuer's telephone number: (408) 938-3030
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---------------------------------------------------------------
(Former name or former address, if changed since last report)
State the number of shares outstanding of each of the issuer's classes
of common equity, as of the latest practicable date: 4,027,616 shares of Common
Stock as of July 31, 2003.
1
HUMAN PHEROMONE SCIENCES, INC.
INDEX
Page
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PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2003 (Unaudited)
and December 31, 2002.......................................................................3
Consolidated Statements of Operations and Comprehensive Income /Loss (Unaudited) for the
For the Three and Six Months Ended June 30, 2003 and 2002...................................4
Consolidated Statements of Cash Flows (Unaudited) for the Six Months
Ended June 30, 2003 and 2002................................................................5
Notes to Consolidated Financial Statements (Unaudited)......................................6
Item 2. Management's Discussion and Analysis
Management's Discussion and Analysis of Financial Conditions and Results of Operations .....9
Item 3. Controls and Procedures....................................................................15
PART II
OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds..................................................16
Item 4. Submission of Matters to a Vote of Security Holders>>.....................................16
Item 6. Exhibits and Reports on Form 8-K .........................................................16
SIGNATURES..................................................................................................17
2
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
Human Pheromone Sciences, Inc.
Consolidated Balance Sheets
June 30, December 31,
(in thousands except share data) 2003 2002
- ---------------------------------------------------------------------------------- ----------- -----------
(unaudited)
Assets
Current assets:
Cash and cash equivalents $ 2,057 $ 1,394
Accounts receivable, net of allowances of $12,000 and $70,000
in 2003 and 2002, respectively 142 249
Inventories, net 110 151
Assets to be sold -- 493
Other current assets 41 10
-------- --------
Total current assets 2,350 2,297
Property and equipment, net 9 5
Product licenses 50 50
-------- --------
$ 2,409 $ 2,352
======== ========
Liabilities, Convertible Redeemable Preferred Stock and Shareholders'
Equity (Deficiency)
Current liabilities:
Accounts payable $ 58 $ 186
Liabilities associated with assets to be sold -- 330
Accrued income tax 21 --
Accrued professional fees 42 57
Accrued vacation 43 34
Other accrued expenses 18 19
-------- --------
Total current liabilities 182 626
-------- --------
Commitments and Contingencies
Convertible redeemable preferred stock:
Preferred stock, issuable in series, no par value, 10,000,000 shares
authorized, Series AA 100,000 and 1,433,333 convertible shares
issued and outstanding in 2003 and 2002, respectively
(total liquidation value $150 and $2,150, respectively) 150 2,146
Series BB 17,448 convertible shares issued and outstanding
at December 31, 2002 (total liquidation value $1,745) -- 1,560
-------- --------
Total convertible redeemable preferred stock 150 3,706
-------- --------
Shareholders' equity (deficiency):
Common stock, no par value, 13,333,333 shares authorized, 4,027,616 and
3,429,839 shares issued and outstanding at 2003 and 2002, respectively 20,717 17,667
Accumulated deficit (18,640) (19,581)
Foreign currency translation -- (66)
-------- --------
Total shareholders' equity (deficiency) 2,077 (1,980)
-------- --------
$ 2,409 $ 2,352
======== ========
See accompanying notes to consolidated financial statements.
3
Human Pheromone Sciences, Inc.
