SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
Forthe Fiscal Year Ended Commission File No. 0-11550
December 31, 2003
PHARMOS CORPORATION
(Exact name of registrant as specified in its charter)
NEVADA 36-3207413
(State or other jurisdiction of (IRS Employer Id. No.)
incorporation or organization)
99 WOOD AVENUE SOUTH, SUITE 311
ISELIN, NJ 08830
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (732) 452-9556
Securities registered pursuant to Section 12(b) of the Act:
NONE
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.03 PAR VALUE
(Title of Class)
Indicate by check mark 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [x ] No [ ].
The aggregate market value of the registrant's Common Stock at June 30,
2003 held by those persons deemed to be non-affiliates was approximately
$176,106,260.
As of March 15, 2004, the Registrant had outstanding 87,913,692 shares of
its $.03 par value Common Stock.
1
PART I
This Form 10-K contains "forward-looking" statements, as defined in the Private
Securities Litigation Reform Act of 1995 that are based on current expectations,
estimates and projections. Statements that are not historical facts, including
statements about our beliefs and expectations, are forward-looking statements.
These statements involve potential risks and uncertainties; therefore, actual
results may differ materially. You are cautioned not to place undue reliance on
these forward-looking statements, which speak only as of the date on which they
were made. We do not undertake any obligation to update any forward-looking
statements, whether as a result of new information, future events or otherwise.
Important factors that may affect these expectations include, but are not
limited to: the risks and uncertainties associated with completing pre-clinical
and clinical trials of our compounds that demonstrate such compounds' safety and
effectiveness; manufacturing losses and risks associated therewith; obtaining
additional financing to support our operations; obtaining and maintaining
regulatory approval for such compounds and complying with other governmental
regulations applicable to our business; obtaining the raw materials necessary in
the development of such compounds; consummating and maintaining collaborative
arrangements with corporate partners for product development; achieving
milestones under collaborative arrangements with corporate partners; developing
the capacity to manufacture, market and sell our products, either directly or
with collaborative partners; developing market demand for and acceptance of such
products; competing effectively with other pharmaceutical and biotechnological
products; obtaining adequate reimbursement from third party payers; attracting
and retaining key personnel; obtaining patent protection for discoveries and
risks associated with commercial limitations imposed by patents owned or
controlled by third parties; and those other factors set forth in "Risk Factors"
in the Company's most recent Registration Statement.
We do not undertake to discuss matters relating to our ongoing clinical trials
or our regulatory strategies beyond those, which have already been made public
or discussed herein.
ITEM 1. BUSINESS
INTRODUCTION
Pharmos Corporation (the "Company" or "Pharmos") is a bio-pharmaceutical company
that discovers and develops new drugs to treat a range of neuro-inflammatory
disorders. We have a portfolio of drug candidates under development, as well as
discovery, preclinical and clinical capabilities. Prior to the sale of our
ophthalmic product line to Bausch & Lomb Incorporated ("Bausch & Lomb") in
October of 2001, we had two successful ophthalmic products on the market. To
date, our principal sources of cash have been the sale of our ophthalmic
business, revenues from our ophthalmic product line, public and private
financings and research grants.
Our main product, dexanabinol, is a synthetic non-psychotropic cannabinoid
currently in late-stage clinical development for the treatment of severe
traumatic brain injury (TBI). In mid-March 2004, the Company completed
enrollment of U.S. and international TBI patients in its pivotal, Phase III
clinical trial of dexanabinol. The Phase II trial, completed in early 2000,
demonstrated a good safety profile and showed a trend of efficacy in the
drug-treated groups versus the placebo group. The trial also demonstrated that
dexanabinol significantly inhibited the increase in intracranial pressure above
20mmHg, the level of pressure necessitating immediate treatment. In addition,
neurological recovery appeared to be accelerated in the dexanabinol treated
group, such that the percentage of dexanabinol treated patients achieving good
recovery at one month after injury was significantly higher than patients in the
placebo group.
In September 2003, the FDA granted fast track designation to dexanabinol for
treatment of severe traumatic brain injury. Fast track designation allows New
Drug Application (NDA) submission on a rolling basis as each section is
completed and requires an FDA priority review of the full NDA.
2
Our development of dexanabinol for severe traumatic brain injury involves
only one pivotal clinical trial. Assuming a successful clinical trial, Pharmos
plans to submit a New Drug Application to the FDA. A requirement by the FDA for
further significant clinical testing after the completion of the current pivotal
Phase III clinical trial or a rejection of our NDA would have a material adverse
effect on Pharmos and its operations.
In March 2003, the Company initiated a double-blinded placebo controlled Phase
II trial of dexanabinol as a preventive agent against the cognitive impairment
(CI) that can follow coronary surgery involving cardiopulmonary bypass (CS-CPB).
This trial is being conducted at five leading medical centers in Israel.
Enrollment of patients undergoing CS-CPB in the trial is expected to be
completed by Q2 2004.
Pharmos is developing synthetic compounds, which preferentially activate the CB2
cannabinoid receptor. Preclinical investigations of these compounds are underway
for treatment of a wide range of neuro-inflammatory disorders, especially pain.
One compound, PRS 211.375 has been selected for advanced preclinical development
including toxicology and Absorption, Distribution, Metabolism, Excretion (ADME)
in preparation for clinical testing.
On October 9, 2001, Pharmos sold all of its rights to its ophthalmic product
line to Bausch & Lomb for cash and assumption of certain ongoing obligations.
Please refer to the description of the transaction under the heading Bausch &
Lomb.
STRATEGY
Pharmos' business is the discovery and development of new drugs to treat a range
of neuro-inflammatory disorders. We seek to enter into collaborative
relationships with established pharmaceutical companies to complete development
and commercialization of our products.
Pharmos is applying its experience in rational drug design, novel drug delivery
technology and drug development to developing products directed at several
therapeutic indications, including neuroprotective compounds for traumatic brain
injury and stroke as well as neurological, vascular and other conditions
involving inflammatory components such as pain.
PRODUCTS
PLATFORM TECHNOLOGIES
Pharmos is developing two families of compounds based on its scientific
knowledge of the medicinal activities of cannabinoids, a class of compounds with
chemical structures related to the main active component of cannabis. The
company utilizes state-of-the-art technologies to synthesize, evaluate and
develop new cannabinoid molecules that appear to exhibit enhanced therapeutic
benefit. According to Pharmos' research to date, dexanabinol has been shown to
possess minimal psychotropic properties. As part of the filing requirements with
FDA, Pharmos will study the addiction potential of dexanabinol. If the potential
of addiction is found in the animal, then additional regulatory requirements may
be imposed by the FDA and Drug Enforcement Agency (DEA). Pharmos continues to
expand its library of compounds through a hybrid methodology combining the
rational design of compounds based on knowledge of detailed molecular
requirements for drug activity with combinatorial chemistry, a technique that
utilizes randomized chemical reactions to synthesize large numbers of different
molecules. In contrast to the conventional random methods of combinatorial
chemistry, this hybrid approach leads to a larger percentage of synthesized
compounds that demonstrate activity in screening assays and increases the
potential of developing potent and selective drug candidates.
Pharmos' chemical library consists of two chemically distinct cannabinoid
platforms, tricyclic dextrocannabinoids and bicyclic cannabinoids. The two
classes of synthetic cannabinoids have different
3
mechanisms of action, but there is considerable overlap in their therapeutic
potential for treating neurological, cardiovascular, autoimmune and inflammatory
disorders.
TRICYCLIC DEXTROCANNABINOIDS
The tricyclic dextrocannabinoids, for which dexanabinol is the prototype, do not
bind appreciably to either of the two known classes of cannabinoid receptors.
Therefore, the tricyclic dextrocanabinoids demonstrate minimal psychotropic and
other negative side effects that are associated with naturally occurring
cannabinoids. The biological activity of drug candidates in this family derives
from their ability to block the activation of specific NMDA mediated channels in
nerve cells and attenuating several major inflammatory mechanisms by modulating
the synthesis of pro-inflammatory factors. Both activities may reduce the amount
of sudden and programmed cell death caused by certain disorders.
Dexanabinol is currently undergoing a Phase III clinical study for the treatment
of severe head injury. In addition, it is undergoing a Phase II trial for use as
a preventive agent against the cognitive impairment (CI) that can follow
coronary surgery involving cardiopulmonary bypass (CS-CPB). Other tricyclic
dextrocannabinoids are under evaluation in preclinical models for stroke;
neuropathic pain, which results from nerve damage or dysfunction; nociceptive
pain, which is caused by activation of nerve sensors as a result of acute tissue
damage; and autoimmune disorders such as multiple sclerosis.