Consolidated Statements of Operations and Comprehensive Income (Loss)
(unaudited)
Three months ended June 30, Six months ended June 30,
--------------------------- -------------------------
(in thousands except per share data) 2003 2002 2003 2002
------- ------- ------- -------
Net revenues 61 146 279 291
Cost of goods sold 19 42 84 81
------- ------- ------- -------
Gross profit 42 104 195 210
Operating Expenses:
Research and development 4 82 7 162
Selling, general and administrative 264 226 527 489
------- ------- ------- -------
Total operating expenses 268 308 534 651
------- ------- ------- -------
Income (loss) from operations (226) (204) (339) (441)
Other income (expense)
Interest income (net) 5 5 8 10
Income tax benefit from on-going operations 33 -- 33 --
------- ------- ------- -------
Income (loss) from on-going operations (188) (199) (298) (431)
Net income from discontinued operations 7 81 79 347
Net gain from sale of assets 1,226 -- 1,226 --
------- ------- ------- -------
Net income (loss) available to common shareholders 1,045 (118) 1,007 (84)
Other comprehensive loss - translation adjustment -- 2 -- 2
------- ------- ------- -------
Comprehensive income (loss) $ 1,045 $ (116) $ 1,007 $ (82)
======= ======= ======= =======
Net income (loss) per common share- basic
From on-going operations $ (0.05) $ (0.06) $ (0.08) $ (0.12)
From discontinued operations $ 0.00 $ 0.02 $ 0.02 $ 0.10
From assets sold $ 0.33 $ 0.00 $ 0.34 $ 0.00
------- ------- ------- -------
Net income (loss) $ 0.28 $ (0.04) $ 0.28 $ (0.02)
======= ======= ======= =======
Net income (loss) per common share-fully diluted
From on-going operations $ (0.04) $ (0.06) $ (0.06) $ (0.12)
From discontinued operations $ 0.00 $ 0.02 $ 0.02 $ 0.10
From assets sold $ 0.26 $ 0.00 $ 0.24 $ 0.00
------- ------- ------- -------
Net income (loss) $ 0.22 $ (0.04) $ 0.20 $ (0.02)
======= ======= ======= =======
Weighted average common shares outstanding- basic 3,686 3,430 3,558 3,430
======= ======= ======= =======
Weighted average common shares outstanding -
fully diluted 4,773 3,430 5,011 3,430
======= ======= ======= =======
See accompanying notes to consolidated financial statements.
4
Human Pheromone Sciences, Inc.
Consolidated Statements of Cash Flows
(unaudited)
Six months ended
June 30,
-------------------
(in thousands) 2003 2002
- --------------------------------------------------------- ------- --------
Cash flows from operating activities
Net income (loss) $ 1,007 $ (84)
Net income from discontinued operations 79 347
Net income from sale of assets 1,226 --
------- -------
Net loss from on-going operations (298) (431)
Adjustments to reconcile net income to net cash provided
or used by operating activities:
Depreciation and amortization 2 4
Changes in operating assets and liabilities:
Accounts receivable 41 23
Inventories 40 11
Other current assets (30) (28)
Accounts payable and accrued liabilities (79) (24)
------- -------
Net cash used by on-going operating activities (324) (445)
------- -------
Net cash provided by operations of assets sold 156 383
------- -------
Cash flows provided (used) in investing activities
Sale of Realm assets 1,342 --
Acquisition of fixed assets (6) --
------- -------
Net cash provided by investing activities 1,336 --
Cash flows used in financing activities
Purchase of Series BB preferred stock (505) --
Effect of exchange rate on cash -- 2
------- -------
Net increase in cash and cash equivalents 663 (60)
Cash and cash equivalents at beginning of period 1,394 1,355
------- -------
Cash and cash equivalents at end of period $ 2,057 $ 1,295
======= =======
See accompanying notes to consolidated financial statements.
5
Human Pheromone Sciences, Inc.
Notes to Consolidated Financial Statements
(unaudited)
June 30, 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Operations
Human Pheromone Sciences, Inc. (the "Company") was incorporated in the
State of California in 1989 under the name of EROX Corporation. The Company
changed the name to Human Pheromone Sciences, Inc. in May 1998. The Company is
engaged in the research, development, manufacturing and marketing of consumer
products containing synthetic human pheromones as a component. The Company
initiated commercial operations in late 1994 with a line of fine fragrances and
toiletries. In April 2000, the Company licensed the sale of its REALM fragrance
products through department and specialty stores across the United States and
selected international markets to Niche Marketing, Inc. In April 2003 the
Company sold the REALM(R) and innerREALM(R) brands and trademarks to Niche
Marketing Group, Inc. The Company will continue to license and sell its human
pheromones for inclusion in other companies products in exchange for supply
revenues and/or royalties, and will continue to involved in brand and product
development.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-QSB and Item 310(b)
of Regulation S-B. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three and six months ended June 30,
2003 are not necessarily indicative of the results that may be expected for the
calendar year ending December 31, 2003. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-KSB for the year ended December 31, 2002.