DEXANABINOL
Dexanabinol - Clinical Development
Pharmos has completed two Phase I studies in healthy volunteers that
demonstrated dexanabinol's safety and tolerance at doses higher than the
expected therapeutic dose. A Phase II clinical trial of dexanabinol in severe
traumatic brain injury patients was completed in early 2000. The objective of
this study was to establish the safety of intravenous dexanabinol when given to
patients within 6 hours after sustaining a severe traumatic brain injury. The
study was conducted at six neurosurgical intensive care units in Israel between
October 1996 and March 1998. A total of 100 patients were enrolled in the study;
fifty-one patients received dexanabinol and forty-nine received matching
placebo. Patients were randomized to one of three treatment arms and where
treated with dexanabinol 48mg, 150mg or 200mg. Because the study was conducted
in a dose escalating, stepwise fashion each treatment group had a matching
placebo group.
The study achieved its objective in establishing the safety of dexanabinol in
patients suffering from traumatic brain injury. There were no unexpected adverse
experiences reported in either the drug-treated or the placebo group. In
addition, the reported adverse experiences did not differ between the drug and
placebo groups in the nature or severity of the events. In this study the
mortality rate in the placebo group was 14.3 percent and 11.8 percent in the
dexanabinol group.
Although the study was not statistically powered to detect differences in
efficacy, some efficacy parameters were explored as secondary safety parameters
to ascertain if dexanabinol did not negatively effect patient outcome.
Intracranial pressure (ICP) is an important assessment of the brain's reaction
to injury. An ICP above 20mmHg is considered to be clinically significant,
necessitating immediate treatment. Dexanabinol treated patients had a lower
duration of elevated ICP (above 20mmHg) compared to the placebo group. The
Glasgow Outcome Score (GOS) showed a higher percentage of good outcome in the
dexanabinol-treated patients. During the early post-treatment period (1 month)
the effect was statistically significant, whereas the difference at 3 and 6
months was not. Similarly, the dexanabinol-treated patients scored better than
the placebo patients on the Galveston Orientation and Amnesia Test (GOAT) during
the six month follow-up period.
4
The GOAT, which is a neurological test that measures awareness of surroundings
and ability to remember, demonstrated significantly better results in the
dexanabinol treated patients at 1, 3 and 6 months follow-up compared to placebo.
A manuscript describing the analysis of the first two cohorts of patients was
published by Knoller, et al. in, Critical Care Medicine 2002,Vol30:548-554.
INTERNATIONAL PHASE III CLINICAL TRIAL OF DEXANABINOL FOR SEVERE TRAUMATIC BRAIN
INJURY
In January 2001, the international Phase III pivotal trial of dexanabinol for
severe traumatic brain injury was initiated in Europe and Israel. In February
2003, the FDA accepted the Company's IND application, which allowed the Company
to commence patient enrollment in the U.S. as part of the international trial.
Over eighty centers throughout the U. S., Europe, Australia, and Israel enrolled
patients in the trial. European countries participating in the study included
Belgium, Denmark, Finland, France, Germany, Italy, the Netherlands, Poland,
Spain, Switzerland, Turkey, and the U.K. Collaborations with the European Brain
Injury Consortium and the American Brain Injury Consortium, which were key to
recruitment efforts with trauma centers, will continue through trial completion
and data analysis.
In mid-March 2004, the Company completed enrollment of U.S. and international
TBI patients in its pivotal, Phase III clinical trial of dexanabinol.
Approximately six months after the completion of enrollment, Pharmos anticipates
completing the clinical trial, as the trial protocol requires periodic
examinations and testing of patients enrolled in the trials during the six
months following their initial treatment. Several months after the completion of
the last patient last follow-up visit, Pharmos plans to unblind the study and
announce the main study results.
PHASE II TRIAL OF DEXANABINOL TO PREVENT COGNITIVE IMPAIRMENT IN FOLLOWING
CORONARY SURGERY UNDER CARDIOPULMONARY BYPASS
In March 2003, the Company initiated a double-blinded placebo controlled Phase
II trial of dexanabinol as a preventive agent against the cognitive impairment
(CI) that can follow coronary surgery involving cardiopulmonary bypass (CS-CPB)
operations. This trial is being conducted at five leading medical centers in
Israel. The enrollment of CS-CPB patients in this trial is expected to be
completed in the second quarter of 2004.
BICYCLIC CANNABINOIDS
Bicyclic cannabinoids are synthetic analogs and derivatives of the tricyclic
dextrocannabinoids that have some properties that are similar to those of their
parent tricyclic molecules as well as possessing some additional properties.
As with the tricyclic dextrocannabinoids, the bicyclic cannabinoids may display
less of the unwanted psychotropic side effects seen with some natural
cannabinoids. However, the molecular activity of the bicyclics is different from
the tricyclics in that the bicyclic cannabinoids bind with high affinity to the
cannabinoid type two (CB2) receptor which is located primarily on immune and
inflammatory cells and with appreciably lower affinity to the cannabinoid type
one (CB1) receptor, located in the central nervous system. Pharmaceuticals that
preferentially activate the CB2 receptors may be important in treating various
pain syndromes as well as autoimmune, inflammatory and neuro-degenerative
disorders. Several candidates from Pharmos' bicyclic cannabinoid library have
demonstrated promise in animal models for autoimmune inflammatory disorders such
as multiple sclerosis and rheumatoid arthritis. These compounds have also
demonstrated efficacy in animal models of neuropathic and nociceptive pain. In
preclinical models these compounds have demonstrated analgesic activity
equivalent to morphine but without the unwanted opioid side effects such as
sedation and repiratory depression. The anti-inflammatory activity of these
compounds is equivalent or superior to non-steroidal anti-inflammatory drugs
(NSAIDS). One compound, PRS 211.375 is being tested in preclinical experiments
to assess its analgesic and other therapeutic potentials.
5
LOTEPREDNOL ETABONATE
Loteprednol etabonate is a unique steroid that is designed to act in the eye and
alleviate inflammatory and allergic conditions, and that is quickly and
predictably reduced into inactive particles before it reaches the inner eye or
systemic circulation. This action results in improved safety by avoiding the
side effects related to exposure to most ocular steroids. In the eye, the most
unwanted side effect of steroids is the elevation of intra-ocular pressure,
which can be sight threatening. While steroids, for lack of an alternative, are
regularly used for severe inflammatory conditions of the eye, milder conditions,
such as allergies, are preferentially treated with less effective non-steroidal
agents.
On October 9, 2001, Pharmos sold all of its rights to its ophthalmic product
line to Bausch & Lomb for cash and assumption of certain ongoing obligations.
Please refer to the description of the transaction under the heading Bausch &
Lomb, below.
COMPETITION
The pharmaceutical industry is highly competitive. Pharmos competes with a
number of pharmaceutical companies that have financial, technical and marketing
resources that are significantly greater than those of Pharmos. Some companies
with established positions in the pharmaceutical industry may be better equipped
than Pharmos to develop, market and distribute products in the markets Pharmos
is seeking to enter. A significant amount of pharmaceutical research is also
being carried out at universities and other not-for-profit research
organizations. These institutions are becoming increasingly aware of the
commercial value of their findings and are becoming more active in seeking
patent protection and licensing arrangements to collect royalties for the use of
technology they have developed. They may also market competitive commercial
products on their own or through joint ventures and will compete with Pharmos in
crecuiting highly qualified scientific personnel. Further, these institutions
will compete with Pharmos in recruiting qualified patients for enrollment in
their trials.
Pharmos is pursuing areas of product development in which there is a potential
for extensive technological innovation. Pharmos' competitors may succeed in
developing products that are more effective than those of Pharmos. Rapid
technological change or developments by others may result in Pharmos' potential
products becoming obsolete or non-competitive.
We know of no products on the market or in late stage trials which would be
competitive with dexananbinol. For Bausch & Lomb's ophtahalmic product, LE-T, in
which we have a financial interest of up to $10 million market potential, there
are competing products currently on the market including Tobradex(R) from Alcon,
which is the largest selling product in its category, as well as Vexol(R) from
Alcon and Pred Forte(R) from Allergan.
COLLABORATIVE RELATIONSHIPS
Pharmos' commercial strategy is to develop products independently and, where
appropriate, in collaboration with established pharmaceutical companies and
institutions. Collaborative partners may provide financial resources, research
and manufacturing capabilities and marketing infrastructure to aid in the
commercialization of Pharmos' products in development as well as potential
future products. Depending on the availability of financial, marketing and
scientific resources, among other factors, Pharmos may license its technology or
products to others and retain profit sharing, royalty, manufacturing,
co-marketing, co-promotion or similar rights. Any such arrangements could limit
Pharmos' flexibility in pursuing alternatives for the commercialization of its
products. Due to the often unpredictable nature of the collaborative process,
Pharmos cannot be certain that it will be able to establish any additional
collaborative arrangements or that, if established, any of these relationships
will be successful.
BAUSCH & LOMB
In October 2001, Pharmos sold to Bausch & Lomb all of its rights in the U.S. and
Europe to manufacture and market Lotemax(R) and Alrex(R) and the third
loteprednol etabonate-based product, LE-T, which was submitted to the FDA for
marketing approval in September 2003.
6
Pharmos received gross proceeds of approximately $25 million in cash.
Additionally Pharmos may receive up to an additional $12 million in gross
proceeds, based upon the date of FDA approval of the product and good faith
negotiations with Bausch & Lomb, and a milestone payment of up to $10 million if
actual sales during the first two years following commercialization exceed
agreed-upon forecasted amounts. Pharmos agreed to pay up to $3.75 million of the
costs of developing LE-T, of which $600,000 was deducted from the purchase price
paid by Bausch & Lomb in October 2001. In July 2003, another $1.57 million was
paid to Bausch & Lomb. As of December 31, 2003, Pharmos owes an additional $1.56
million as its share of these research and development related LE-T expenses,
which is included in accounts payable and represents the final amount Pharmos
owes Bausch & Lomb for their project development under the terms of the 2001
agreement.
Pharmos paid Dr. Nicholas Bodor, the loteprednol etabonate patent owner and
licensor, who is also a former director of and consultant to Pharmos, a total of
approximately $2.7 million from the initial proceeds of the sale of Lotemax(R)
and Alrex(R) in return for his consent to Pharmos' assignment of its rights
under the license agreement to Bausch & Lomb ($1.5 million paid at closing and
$1.2 million paid in October 2002). Pharmos will also pay Dr. Bodor 11% of our
LE-T proceeds due upon FDA approval and 14.3% of the payment we will receive in
the event that certain sales levels are exceeded in the first two years
following commencement of sales in the U.S.
PATENTS, PROPRIETARY RIGHTS AND LICENSES
PATENTS AND PROPRIETARY RIGHTS
Proprietary protection generally has been important in the pharmaceutical
industry, and the commercial success of products incorporating Pharmos'
technologies may depend, in part, upon the ability to obtain strong patent
protection.
Some of the technologies underlying Pharmos' potential products were invented by
or are owned by various third parties, including the Hebrew University of
Jerusalem. Pharmos is the licensee of these technologies under patents held by
the applicable owner, through licenses that generally remain in effect for the
life of the applicable patent. Pharmos generally maintains, at its expense, U.S.
and foreign patent rights with respect to both the licensed technology and its
own technology and files and/or prosecutes the relevant patent applications in
the U.S. and foreign countries. Pharmos also relies upon trade secrets,
know-how, continuing technological innovations and licensing opportunities to
develop its competitive position. Pharmos' policy is to protect its technology
by, among other things, filing, or requiring the applicable licensor to file,
patent applications for technology that it considers important to the
development of its business. Pharmos intends to file additional patent
applications, when appropriate, relating to its technology, improvements to its
technology and to specific products it develops.
The patent positions of pharmaceutical firms, including Pharmos, are uncertain
and involve complex factual questions. In addition, the coverage claimed in a
patent application can be significantly reduced before or after the patent is
issued. Consequently, Pharmos does not know whether any of the pending patent
applications underlying the licensed technology will result in the issuance of
patents or, if any patents are issued, whether they will provide significant
proprietary protection or will be circumvented or invalidated. Since patent
applications in the U.S. and elsewhere publish only 18 months after priority
date, and since publication of discoveries in the scientific or patent
literature often lag behind actual discoveries, Pharmos cannot be certain that
it or its licensors, as the case may be, were the first creators of inventions
covered by pending and issued patents or that it or its licensors, as the case
may be, were the first to file patent applications for such inventions.
Moreover, it may be necessary for Pharmos to participate in interference
proceedings declared by the U.S. Patent and Trademark Office in order to
determine priority of invention. Involvement in these proceedings could result
in substantial cost to Pharmos, even if the eventual outcomes are favorable to
Pharmos. Because the results of the judicial process are often uncertain, we
cannot be
7
certain that a court of competent jurisdiction will uphold the patents, if
issued, relating to the licensed technology, or that a competitor's product will
be found to infringe those patents.
Other pharmaceutical and drug delivery companies and research and academic
institutions may have filed patent applications or received patents in Pharmos'
fields. If patents are issued to other companies that contain competitive or
conflicting claims and those claims are ultimately determined to be valid, it is
possible that Pharmos would not be able to obtain licenses to these patents at a
reasonable cost or be able to develop or obtain alternative technology.
Pharmos also relies upon trade secret protection for its confidential and
proprietary information. It is always possible that others will independently
develop substantially equivalent proprietary information and techniques or
otherwise gain access to Pharmos' trade secrets.
It is Pharmos' policy to require its employees, consultants, outside scientific
collaborators, sponsored researchers and other advisors to execute
confidentiality agreements upon the commencement of employment or consulting or
advisory relationships with Pharmos. These agreements generally provide that all
confidential information developed or made known to the individual during the
course of the individual's relationship with Pharmos is to be kept confidential
and not disclosed to third parties except in specific circumstances. Further,
these agreements provide for the maintenance of confidentiality following the
termination of the individual's relationship with Pharmos. In the case of
employees and certain consultants, the agreements provide that all inventions
conceived by the individual in the course of their employment or consulting
relationship shall be the exclusive property of Pharmos. Due to the vital nature
of trade secrets and the often uncertain results of the judicial process, we
cannot be sure, however, that these agreements will provide meaningful
protection or adequate remedies for Pharmos' trade secrets in the event of
unauthorized use or disclosure of such information. Pharmos' patents and
licenses underlying its potential products described herein are summarized
below.
Neuroprotective Agents. Pharmos has licensed from the Hebrew University of
- ------------------------
Jerusalem, which is the academic affiliation of the inventor, Dr. Raphael
Mechoulam, patents covering new cannabinoid compounds that have demonstrated
beneficial activity which may prevent damage or death to nerve cells resulting
from various diseases and disorders of the nervous system while appearing to be
devoid of most of the deleterious side effects usually associated with this
class of compounds. Several patents have been designed to protect this family of
compounds and their uses devised by inventors at Pharmos and the inventors at
the Hebrew University. The earliest patent applications resulted in patents
issued in 1989, and the most recent patents date from 2003. These patents cover
dexanabinol, which is under development for the treatment of head trauma,
post-operative cognitive impairment and other conditions, and new molecules
discovered by modifying the chemical structure of dexanabinol.
Anti-inflammatory and Analgesic Agents. Pharmos has also licensed from the
- ------------------------------------------
Hebrew University of Jerusalem, patents for inventions of Dr. Mechoulam covering
new compounds that have demonstrated beneficial activity, which may be effective
in treating not only neurological disorders, but also inflammatory diseases and
most importantly pain. These bicyclic compounds are expected to cause less
adverse deleterious side effects usually associated with cannabinoids. Several
patents have been designed to protect this family of compounds and their uses by
inventors at Pharmos and Hebrew University. The earliest patent applications
resulted in patents issued in 1995, and the most recent patent dates from 2003.
Selective Estrogen Receptor Modulators (SERM). Pharmos has filed patent
- --------------------------------------------------
applications in the U.S., Israel, Australia, Canada, Japan, Brazil, Korea and
the European Patent Office to protect certain derivatives of tamoxifen, a drug
approved by the FDA, and other molecules that enhance or improve the actions of
steroid hormones. In July 1997, the U.S. Patent and Trademark Office issued a
patent with claims covering the compounds themselves and their use. A second
patent issued in July 2000 claims the use of these compounds as agents to
inhibit growth of new blood vessels, a potential method of treating various
cancers. The most recent patents issued in these families are dated in 2003.
Pharmos believes that these derivatives may be superior to the parent compounds
in that they are devoid of central nervous system side effects.
8
Emulsion-based Drug Delivery Systems. In the general category of SubMicron
- ----------------------------------------
Emulsion technology, Pharmos holds a license to one family of patents from the
Hebrew University of Jerusalem and has filed ten independent patent families of
applications including more than ninety patent applications that are at
different stages of prosecution. These patents and patent applications have been
devised to protect a group of formulation technologies devised by Pharmos and
the inventors as they relate to pharmaceutical and medicinal products. The
earliest patent filings for SubMicron Emulsion technology date from 1993 and the
most recent are dated in 2003. These patents cover a broad range of new
formulations, which improve the absorption of drugs that are poorly soluble in
water.
LICENSES
As discussed above, Pharmos has licensed patents covering neuroprotective agents
and certain emulsion-based drug delivery systems from the Hebrew University of
Jerusalem. Pharmos assigned its rights as licensee of Dr. Bodor's loteprednol
etabonate-based ophthalmic compounds to Bausch & Lomb in October 2001.
In December 2001, Pharmos' subsidiary Pharmos Ltd. licensed its patents related
to the oral delivery of lipophilic substances in the limited field of use of
nutraceuticals to Herbamed, Ltd., a company in Israel controlled by the Chairman
and Chief Executive Officer of Pharmos. The terms of the license agreement are
discussed in "Item 13. Certain Relationships and Related Transactions."