Certain prior period balances have been reclassified to conform to the current
period presentation.
Revenue Recognition
Revenue is recorded at the time of merchandise shipment, net of
provisions for returns. 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. 101. The majority of the
Company's sales are to distributors and licensees, and these distributors and
licensees have no right to return products.
Inventories
Inventories are stated at the lower of cost (first in - first out
method) or market. The inventory at June 30, 2003 consists of finished goods
inventory valued at $17,000 and raw materials of $93,000. At December 31, 2002,
these balances were $14,000 and $137,000, respectively.
Sale of Assets
On April 14, 2003 the Company sold to Niche Marking Group, Inc. the
assets and worldwide ownership rights to the REALM Women, REALM Men and
innerREALM product lines. .Assets consisting REALM and innerREALM trademarks,
inventory and product licenses were sold resulting in a net gain of $1,226,000.
All REALM and innerREALM operating results have been classified as discontinued
operations, $79,000 for the six months ending June 30, 2003 and $347,000 the
comparable period in 2002. Reclassifications of certain 2002 financial statement
information have been made to present the operating results from on-going
operations on a comparable basis.
6
License Fees
The Company capitalizes license fees paid for the rights to use new
pheromone discoveries. License agreements for pheromones and products that are
not yet available for sale are not subject to amortization in accordance with
Statement of Financial Accounting Standards No. 142: Goodwill and Other
Intangible Assets.
The Company continually evaluates whether events or circumstances have
occurred that indicate the remaining estimated value of the license agreements
may not be recoverable. When factors indicate that the value license may be
impaired, the Company estimates the remaining value and reduces the license
agreement to that amount.
Income Taxes
The Company has recorded a tax provision of $22,000 for 2003 and no
income tax provision for 2002, 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.
As of June 30, 2003, the Company's gross deferred tax asset, which relates
primarily to net operating losses carried forward was $6,410,000. California has
suspended for 2003 the utilization of operating loss carry forwards which will
result in a tax liability for the year if the Company's taxes exceed the
available Research & Development tax credit of $82,000.
Earnings (Loss) Per Share
The Company calculates earnings (loss) per share in accordance with
SFAS No. 128, "Earnings Per Share." SFAS No. 128 replaced the presentation of
primary and fully diluted earnings per share with the presentation of basic and
diluted earnings per share. Basic earnings per share excludes dilution and is
calculated by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period. Diluted
earnings per share includes the potential dilutive effects that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock ("potential common stock") that would then share in the
earnings of the Company.
As of June 30, 2003 and 2002, the unaudited components of basic and
diluted earnings per share are as follows (all amounts are in thousands):
2003 2002
---------- --------
Net income (loss) available to common shareholders $ 1,007 $ (84)
========== ========
Weighted-average common shares outstanding during the period 3,558 3,430
Incremental shares from assumed conversions of convertible
preferred stock and stock options 1,453 1,721
---------- --------
Fully diluted weighted-average common shares and potential
commons stock (unaudited) 5,011 5,151
========== ========
Convertible Redeemable Preferred Stock
On May 22, 2003 the Company purchased, from a fund of whom a board
member is a general partner, all of the outstanding shares of its Series BB
Preferred Stock for $505,000. In a related transaction 1,333,333 shares of
Series AA Preferred Stock was converted into 597,777 shares of common stock.
7
Capital Stock and Stock Options
Outstanding options to purchase shares of common stock and potential
common shares issuable upon conversion of preferred stock are excluded from the
computation of diluted earnings per share since when the average stock price for
the period is less than the exercise price of outstanding options or when their
effect would be antidilutive.
On June 25, 2003 the Board of Directors adopted the 2003 Nonemployee
Directors Stock Option Plan of Human Pheromone Sciences, Inc. A maximum of
300,000 shares of commons tock may be issued on exercise of the Options granted
pursuant to this plan. The plan will expire June 24, 2010. This plan replaces
the previous plan which expired June 13, 2003.
During the three months ended June 30, 2003 no common or preferred
stock was issued, common stock options totaling 80,000 shares under the 2003 Non
Employee Directors Stock Option Plan were granted and no issued options were
exercised.
Recent Accounting Pronouncements
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. SFAS No. 145 updates, clarifies, and simplifies existing accounting
pronouncements. This statement rescinds SFAS No. 4, which required all gains and
losses from extinguishments of debt to be aggregated and if material, classified
as an extraordinary item, net of related income tax effect. As a result, the
criteria in APB No. 30 will now be used to classify those gains and losses. SFAS
No. 64 amended SFAS No. 4 and is no longer necessary as SFAS No. 4 has been
rescinded. SFAS No. 44 has been rescinded as it is no longer necessary. SFAS No.
145 amends SFAS No. 13 to require that certain lease modifications that have
economic effects similar to sale-leaseback transactions be accounted for in the
same manner as sale-lease transactions. This statement also makes technical
corrections to existing pronouncements. While those corrections are not
substantive in nature, in some instances, they may change accounting practice.
This statement is not applicable to the Company.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. This statement addresses financial
accounting and reporting for costs associated with exit or disposal activities
and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring). This statement
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under EITF Issue 94-3, a
liability for an exit cost, as defined, was recognized at the date of an
entity's commitment to an exit plan. The provisions of this statement are
effective for exit or disposal activities that are initiated after December 31,
2002 with earlier application encouraged. The Company does not expect adoption
of SFAS No. 146 to have a material impact, if any, on its financial position or
results of operations.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain
Financial Institutions. SFAS No. 147 removes the requirement in SFAS No. 72 and
Interpretation 9 thereto, to recognize and amortize any excess of the fair value
of liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset. This statement
requires that those transactions be accounted for in accordance with SFAS No.
141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible
Assets. In addition, this statement amends SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, to include certain financial
institution-related intangible assets. This statement is not applicable to the
Company.
In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No.
123. SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require more prominent and more frequent disclosures in
financial statements about the effects of stock-based compensation. This
statement is effective for financial statements for fiscal years ending after
December 15, 2002. SFAS No. 148 will not have any impact on the Company's
financial statements as management does not have any intention to change to the
fair value method.
In April 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." SFAS No. 149 amends and clarifies accounting and reporting for
derivative instruments and hedging activities under SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective
for derivative instruments and hedging activities entered into or modified after
June 30, 2003, except for certain forward purchase and sale securities. For
these forward purchase and sale securities, SFAS No. 149 is effective for both
new and existing securities after June 30, 2003. Management does not expect
adoption of SFAS No. 149 to have a material impact on the Company's statements
of earnings, financial position, or cash flows.
8
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for how an issuer classifies and measures in its
statement of financial position certain financial instruments with
characteristics of both liabilities and equity. In accordance with the standard,
financial instruments that embody obligations for the issuer are required to be
classified as liabilities. SFAS No. 150 will be effective for financial
instruments entered into or modified after May 31, 2003 and otherwise will be
effective at the beginning of the first interim period beginning after June 15,
2003. The Company has classified redeemable preferred stock as a separate
liability.
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. In addition to the risks and uncertainties described in "Risk
Factors", below, 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.
Risk Factors
The Company's future results may be affected to a greater or lesser
degree by the following factors among others:
The Company has not had sustained profitable operations since 1997.
Since 1997, the Company has incurred losses from operations. The Company's
business model is based on obtaining product-licensing agreements. While the
Company anticipates that this business model will result in profitable
operations, the Company's license based business model may not be successful..
The Company's marketing strategy may not be successful. The Company or
its distributors and licensees may not be able to establish and maintain the
necessary sales and distribution channels. Retail outlets and catalogs may
choose not to carry the Company's or its licensees' products. The Company, its
licensees or its distributors may not have sufficient funds to successfully
market its products if the current marketing strategy is not successful.
The Company not be able to protect its technology or trade secrets. The
Company's patents and patent applications may not protect the Company's
technology or ensure that the Company's technology does not infringe another's
valid patent. Others may independently develop substantially equivalent
proprietary information. The Company may not be able to protect its technology,
proprietary information or trade secrets.
The Company's ongoing research and product development efforts may not
be successful. While the Company plans to initiate several studies on human
subjects, the products being tested may not be effective.