Site-Specific Drugs. In the general category of site-specific drugs that are
- ---------------------
active mainly in the eye and have limited systemic side effects, Pharmos
licensed several patents from Dr. Nicholas Bodor. It assigned its rights under
the Bodor license to Bausch & Lomb in October 2001 in connection with its sale
of its ophthalmic business. The earliest patents date from 1984 and the most
recent from 1996. Some of these patents cover loteprednol etabonate-based
products and its formulations.
GOVERNMENT REGULATION
FDA AND COMPARABLE AUTHORITIES IN OTHER COUNTRIES
Regulation by governmental authorities in the U.S. and other countries is a
significant factor in our ongoing research and development activities and in the
production and marketing of our products. Pharmaceutical products intended for
therapeutic use in humans are governed in the U.S. by the Federal Food, Drug and
Cosmetic Act (21 U.S.C. ss. 321 et seq.) and by FDA regulations and by
comparable agency regulations in other countries. Specifically, in order to
undertake clinical tests, to produce and market products for human therapeutic
or diagnostic use, mandatory procedures and safety standards established by the
FDA and Department of Health and Human Services in the U.S. and comparable
agencies in other countries must be implemented and followed. These standards
include protection of human research subjects.
The following is an overview of the steps that must be followed before a drug
product may be marketed lawfully in the U.S.:
(i) Preclinical studies including pharmacology, laboratory evaluation
and animal studies to test for initial safety and efficacy;
(ii) Submission to the FDA of an Investigational New Drug (IND)
Application, which must become effective before human clinical
trials may commence;
(iii) Adequate and well-controlled human clinical trials to establish the
safety and efficacy of the drug in its intended application;
9
(iv) Submission to the FDA of a New Drug Application (NDA), which
application is not automatically accepted by the FDA for
consideration; and
(v) FDA approval of the New Drug Application prior to any commercial
sale or shipment of the drug.
In addition to obtaining FDA approval for each product, each drug-manufacturing
establishment must be registered or licensed by the FDA for each product sold
within the US that is manufactured at that facility. Manufacturing
establishments are subject to inspections by the FDA and by other national and
local agencies and must comply with current Good Manufacturing Practices
(cGMPs), requirements that are applicable to the manufacture of pharmaceutical
drug products and their components.
Preclinical studies include laboratory evaluation of product chemistry and
animal studies to assess the potential safety and efficacy of the product and
its formulation. The results of the preclinical studies are submitted to the FDA
as part of an IND, and unless the FDA objects, the application will become
effective 30 days following its receipt by the FDA. If the potential of
addiction is found in the animal, then additional regulatory requirements maybe
imposed by the FDA and DEA.
Clinical trials involve the administration of the drug to healthy volunteers as
well as to patients under the supervision of a qualified "principal
investigator", who is a medical doctor. Clinical trials in humans are necessary
because effectiveness in humans may not always be gleaned from findings of
effectiveness in animals. They are conducted in accordance with protocols that
detail the objectives of the study, the parameters to be used to monitor safety
and the efficacy criteria to be evaluated. Each protocol is submitted to the FDA
as part of the application. Each clinical study is approved and monitored by an
independent Institutional Review Board (IRB) (Ethics Committee) at each clinical
site. The IRB must consider, among other things, the process of obtaining the
informed consents of each study subject, the safety of human subjects, the
possible liability of the institution conducting a clinical study, as well as
various ethical factors.
Clinical trials typically are conducted in three sequential phases, although the
phases may overlap. In Phase I, the initial introduction of the drug to humans,
the drug is tested in a small group of healthy volunteers for safety and
clinical pharmacology such as metabolism and tolerance. Phase I trials may also
yield preliminary information about the product's effectiveness and dosage
levels. Phase II involves detailed evaluation of safety and efficacy of the drug
in patients with the disease or condition being studied. It also involves a
determination of optimal dosage and identification of possible side effects in a
larger patient group. Phase III trials consist of larger scale evaluation of
safety and efficacy and usually require greater patient numbers and multiple
clinical trial sites, depending on the clinical indications for which marketing
approval is sought.
The process of completing clinical testing and obtaining FDA approval for a new
product is likely to take a number of years and require the expenditure of
substantial resources. The FDA may grant an unconditional approval of a drug for
a particular indication or may grant approval conditioned on further
post-marketing testing. The FDA also may conclude that the submission is not
adequate to support an approval and may require further clinical and preclinical
testing, re-submission of the New Drug Application, and further review. Even
after initial FDA approval has been obtained, further studies may be required to
provide additional data on safety or to gain approval for the use of a product
for clinical indications other than those for which the product was approved
initially. This could delay the NDA approval process.
The 1962 amendments to the Federal Food, Drug and Cosmetic Act required for the
first time that drug effectiveness be proven by adequate and well-controlled
clinical trials. The FDA interpretation of that requirement is that at least two
such trials are necessary to demonstrate effectiveness for approval of an NDA.
This interpretation is based on the scientific need for independent
substantiation of study results. However, Section 115 of FDAMA revised Section
505 of the Act to read, in pertinent part that "based on relevant science, ...
data from one adequate and well-controlled clinical investigation and
confirmatory evidence ... are sufficient to establish effectiveness." The FDA
has not issued comprehensive standards of testing conditions for pivotal trials.
The FDA has interpreted this language for approval based on a single
10
persuasive trial to be limited to special cases including life-threatening
diseases where no effective therapy exists. The FDA still maintains a preference
for at least two adequate and well-controlled clinical trials. Therefore,
despite the design and scale of Pharmos' trial, there are no assurances that the
FDA would approve the NDA based on a single trial. Dexanabinol has been shown to
be devoid of psychotropic properties, and Pharmos believes that the potential of
addictive properties is remote. However, because dexanabinol is a cannabinoid
the Company will conduct a test to specifically evaluate any addictive
potential. If the test shows the possibility of addiction, additional regulatory
requirements would have to be met which could delay the NDA approval process.
Pharmos' products will be subject to foreign regulatory approval before they may
be marketed abroad. Marketing beyond the US is subject to regulatory
requirements that vary widely from country to country. In the European Union,
the general trend has been towards coordination of the common standards for
clinical testing of new drugs. Centralized approval in the European Union is
coordinated through the European Medicines Evaluation Agency (EMEA). The time
required to obtain regulatory approval from comparable regulatory agencies in
each country may be longer or shorter than that required for FDA or EMEA
approval. Further, in certain markets, reimbursement may be subject to
governmentally mandated prices.
CORPORATE HISTORY
Pharmos Corporation, (formerly known as Pharmatech, Inc.), a Nevada corporation
was incorporated under the laws of the State of Nevada on December 20, 1982. On
October 29, 1992, Pharmos, the Nevada Corporation, completed a merger with a
privately held New York corporation known as Pharmos Corporation, and in 1992
acquired all of the outstanding shares of Xenon Vision, Inc., a privately held
Delaware corporation.
HUMAN RESOURCES
As of March 1, 2004, Pharmos had 59 employees (53 full-time and 6 part-time),
including 15 in the U.S. (1 part-time) and 44 in Israel (5 part-time). Of the 59
employees, 20 hold doctorate or medical degrees.
Pharmos' employees are not covered by a collective bargaining agreement. To
date, Pharmos has not experienced employment-related work stoppages and
considers its employee relations to be excellent.
PUBLIC FUNDING AND GRANTS
Pharmos' subsidiary, Pharmos Ltd., has received certain funding from the Chief
Scientist of the Israel Ministry of Industry and Trade (the Chief Scientist)
for: (1) research and development of dexanabinol; (2) SubMicron Emulsion
technology for injection and nutrition; and (3) research relating to
pilocarpine, dexamethasone and ophthalmic formulations for dry eyes. As of
December 31, 2003, the total amounts received under such grants amounted to
$10,905,358. Aggregated future royalty payments related to sales of products
developed, if any, as a result of the grants are limited to $9,203,583 based on
grants received through December 31, 2003. Pharmos will be required to pay
royalties to the Chief Scientist ranging from 3% to 5% of product sales, if any,
as a result of the research activities conducted with such funds. Aggregate
royalty payments per product are limited to the amount of funding received to
develop that product. Additionally, funding by the Chief Scientist places
certain legal restrictions on the transfer of know-how and the manufacture of
resulting products outside of Israel. See "Conditions in Israel."