The Company, its distributors and licensees may not be able to
effectively compete with larger companies or with new products. The fragrance,
toiletries and cosmetics markets are extremely competitive. Many competitive
products are better known than the Company's products and compete for
advertising and retail shelf space. Many competitors have significantly greater
resources that will allow them to develop and introduce new competing products
or increase the promotion of current products.
The product life cycle of these products can be very short. Changing
fashions and fads can dramatically shift consumer preferences and demands.
Traditional fragrance, toiletries and cosmetics companies introduce a new
products every year or so. Changing fashions and new products may reduce the
chance of creating long term brand loyalty to human pheromone-based products.
9
The current retail environment may cause pricing and promotional
pressures. Less than ten companies control the majority of the sales in the U.S.
in the fragrance, toiletries and cosmetics arena. Because of their market share,
each company will have significant power to determine the price and promotional
terms that the Company and its licensees or distributors must meet in order to
introduce and sell its products to the consumer.
Seasonality in sales may cause significant variation in quarterly
results. Sales in the fragrance industry are generally seasonal with sales
higher in the second half of the year because of Christmas. This seasonality
could cause a significant variation in the Company's quarterly operating
results.
The Company may not be able to recruit and retain key personnel. The
Company's success substantially depends upon recruiting and retaining key
employees and consultants with research, product development and marketing
experience. The Company may not be successful in recruiting and retaining these
key people.
The Company relies upon other companies to manufacture its products.
The Company relies upon other companies to manufacture its pheromones, supply
components, and to blend, fill and package its fragrance products. The Company
may not be able to obtain or retain pheromone manufacturers, fragrance
suppliers, or component manufacturers on acceptable terms. If not, the Company
may not be able to obtain commercial quantities of its products. This would
adversely affect operating results.
Results of Operations
On April 24, 2000, the Company signed a multi-year licensing agreement
for its REALM and innerREALM fragrance and toiletry products with Niche
Marketing, Inc. ("Niche"), a newly formed affiliate of Northern Brands, Inc.
Under the agreement, Niche will be responsible for the manufacture, marketing,
selling and distribution of the REALM and innerREALM products in the United
States and Internationally, excluding the Far East.
On April 14, 2003, the Company sold to Niche Marking Group, Inc. the
assets and worldwide ownership rights to the REALM Women, REALM Men and
innerREALM product lines. The Company will continue to focus operations on the
marketing of its patented technology to companies with established consumer
product franchises while directly managing the on-going development of
identified compounds for potential new products.
All REALM(R) and innerREALM(R) financial activities have been
classified as assets to be sold as a result of the April 14, 2003 sale.
Therefore reclassifications of certain 2002 financial statement information have
been made to present the operating results from on-going operations on a
comparable basis.
Three Months ended June 30, 2003 compared to the Three Months ended June 30,
2002
Net sales and revenues for the second quarter of 2003 were $61,000,
representing an decrease of 58% from sales of $146,000 for the prior year's
quarter. The $78,000, or 63%, decrease in license and supply revenues, from
customers utilizing the Company's technology as a components in their consumer
products, was the result of strong orders in the first quarter of the current
year that resulted in lower shipments in the second quarter from established
product lines. Sales of the Natural Attraction(R) products to the international
and U.S. distributors utilizing a new bottle design began the last week of the
quarter when the first production run was completed. Several pending orders
could not be shipped during the quarter because of a delay in receipt of
components; these will carry-over to the next quarter.
Net sales for the quarters ended June 30, 2003 and 2002 were as follows
(in thousands).
2003 2002
- --------------------------------------------------------------------------------
Markets:
License and Supply Revenues $ 45 $123
Direct Marketing 10 23
U.S. Retail & Distributor Markets 5 --
International Markets 1 --
---- ----
Net Sales $ 61 $146
==== ====
10
Gross profit for the quarter ended June 30, 2003 of $42,000 is 60% less
than last years $104,000. As a percentage of sales, gross profit of 69% was
slightly less than last years of 71% due to a reduction of license fees revenue
earned during the quarter.
Research and Development expenses for the first quarters of 2003 and
2002 were $4,000 and $82,000, respectively. As part of the Company's desire to
directly control all future research and development work the Company terminated
its relationships with its primary consultants in October 2002. The Company
incurred very minimal expenses in the second quarter of 2003 since its
independent research and development efforts had not commenced.
Selling, general and administrative expenses of $264,000 were higher
than last years second quarter expenses of $226,000. Selling, and marketing and
distribution expenses were $7,000 less than the prior year as a result of
decreased sales activities for Natural Attraction as the new bottle inventory
was not available for the majority of the quarter. General, administrative and
facility costs were $45,000 more in the current year's quarter due to last years
$32,000 bad debt recovery and $9,000 of expenses related to the annual
shareholder meeting which was held in the third quarter last year and additional
SEC filings and related cost resulting from the sale of Realm and redemption and
conversion of the Company's Series BB preferred stock.
The Company earned $5,000 in net interest income in both 2003 and 2002.
The increase in cash balances was offset by lower interest rates earned.
The Company has recorded a tax provision of $22,000, 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. As of June 30, 2003, the Company's gross deferred
tax asset, which relates primarily to net operating losses carried forward was
$6,410,000. However, California has suspended for 2003 the utilization of
operating losses carried forward which will result in a tax liability for the
year if the Company's taxes exceed the available Research & Development tax
credit of $82,000
On April 14, 2003 the Company sold to Niche Marking Group, Inc. the
assets and worldwide ownership rights to the REALM Women, REALM Men and
innerREALM product lines. Assets consisting REALM and innerREALM trademarks,
inventory and product licenses were sold resulting in a net gain of $1,226,000.
All REALM and innerREALM operating results have been classified as discontinued
operations, for the quarter ending June 30, 2003 income from these operations
were $7,000 which is less than last years $81,000. The reduction was primarily
due to the sale which was the third week of the quarter.
Six Months ended June 30, 2003 as compared to the Six Months ended June 30, 2002
Net revenues for the six months ended June 30, 2003 were $279,000. This
was a 4% decrease from net revenues of $291,000 for the first half of 2002.
License and supply revenues increased by $25,000 for the first six months of
2003 to $247,000 as a result of increased licensing and supply activities to
Avon Products in 2003. Sales in International markets decreased by $35,000 due
to the conversion to a new bottle for the Natural Attraction product line, and
reduced promotional efforts.
Net sales for the six months ended June 30, 2003 and 2002 were as
follows:
================================================================================
Markets 2003 2002
- --------------------------------------------------------------------------------
License and Supply Revenues $247 $222
Direct Marketing 20 31
U.S. Retail & Distributor Markets 11 2
International Markets 1 36
---- ----
Net Sales $279 $291
11
Gross profit for the first half of 2003 declined 7% to $195,000 from
$210,000 in 2002. The decrease is the result of reduced license revenue from a
single customer. Gross profit as a percentage of revenues decreased to 70%
compared to 72% in 2002 a result of the reduced license revenue.
Research and Development expenses for the first half of 2003 and 2002
were $7,000 and $162,000, respectively. The Company has ended its relationship
with Pherin Pharmaceuticals and plans to conduct its own independent research
and development operations, which have not commenced as of June 30, 2003.
Selling, general and administrative expenses for the first half of 2003
were $527,000 and $489,000 for the comparable period of 2002. Selling, marketing
and distribution expenses are $10,000 less than the prior year as Natural
Attraction sales activity was limited awaiting the new component inventory.
Selling, administrative and facilities were $ 48,000 more than last year. In
2002 a $32,000 bad debt recovery was made and no similar recovery was made in
2003. Additional administrative costs were incurred this year due to the sale of
assets in April 2003, the redemption and conversion of the of Company's Series
BB preferred stock in May 2003.
The Company's cash balances generated $8,000 in net interest income
during the first half of 2003, as compared to $10,000 in 2002. The decrease is
due to reduced interest rates.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2003, the Company had cash of $2,057,000 with no
outstanding bank borrowings and working capital of $2,068,000; at December 31,
2002, it had cash of $1,394,000 with no outstanding bank borrowings and working
capital of $1,671,000. For the first six months of 2003, net cash provided from
all activities was $663,000. For the first six months of 2002, net cash used
from all activities was $60,000.