Pharmos received funding of $925,780 from the Israel-U.S. Binational Industrial
Research and Development Foundation to develop Lotemax(R) and LE-T. Pharmos was
required to pay royalties to this foundation on product sales, if any, of 2.5%,
through September 1999, then 5% thereafter, as a result of the research
activities conducted with such funds. Aggregate royalty payments are limited to
150% of the amount of such funding received, linked to the exchange rate of the
U.S. dollar and the New Israeli Shekel. During October 2001, in connection with
the sale of Pharmos's existing ophthalmic business, Pharmos paid
11
the foundation royalties of approximately $1.0 million for Lotemax(R) which
concluded Pharmos' obligation to pay royalties to the foundation with respect to
Lotemax(R). Pharmos retains the contingent obligation to repay that portion of
funding it received from the foundation with respect to LE-T of $308,350.
In April 1997, Pharmos signed an agreement with the Consortium Magnet, operated
by the Office of the Chief Scientist, for developing generic technologies and
for the design and development of drug and diagnostic kits. Under such
agreement, Pharmos was entitled to a non-refundable grant amounting to
approximately 60% of the actual research and development and equipment
expenditures on approved projects. No royalty obligations were required within
the framework. As of December 31, 2003 Pharmos had received grants totaling
$1,659,549 for this program which was completed and closed.
During 2003, the Company signed an agreement with Consortium Magnet to develop a
supply of water-soluble prodrugs of lipophilic compounds that improve their
bioavailability and biopharmaceutical properties. Under such agreement the
Company is entitled to a non-refundable grant amounting to approximately 60% of
actual research and development and equipment expenditures on approved projects.
No royalty obligations are required within the framework. During 2003, Pharmos
was awarded a grant of $220,000.
CONDITIONS IN ISRAEL
A significant part of Pharmos' operations is conducted in Israel through its
wholly owned subsidiary, Pharmos Ltd., and we are directly affected by economic,
political and military conditions there.
Since the establishment of the State of Israel in 1948, a number of armed
conflicts have taken place between Israel and its Arab neighbors, as well as
incidents of civil unrest. In addition, Israel and companies doing business with
Israel have, in the past, been the subject of an economic boycott. Although
Israel has entered into various agreements with certain Arab countries and the
Palestinian Authority, there has been an increase in the unrest and terrorist
activity that began in September 2000 and has continued with varying levels of
severity into 2004. We do not believe that the political and security situation
has had any material negative impact on our business to date; however, the
situation is volatile and we cannot be sure that security and political
conditions will have no such effect in the future.
Many of our employees in Israel are obligated to perform military reserve duty.
In the event of severe unrest or other conflict, individuals could be required
to serve in the military for extended periods of time. Our operations could be
disrupted by the absence for a significant period of time of some of our
employees due to military service.
Since 1997, Pharmos Ltd. has received funding from the Office of the Chief
Scientist of the Israel Ministry of Industry and Trade relating to various
technologies for the design and development of drugs and diagnostic kits. This
funding prohibits the transfer or license of know-how and the manufacture of
resulting products outside of Israel without the permission of the Chief
Scientist. Although we believe that the Chief Scientist does not unreasonably
withhold this permission if the request is based upon commercially justified
circumstances and any royalty obligations to the Chief Scientist are
sufficiently assured, the matter is solely within his discretion and we cannot
be sure that such consent, if requested, would be granted upon terms
satisfactory to us or granted at all. Without such consent, we would be unable
to manufacture any products developed by this research outside of Israel, which
may greatly restrict any potential revenues from such products.
AVAILABILITY OF SEC FILINGS
All reports filed by the Company with the SEC are available free of charge via
EDGAR through the SEC website at www.sec.gov. In addition, the public may read
and copy materials filed by the Company with the SEC at the SEC's public
reference room located at 450 Fifth St., N.W., Washington, D.C., 20549. The
12
company also provides copies of its Forms 8-K, 10-K, 10-Q, Proxy and Annual
Report at no charge available through its website at www.pharmoscorp.com as soon
as reasonably practicable after filing electronically such material with the
SEC. Copies are also available, without charge, from Pharmos Corporation, 99
Wood Avenue South, Suite 311, Iselin, NJ, 08830.
ITEM 2. PROPERTIES
Pharmos is headquartered in Iselin, New Jersey, where it leases its executive
offices and maintains clinical, regulatory and business development staff.
Pharmos also leases facilities used in the operation of its research,
development, pilot manufacturing and administrative activities in Rehovot,
Israel. These facilities have been improved to meet the special requirements
necessary for the operation of Pharmos' research and development activities. In
the opinion of the management, these facilities are sufficient to meet the
current and anticipated future requirements of Pharmos. In addition, management
believes that it has sufficient ability to renew its present leases related to
these facilities or obtain suitable replacement facilities. The monthly lease
obligations for our office space in 2004 are $17,433 for Iselin, New Jersey and
$23,735 for Rehovot, Israel. The approximate square footage for Iselin, New
Jersey and Rehovot, Israel are 10,403 and 21,600, respectively.
ITEM 3. LEGAL PROCEEDINGS
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq SmallCap Market under the
symbol "PARS." The following table sets forth the range of high and low bid
prices per share for the Common Stock as reported on the NASDAQ National Market
System and the Nasdaq SmallCap Market during the periods indicated.
YEAR ENDED DECEMBER 31, 2003 HIGH LOW
- ---------------------------- ------- -------
1st Quarter............................... $1.25 $0.76
2nd Quarter............................... 2.65 0.50
3rd Quarter............................... 2.95 1.46
4th Quarter............................... 5.02 2.35
YEAR ENDED DECEMBER 31, 2002 HIGH LOW
- ---------------------------- ------- -------
1st Quarter .............................. $2.55 $1.68
2nd Quarter .............................. 1.73 0.89
3rd Quarter .............................. 1.55 0.73
4th Quarter .............................. 1.38 1.01
The high and low bid prices for the Common Stock during the first quarter of
2004 (through March 12, 2004) were $4.98 and $3.50, respectively. The closing
price on March 12, 2004 was $4.21.
The foregoing represents inter-dealer prices, without retail mark-up, mark-down
or commission, and may not necessarily represent actual transactions.
On February 23, 2004, there were approximately 489 record holders of the Common
Stock of the Company and approximately 23,560 beneficial owners of the Common
Stock of the Company, based upon the number of shares of Common Stock held in
"street name".
The Company has paid no dividends on its Common Stock and does not expect to pay
cash dividends in the foreseeable future. The Company is not under any
contractual restriction as to its present or future ability to pay dividends.
The Company currently intends to retain any future earnings to finance the
growth and development of its business.
14
ITEM 6. SELECTED FINANCIAL DATA
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------
2003 2002 2001 2000 1999
------------ ------------ ------------ ------------ ------------
Revenues -- -- $ 4,298,441 $ 5,098,504 $ 3,279,397
Cost of Goods Sold
(exclusive of depreciation & amortization) -- -- 1,268,589 1,875,955 994,617
Operating expenses $(16,034,146) $(16,858,414) (13,789,291) (9,969,879) (6,999,136)
Other (expense), income, net $ ( 2,679,517) $ (426,409) 15,579,261 (1,236,872) 96,166
Income (Loss) Before Income
Taxes (18,713,663) (17,284,823) 4,819,822* (7,984,202)** (4,618190)
Net (Loss) Income (18,485,865) (17,069,600) 5,045,855 (7,984,202) (4,618,190)
Dividend embedded in
convertible preferred stock -- -- -- -- --
Preferred Stock dividends -- -- -- -- (22,253)
------------ ------------ ------------ ------------ ------------
Net income (loss) applicable to
common shareholders $(18,485,865) $(17,069,600) $ 5,045,855* $ (7,984,202)** $ (4,640,443)
============ ============ ============ ============ ============
Net income (loss) per share applicable
to common shareholders - basic $ (0.27) $ (0.30) $ 0.09 $ (0.15) $ (0.11)
============ ============ ============ ============ ============
Net income (loss) per share applicable
to common shareholders - diluted $ (0.27) $ (0.30) $ 0.09 $ (0.15) $ (0.11)
============ ============ ============ ============ ============
Total assets $ 69,008,071 $ 24,686,682 $ 44,262,991 $ 30,783,109 $ 7,791,294
============ ============ ============ ============ ============
Long term obligations $ 4,783,339 $ 10,000 $ 5,847,951 $ 7,680,872 $ 1,277,565
============ ============ ============ ============ ============
Cash dividends declared -- -- -- -- --
Average shares outstanding - basic 67,397,175 56,520,041 54,678,932 52,109,589 42,725,157
Average shares outstanding - diluted 67,397,175 56,520,041 55,298,063 52,109,589 42,725,157
- ----------
* includes a $16.3 million gain on sale of the ophthalmic product line in
October 2001
** includes a beneficial conversion charge of $1.8 million.
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion and analysis of our financial condition and results of
operations contains forward-looking statements that involve risks and
uncertainties. We have based these forward-looking statements on our current
expectations and projections of future events. Such statements reflect our
current views with respect to future events and are subject to unknown risks,
uncertainty and other factors that may cause results to differ materially from
those contemplated in such forward looking statements. In addition, the
following discussion should be read in conjunction with the audited consolidated
financial statements and the related notes thereto included elsewhere in this
report.