On May 2, 2003, the Company renewed a its Business Loan Agreement with
Mid-Peninsula Bank of Palo Alto, California (the "Bank") providing for a
revolving line of credit. The Company may borrow up to $500,000 at an interest
rate equal to the Bank's prime rate plus 0.75% with borrowings secured primarily
by the Company's trade receivables and inventory. The agreement, which expires
on May 3, 2004, contains certain debt-to-equity and working capital covenants.
At June 30, 2003 the Company was in compliance with such covenants.
On May 22, 2003 the Company purchased, from a fund of whom a board
member is a general partner, all of the outstanding shares of its Series BB
Preferred Stock for $505,000. In a related transaction, with the same fund,
1,333,333 shares of Series AA Preferred Stock was converted into 597,777 shares
of common stock.
Assuming the Company's activities proceed substantially as planned, the
Company's current cash position and projected results of operations for the next
twelve months are not expected to require additional outside financing.
RECENT ACCOUNTING PRONOUNCEMENTS
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
SFAS No. 145 updates, clarifies, and simplifies existing accounting
pronouncements. This statement rescinds SFAS No. 4, which required all gains and
losses from extinguishments of debt to be aggregated and if material, classified
as an extraordinary item, net of related income tax effect. As a result, the
criteria in APB No. 30 will now be used to classify those gains and losses. SFAS
No. 64 amended SFAS No. 4 and is no longer necessary as SFAS No. 4 has been
rescinded. SFAS No. 44 has been rescinded as it is no longer necessary. SFAS No.
145 amends SFAS No. 13 to require that certain lease modifications that have
economic effects similar to sale-leaseback transactions be accounted for in the
same manner as sale-lease transactions. This statement also makes technical
corrections to existing pronouncements. While those corrections are not
substantive in nature, in some instances, they may change accounting practice.
This statement is not applicable to the Company.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities. This statement addresses financial
accounting and reporting for costs associated with exit or disposal
12
activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3,
Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (including Certain Costs Incurred in a Restructuring). This
statement requires that a liability for a cost associated with an exit or
disposal activity be recognized when the liability is incurred. Under EITF Issue
94-3, a liability for an exit cost, as defined, was recognized at the date of an
entity's commitment to an exit plan. The provisions of this statement are
effective for exit or disposal activities that are initiated after December 31,
2002 with earlier application encouraged. The Company does not expect adoption
of SFAS No. 146 to have a material impact, if any, on its financial position or
results of operations.
In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain
Financial Institutions. SFAS No. 147 removes the requirement in SFAS No. 72 and
Interpretation 9 thereto, to recognize and amortize any excess of the fair value
of liabilities assumed over the fair value of tangible and identifiable
intangible assets acquired as an unidentifiable intangible asset. This statement
requires that those transactions be accounted for in accordance with SFAS No.
141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible
Assets. In addition, this statement amends SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, to include certain financial
institution-related intangible assets. This statement is not applicable to the
Company.
In December 2002, the FASB issued SFAS No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No.
123. SFAS No. 148 provides alternative methods of transition for a voluntary
change to the fair value based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements of
SFAS No. 123 to require more prominent and more frequent disclosures in
financial statements about the effects of stock-based compensation. This
statement is effective for financial statements for fiscal years ending after
December 15, 2002. SFAS No. 148 will not have any impact on the Company's
financial statements as management does not have any intention to change to the
fair value method.
In April 2003, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." SFAS No. 149 amends and clarifies accounting and reporting for
derivative instruments and hedging activities under SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective
for derivative instruments and hedging activities entered into or modified after
June 30, 2003, except for certain forward purchase and sale securities. For
these forward purchase and sale securities, SFAS No. 149 is effective for both
new and existing securities after June 30, 2003. Management does not expect
adoption of SFAS No. 149 to have a material impact on the Company's statements
of earnings, financial position, or cash flows.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for how an issuer classifies and measures in its
statement of financial position certain financial instruments with
characteristics of both liabilities and equity. In accordance with the standard,
financial instruments that embody obligations for the issuer are required to be
classified as liabilities. SFAS No. 150 will be effective for financial
instruments entered into or modified after May 31, 2003 and otherwise will be
effective at the beginning of the first interim period beginning after June 15,
2003. The Company has classified redeemable preferred stock as a separate
liability.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial conditions and results of
operations are based upon our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States. The preparation of financial statements require managers 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 consolidated
financial statements.
Revenue Recognition
Revenue is recorded at the time of merchandise shipment, net of
provisions for returns. 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. 101. The majority of the
Company's sales are to distributors and licensees, and these distributors and
licensees have no right to return products.
13
License Fees
The Company capitalizes license fees paid for the rights to use new
pheromone discoveries, and rights for additional REALM and innerREALM sales
territories. License agreements that have a finite useful life are amortized
using the straight-line method over the life of the agreement. License
agreements for pheromones and products that are not yet for available for sale
are not subject to amortization in accordance with Statement of Financial
Accounting Standards No. 142: Goodwill and Other Intangible Assets.
The Company continually evaluates whether events or circumstances have
occurred that indicate the remaining estimated value of the license agreements
may not be recoverable. When factors indicate that the value license may be
impaired, the Company estimates the remaining value and reduces the license
agreement to that amount.
Subsequent Event
On July 1, 2003 Michael D. Kaufman, a director since August 1997,
resigned from the Board of Directors. Mr. Kaufman determined that his other
business commitments would consume significantly more of his time, and prevent
him from devoting the amount of time necessary to fulfill his duties and
responsibilities as a Board member.
14
Item 3. Controls and Procedures
Within 90 days prior to the date of this report, we carried out an evaluation,
under the supervision and with the participation of 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) or 15d-15(e)). Based on this evaluation, our Chief Executive Officer
and Chief Financial Officer concluded that our disclosure controls and
procedures are effective in timely alerting them to material information
required to be included in our periodic SEC reports. It should be noted that the
design of any system of controls is based in part upon certain assumptions about
the likelihood of future events, and there can be no assurance that any design
will succeed in achieving its stated goals under all potential future
conditions, regardless of how remote.
In addition, we reviewed our internal controls, and there have been no
significant changes in our internal controls or in other factors that could
significantly affect those controls subsequent to the date of their last
evaluation.
15
PART II
OTHER INFORMATION
Item 2. Changes in Securities
On May 22, 2003 the Company purchased, from a fund of whom a board
member is a general partner, all 17,448 outstanding shares of its
Convertible Redeemable Series BB Preferred Stock for $505,000. In a
related transaction, with the same fund, 1,333,333 shares of
Convertible Redeemable Series AA Preferred Stock was converted into
597,777 shares of common stock. At the conclusion of the transaction
100,000 shares of the Convertible Redeemable Series AA Preferred Stock
was outstanding.
Item 4. Submission of Matters to a Vote of Security Holders
The Company's annual shareholder meeting was held on June 18, 2003, at
which the following proposal was approved:
Proposal 1: Election for the following Directors:
---------------------------- ------------------- ----------------------
Name Votes For Votes Withheld
---------------------------- ------------------- ----------------------
William P. Horgan 4,056,203 92,356
---------------------------- ------------------- ----------------------
Bernard I. Grosser, M.D. 4,055,224 93,335
---------------------------- ------------------- ----------------------
Michael D. Kaufman (1) 642,611 -
---------------------------- ------------------- ----------------------
Helen C. Leong 4,055,224 93,335
---------------------------- ------------------- ----------------------
Robert Marx 4,055,224 93,335
---------------------------- ------------------- ----------------------
(1) Michael D. Kaufman was nominated and elected by the holders of the
Series AA Preferred Stock.
Item 6. Exhibits and Reports on Form 8-K
a. Exhibits
Exhibit 10.27 Business Loan Agreement dated May 2, 2003
Exhibit 10.28 2003 Nonemployee Directors Stock Option Plan of
Human Pheromone Sciences, Inc.
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
b. Reports on Form 8-K
The Company filed Form 8-K on April 29, 2003 in connection with
the sale of assets transaction.
16
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.
Registrant
Date: August 11, 2003 /s/ William P. Horgan
---------------------
William P. Horgan
Chairman and Chief Executive Officer
Date: August 11, 2003 /s/ Gregory S. Fredrick
-----------------------
Gregory S. Fredrick
Vice President Finance
17