Through the end of the third quarter of 2001, the Company generated revenues
from product sales but continues to be dependent upon external financing,
interest income, and research and development contracts to pursue its intended
business activities. The Company had not been profitable from inception through
2000, was not profitable in 2003 and 2002, and has incurred a cumulative net
loss of $121.0 million through December 31, 2003. In 2001, the Company recorded
a profit due the sale of its ophthalmic product line to Bausch & Lomb. Losses
have resulted principally from costs incurred in research activities aimed at
identifying and developing the Company's product candidates, clinical research
studies, the write-off of purchased research and development, and general and
administrative expenses. The Company expects to incur additional losses over the
next several years as the Company's research and development and clinical trial
programs continue. The Company's ability to achieve profitability, if ever, is
dependent on its ability to develop and obtain regulatory approvals for its
product candidates, to enter into agreements for product development and
commercialization with strategic corporate partners and contract to develop or
acquire the capacity to manufacture and sell its products. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources."
CRITICAL ACCOUNTING POLICIES
The Company considers certain accounting policies related to the tax valuation
allowance and asset impairments to be critical policies due to the estimation
process involved in each.
IMPAIRMENT OF LONG-LIVED ASSETS
We review long-lived assets for impairment whenever events or changes in
business circumstances indicate that the carrying amount of the assets may not
be fully recoverable or that the useful lives of these assets are no longer
appropriate. Each impairment test is based on a comparison of the undiscounted
cash flow to the recorded value of the asset. Subsequent impairment assessments
could result in future impairment charges. Any impairment charge would result in
the reduction in the carrying value of long-lived assets and would reduce our
operating results in the period in which the charge arose.
TAX VALUATION ALLOWANCE
The Company has assessed the future taxable income and has determined that a
100% deferred tax valuation allowance is deemed necessary. In the event the
Company were to determine that it would be able to realize its deferred tax
asset, an adjustment to the deferred tax asset would increase income in the
period such determination is made.
RESULTS OF OPERATIONS
Years Ended December 31, 2003 and 2002
Due to the sale of the Company's ophthalmic product line to Bausch & Lomb in
October 2001, the Company recorded no product sales revenue and cost of sales
during 2003 and 2002. Bausch & Lomb was the Company's marketing partner for its
ophthalmic product line.
16
Total operating expenses decreased by $824,268 or 5%, from $16,858,414 in 2002
to $16,034,146 in 2003. The decrease in operating expense is primarily due to a
reduction in consulting and professional fees. During 2002, the Company was
preparing for the IND application with the FDA, which was ultimately allowed in
February 2003. During 2003, the Company increased expenditures related to the
development of dexanabinol for the treatment of traumatic brain injury and to
increased activity in the Company's cannabinoid program to treat various central
nervous system and inflammation-based conditions.
The Company considers major research & development projects to be those projects
that have reached at least Phase II level of clinical development. The Company's
major product is the development of dexanabinol for the treatment of traumatic
brain injury, which is currently involved in Phase III testing in the U.S.,
Europe, Australia and Israel, and the cognitive impairment that can result from
coronary surgery involving cardiopulmonary bypass operations. During 2003, the
gross cost of the traumatic brain injury project was $10.6 million. Total costs
since the traumatic brain injury project entered Phase II development in 1996
through December 31, 2003 were $35.4 million. In mid-March 2004, the Company
completed enrollment of U.S. and international TBI patients. The principal costs
of completing the project include collection and evaluation of the data,
production of the drug substance and drug product, commercial scale-up, and
management of the project. The primary uncertainties in the completion of the
project are the results of the study upon its conclusion, and the Company's
ability to produce or secure production of finished drug product under current
Good Manufacturing Practice conditions for sale in countries in which marketing
approval has been obtained, as well as the resources required to generate sales
in such countries. Should the uncertainties delay completion of the project on
the current timetable, the Company may experience additional costs that cannot
be accurately estimated. If the Phase III trial of dexanabinol for the treatment
of traumatic brain injury is successfully completed, the Company may begin to
earn revenues upon marketing approval as early as 2006; however, should our
product candidate experience setbacks or should a product fail to achieve FDA or
other regulatory approvals or fail to generate commercial sales, it would have a
material adverse affect on our business.
In addition, during 2003, the Company initiated a Phase II trial of dexanabinol
as a preventive agent against the cognitive impairment (CI) that can follow
coronary surgery involving cardiopulmonary bypass (CS-CPB) that was approved by
Israel's Ministry of Health. Enrollment of patients undergoing CS-CPB in the
trial are expected to be completed by Q2 2004. Gross expenses directly related
to this project were $866,000 for the twelve months ended December 31, 2003.
Gross expenses for other research & development projects in earlier stages of
development for the twelve months of 2003 and 2002 were $3,433,498 and
$3,324,882, respectively. Research and development expenses, net of grants, for
2003 and 2002 were $11,632,959 and $12,337,840, respectively. The company
received from the Office of the Chief Scientist of Israel's Ministry of Industry
and Trade grant money of $3,295,819 and $2,755,882 during 2003 and 2002,
respectively, which reduced the research and development expenses.
Selling, general and administrative expenses decreased by $82,180 or 2%, from
$3,828,750 in 2002 to $3,746,570 in 2003. The decrease is due to a reduction in
consultant fees, investor relations and professional fees, which offset higher
salaries and benefits, travel and board of director costs.
Depreciation and amortization expenses decreased by $37,207, or 5%, from
$691,824 in 2002 to $654,617 in 2003. The decrease is due to some fixed assets
becoming fully depreciated.
Other expense, net of interest and other expenses, increased by $2,253,108 from
$426,409 in 2002 to $2,679,517 in 2003. The warrants issued in the March 2003
private placement offering are subject to the requirements under EITF 00-19 and
thus are currently being accounted for as a liability. The value of the warrants
are being marked to market each reporting period until exercised or expiration.
The charge associated with these warrants amounted to approximately $1.8
million. Additionally, in accordance with Emerging Issues Task Force Issue No.
98-5, Accounting for Convertible Securities with Beneficial
17
Conversion Features or Contingently Adjustable Conversion Ratios ("BCF"), the
Company recorded a charge of $1.8 million which was fully amortized at December
31, 2000 in connection with the issuance of convertible debt with a favorable
conversion feature. In accordance with EITF 00-27, a net credit of $786,000 was
recorded as interest income during the first quarter of 2003 to reverse the BCF
previously recorded which was associated with the remaining balance of the
September 2000 Convertible Debenture offering with a face amount of $3.5 million
which was not converted. The lower average cash balance during 2003 resulted in
a decrease in interest income of $268,987. Interest expense increased by
$942,358 due to the $21 million financing of Convertible Debentures completed in
September 2003.
During 2003, the Company recognized royalties of a non-material amount per the
licensing agreement with Herbamed, Ltd, a company controlled by Dr. Haim Aviv,
the Company's CEO.
Years Ended December 31, 2002 and 2001
There were no product sales or cost of goods sold for the twelve months ended
December 31, 2002. Revenue totaled $4,298,441 and cost of goods sold totaled
$1,268,589 for the twelve months ended December 31, 2001. The decrease in both
product sales, license fee income, and cost of goods sold is due to the sale of
the Company's ophthalmic product line to Bausch & Lomb in October 2001. Bausch &
Lomb was the Company's marketing partner for its ophthalmic product line.
Total operating expenses increased by $3,069,123 or 22%, from $13,789,291 in
2001 to $16,858,414 in 2002. The increase in operating expenses is primarily due
to increased research and development expenses as the Company increased
expenditures related to the development of dexanabinol for the treatment of
traumatic brain injury and to increased activity in the Company's cannabinoid
program to treat various central nervous system and inflammation-based
conditions.
The Company considers major research & development projects to be those projects
that have reached at least Phase II level of clinical development. The Company's
major product is the development of dexanabinol for the treatment of traumatic
brain injury, which is currently involved in Phase III testing in the U.S.,
Europe, Australia and Israel, and the cognitive impairment that can follow
coronary surgery under cardiopulmonary bypass operations. During 2002, the gross
cost of the traumatic brain injury project was $10.0 million. Total costs since
the traumatic brain injury project entered Phase II development in 1996 through
December 31, 2002 were $24.8 million.
In addition, during 2002, the Company received approval from Israel's Ministry
of Health to commence a Phase IIa trial of dexanabinol as a preventive agent
against the cognitive impairment (CI) that can follow coronary surgery involving
cardiopulmonary bypass (CS-CPB). Expenses directly related to this project were
not material for the twelve months ended December 31, 2002.
Expenses for other research & development projects in earlier stages of
development for the twelve months of 2002 and 2001 were $3,324,882 and
$3,464,781, respectively. Research and development expenses, net of grants, for
2002 and 2001 were $12,337,840 and $9,349,025, respectively. The company
received from the Office of the Chief Scientist of Israel's Ministry of Industry
and Trade grant money of $2,755,882 and $1,336,566 during 2002 and 2001,
respectively, which reduced the research and development expenses.
Selling, general and administrative expenses increased by $162,457 or 4%, from
$3,666,293 in 2001 to $3,828,750 in 2002. The increase is due to higher
professional fees, consultants, and investor relations while offset by a
reduction in the overhead allocation.
Depreciation and amortization expenses decreased by $82,149, or 11%, from
$773,973 in 2001 to $691,824 in 2002. The decrease is primarily due to
amortization of the remaining balance of intangible assets in 2001. This
increase was netted against an increase in depreciation expense related to
laboratory equipment purchases.
Other income (expense), net of interest and other expenses, decreased by
$16,005,670 from income of
18
$15,579,261 in 2001 to expense of $426,409 in 2002. The change is primarily due
to a one-time gain of $16.3 million from the sale of the Company's ophthalmic
product line to Bausch & Lomb that occurred in October 2001. The reported gain
includes charges of $3.75 million representing the Company's maximum liability
for the completion of the clinical development of LE-T, the final product
resulting from the ophthalmic marketing relationship with Bausch & Lomb. Should
LE-T gain FDA approval, the Company will receive additional gross proceeds up to
a maximum of $12 million depending on the date of FDA approval and up to an
additional $10 million based upon the achievement of certain sales goals. Also,
the decrease was attributable to the lower debt payable at December 31, 2002
resulting from (i) the conversion from debt to equity in the first quarter of
2002 of $2.6 million of our Convertible Debentures issued in 2000, and (ii) the
repayment of $2 million of the Convertible Debentures in the first quarter of
2002. This conversion and repayment resulted in lower interest expense. Interest
income decreased by $445,005, which was primarily due to a lower average cash
balance in 2002 than in 2001 combined with the decrease in interest rates.
LIQUIDITY AND CAPITAL RESOURCES
While the Company recorded revenues since 1998 until the third quarter of 2001
from the sale of its approved products, it has incurred cumulative operating
losses since its inception and had an accumulated deficit of $121.0 million at
December 31, 2003. The Company has financed its operations with public and
private offerings of securities, advances and other funding pursuant to a
marketing agreement with Bausch & Lomb, research contracts, license fees,
royalties and sales, the sale of a portion of our New Jersey State Net Operating
Losses carryforwards, and interest income. Should the Company be unable to raise
adequate financing in the future, long-term projects will need to be scaled back
or discontinued.
The Company had working capital of $42.0 million as of December 31, 2003.
Included in the current assets of $62.8 million is $49.4 million of cash and
cash equivalents, and $11.2 million in restricted cash. As part of the September
2003 financing, the Company received a total of $16.0 million of restricted cash
held in escrow, which will remain in escrow until either the Company's
convertible debentures are converted into common shares of the Company by the
investor or by the Company, or such funds are repaid by the Company or are used
to fund acquisition(s) approved by the investors.
In October 2001, Bausch & Lomb purchased all rights to the Company's loteprednol
etabonate (LE) ophthalmic product line for cash and assumption of certain
ongoing obligations. The Company received gross proceeds of approximately $25
million in cash for its rights to Lotemax(R) and Alrex(R), prescription products
that are made and marketed by Bausch & Lomb under a 1995 Marketing Agreement
with the Company; in addition, Bausch & Lomb also acquired future extensions of
LE formulations including LE-T, a product that was submitted to the FDA for
marketing approval in September 2003. The Company had no product sales beginning
in the fourth quarter of 2001. Upon FDA approval, Bausch & Lomb will pay the
Company up to an additional maximum gross proceeds of $12 million, with the
actual payment price based on the date of FDA approval of this new combination
therapy. An additional milestone payment of up to $10 million could be paid to
the Company to the extent sales of the new product exceed an agreed-upon
forecast in the first two years. The Company has a passive role as a member of a
joint committee overseeing the development of LE-T and has an obligation to
Bausch & Lomb to fund up to a maximum of $3.75 million of the LE-T development
cost, of which $600,000 was deducted from the purchase price paid by Bausch &
Lomb to Pharmos in October 2001. As a result of this transaction, the Company
recorded a net gain of $16.3 million during the fourth quarter of 2001. In July
2003, the Company paid Bausch & Lomb $1.57 million of its liability for the LE-T
development. As of December 31, 2003, Pharmos owes an additional $1.56 million
as its share of these research and development related LE-T expenses. This
amount is included as part of accounts payable at December 31, 2003, and
represents the maximum amount Pharmos owes Bausch & Lomb. The Company incurred
transaction and royalty costs of approximately $2 million. The Company also
compensated the LE patent owner approximately $2.7 million ($1.5 million paid
upon closing and $1.2 million paid in October 2002) from the proceeds of the
sale of Lotemax and Alrex in return for his consent to the Company's assignment
of its rights under the license agreement to
19
Bausch & Lomb. Additionally, the patent owner will receive 11% of the proceeds
payable to the Company following FDA approval of LE-T, as well as 14.3% of its
milestone payment, if any.
In September 2000, the Company completed a private placement of Convertible
Debentures, common stock and warrants to purchase shares of common stock with
institutional investors, generating gross proceeds of $11 million. The
Convertible Debentures, which generated gross proceeds of $8 million, were due
in February 2002 and carried a 6% interest payable semiannually in cash or
common stock. In connection with the Convertible Debenture, the institutional
investors also received warrants for the purchase of 276,259 common shares with
a relative fair value of $725,000. The Convertible Debentures were convertible
into common shares of the Company at the conversion price of $3.83 per share (or
2,088,775 common shares) and were convertible beginning October 31, 2000. Under
certain limited anti-dilutive conditions, the conversion price may change. Until
converted into common stock or the outstanding principal is repaid, the terms of
the Convertible Debentures required the Company to deposit $4 million in an
escrow account. The escrowed capital is shown as Restricted Cash on the
Company's balance sheet at December 31, 2002 and was released to the Company in
proportion to the amount of Convertible Debentures converted into common shares
or upon the repayment of the debt. The issuance costs related to the Private
Placement of approximately $1.4 million were capitalized and amortized over the
life of the debt.
In December 2001, the holders of the Convertible Debentures and the Company
agreed to modify the repayment and conversion terms. The holders of $5.8 million
convertible debt (book value on December 31, 2001, including accrued interest)
extended the maturity date to June 2003 in exchange for a reduction in the
conversion price from $3.83 to $2.63 for half of the outstanding balance and $
2.15 for the other half of the outstanding balance. The convertible debt with a
maturity date of June 2003 was convertible beginning December 31, 2001. The
holder of the remaining outstanding debt of $1.9 million (including accrued
interest) changed the maturity date from February 28, 2002 to January 31, 2002
in exchange for lowering the conversion price for the other holders. As the
modification was not significant in accordance with EITF 96-19 the change in the
fair value between the original convertible debt and the modified convertible
debt was accreted over the remaining term of the convertible debt with a
corresponding charge into interest expense.
Emerging Issues Task Force Issue No. 98-5, Accounting for Convertible Securities
with Beneficial Conversion Features or Contingently Adjustable Conversion
Ratios, require the Company to compute the Beneficial Conversion Feature ("BCF")
of the convertible debt from the private placement of September 2000. The BCF
must be capitalized and amortized from the closing date until the earliest date
that the investors have the right to convert the debt into common shares. The
BCF was computed at approximately $1.8 million, all of which was amortized and
included as interest expense in the year ending December 31, 2000. Additionally,
the discount on the Convertible Debenture of approximately $800,000 was fully
amortized by December 31, 2001.
During 2001, the Company paid $589,819 and issued 182,964 shares of the common
stock of the Company to the investors in the convertible debenture. The payment
of cash and stock was the option chosen by the Company and represents
adjustments to the pricing based upon the Company's stock price during the
adjustment period. Under the terms of the agreements, no further adjustments are
due.
One investor in the September 2000 private placement had an option, in the form
of a warrant, to purchase an additional $2 million of common shares for a period
of one year provided that the future purchase price is greater than the initial
closing price of $3.65 per share. During the third quarter of 2001, the investor
exercised this option and, accordingly, the Company issued 542,299 shares to the
investor. The Private Placement provided certain conditions under which the
number of shares issued for this option could be adjusted and, accordingly, the
Company issued 281,659 shares to the investor in the fourth quarter of 2001 as
an adjustment to the warrant.
On March 4, 2003, the Company raised $4.3 million from the placement of common
stock and warrants. The private placement offering was completed by issuing
5,058,827 shares of common stock at a price of
20
$0.85 per share and approximately 1.1 million warrants at an exercise price of
$1.25 per share. Additionally, the remaining balance of the September 2000
Convertible Debenture offering was redeemed for cash. The original face amount
of $3.5 million was redeemed for approximately $4.0 million, which included
accrued and unpaid interest. According to EITF 00-19, the issued warrants meet
the requirements of and are being accounted for as a liability since registered
shares must be delivered upon settlement. The Company calculated the initial
value of the warrants, including the placement agent warrants, being
approximately $394,000 under the Black-Scholes option-pricing method
(assumption: volatility 75%, risk free rate 2.88% and zero dividend yield). The
value of the warrants is being marked to market each reporting period as a
derivative loss until exercised or expiration and amounted to $823,029 at
December 31, 2003. Upon exercise of each of the warrants, the related liability
is removed by recording an adjustment to additional paid-in-capital. A total of
$936,156 was recorded as a credit to additional paid-in-capital in 2003 as a
result of exercises and the recording of the initial value of the warrants.
On May 30, 2003, the Company completed a private placement to sell common shares
and warrants to ten investors, generating total gross proceeds of $8.0 million.
The Company filed a registration statement with the Securities and Exchange
Commission to permit resales of the common stock issued. The private placement
offering was completed by issuing 9,411,765 shares of common stock at a price of
$0.85 per share (representing an approximate 20% discount to a ten-day trailing
average of the closing price of the stock ending May 28, 2003) and 3,573,529
warrants at an exercise price of $1.40 per share, which includes 441,177
placement agent warrants. Issuance costs of approximately $525,000 in cash and
$240,000 for the value of the placement agent warrants were recorded as a debit
to additional paid in capital.
On September 26, 2003, the Company completed a private placement of convertible
debentures and warrants to six institutional investors, generating total gross
proceeds of $21.0 million. Five million dollars of the proceeds will be used for
working capital purposes, and $16.0 million will be available to fund
acquisitions upon the approval of the investors. The convertible debentures are
convertible into common stock of the Company at a fixed price of $4.04, 205%
above the closing bid price of the stock for the five days preceding the closing
date. The debentures, which bear an interest rate of 4%, will be redeemed in 13
substantially equal monthly increments beginning March 31, 2004. Amounts
converted into shares of Pharmos common stock will reduce the monthly redemption
amount in inverse order of maturity. The $16.0 million earmarked for acquisition
activity will be held in escrow until used or repaid. In connection with the
financing, the Company also issued 5,514,705 three-year warrants (including
514,705 placement agent warrants) to purchase 5,514,705 shares of common stock
at an exercise price of $2.04 per share. The issuance costs related to the
convertible debentures of approximately $1,229,000 in cash and $434,000 for the
value of the placement agent warrants were capitalized and are being amortized
over the life of the debt. The Company calculated the value of the warrants at
the date of the transaction, including the placement agent warrants, being
approximately $4,652,877 under the Black-Scholes option-pricing method
(assumption: volatility 75%, risk free rate 1.59% and zero dividend yield). The
Company allocated the $21.0 million in gross proceeds between the convertible
debentures and the warrants based on their fair values. The Company is reporting
the debt discount as a direct reduction to the face amount of the debt in
accordance with APB 21. The discount will accrete over the life of the
outstanding debentures. The issuance costs allocated to the convertible
debentures are being deferred and amortized to interest expense over the life of
the debt. APB 21 also requires the Company to allocate the warrant costs between
the convertible debentures and the transaction warrants. The issuance costs
allocated to the warrants were recorded as a debit to additional paid in
capital. During the first quarter of 2004, one of the investors from the
September 2003 Convertible Debentures private placement converted a total of $2
million plus interest. The Company issued 497,662 shares of common stock. As
part of the escrow agreement, approximately $1,524,000 of restricted cash is
available to be released to the Company.
The financing also addressed a possible concern Nasdaq raised informally
relating to a possible violation of one of Nasdaq's corporate governance rules.
Specifically, Nasdaq expressed a concern that the May 2003 private placement,
when aggregated with Pharmos' March 2003 registered private placement, would
have resulted in the possible issuance of more than 20% of Pharmos' outstanding
securities at a price less than the applicable fair market value for such
shares. Completion of the $21.0 million convertible debt financing
21
had the effect of resolving any such Nasdaq concerns.
In December 2003, the Company completed a public offering. Pharmos sold
10,500,000 common shares at a purchase price of $2.75 per share for gross
proceeds of $28,875,000. The stock was offered in a firm commitment underwriting
pursuant to an existing shelf registration statement. The net proceeds of this
offering to Pharmos were approximately $26.9 million. During January 2004, the
underwriters exercised their over-allotment option in full to purchase an
aggregate of 1,575,000 shares of Pharmos' common stock at a purchase price of
$2.75 per share, less the underwriting discount. Total net proceeds from the
offering, including $4.07 million from the exercise of the over-allotment
option, were approximately $31.0 million.
In 2003, and 2002, the Company sold $2,096,487, and $5,561,838, respectively, of
our State Net Operating Loss carryforwards under the State of New Jersey's
Technology Business Tax Certificate Transfer Program (the "Program"). The
Program allows qualified technology and biotechnology businesses in New Jersey
to sell unused amounts of net operating loss carryforwards and defined research
and development tax credits for cash. The proceeds from the sale in 2003 and
2002 were $227,798 and $215,223, respectively and such amounts were recorded as
a tax benefit in the statements of operations. The State renews the Program
annually and limits the aggregate proceeds to $10,000,000. We cannot be certain
if we will be able to sell any of our remaining or future carryforwards under
the Program.
COMMITMENTS AND LONG TERM OBLIGATIONS
As of December 31, 2003, we had the following contractual commitments and long
term obligations:
2004 2005 2006 2007 THEREAFTER TOTAL
----------- ----------- --------- --------- --------- -----------
Operating Lease
Obligations $ 377,736 $ 81,375 $ 57,978 $ 12,212 $ -- $ 529,301
Other Long-Term
Obligations 16,153,846 4,846,154 -- -- -- 21,000,000
R&D commitments 928,130 -- -- -- -- 928,130
----------- ----------- --------- --------- --------- -----------
Grand total $17,459,712 $ 4,927,529 $ 57,978 $ 12,212 $ -- $22,457,431
On September 26, 2003, the Company completed a private placement of convertible
debentures and warrants with six institutional investors, generating total gross
proceeds of $21.0 million. The convertible debentures are convertible into
common stock of the Company at a fixed price of $4.04, 205% above the closing
bid price of the stock for the five days preceding the closing date. The
debentures, which bear an interest rate of 4%, will be redeemed in 13 equal
monthly increments beginning March 31, 2004.
The R&D commitments represent scheduled professional fee payments for clinical
services relating to the Phase III clinical study of dexanabinol for severe
traumatic brain injury. One of the clinical service based agreements, if fully
executed, currently totals $10.9 million and is not committed beyond 2004.
Through December 31, 2003, the Company has recorded $9.0 million as an expense.
The Company has entered into various employment agreements. The terms of these
employment agreements include one-year renewable terms and do not represent long
term commitments of the Company.
Management believes that cash and cash equivalents of $49.4 million as of
December 31, 2003, will be sufficient to support the Company's continuing
operations beyond December 2004. The Company is continuing to actively pursue
various funding options, including additional equity offerings, strategic
corporate alliances, business combinations and the establishment of product
related research and development limited partnerships, to obtain additional
financing to continue the development of its products and bring them to
commercial markets.
22
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We assessed our vulnerability to certain market risks, including interest rate
risk associated with financial instruments included in cash and cash
equivalents, restricted cash, and convertible debentures. Due to the short-term
nature of the cash and cash equivalent investments, restricted cash, and the
fixed interest rate on the convertible debt, we have determined that the risks
associated with interest rate fluctuations related to these financial
instruments do not pose a material risk to us.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information called for by this Item 8 is included following the "Index to
Financial Statements" contained in this Annual Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our principal executive officer and
principal financial officer, has evaluated the effectiveness of the design and
operation of our disclosure controls and procedures (as defined in Rules
13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended)
as of the end of the period covered by this annual Report on Form 10-K. Based on
this evaluation, our principal executive officer and principal financial officer
concluded that these disclosure controls and procedures are effective and
designed to ensure that the information required to be disclosed in our reports
filed or submitted under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the requisite time periods.
Our management, including our Chief Executive Officer and Chief Financial
Officer, does not expect that our disclosure controls and procedures or internal
control over financial reporting will prevent all errors and all fraud. A
control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the system are met
and cannot detect all deviations. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud or deviations, if any within the
company have been detected. While we believe that our disclosure controls and
procedures have been effective, in light of the foregoing, we intend to continue
to examine and refine our disclosure control and procedures to monitor ongoing
developments in this area.
CHANGES IN INTERNAL CONTROLS
There was no change in our internal control over financial reporting (as defined
in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as
amended) identified in connection with the evaluation of our internal control
performed during our last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
23
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The directors, officers and key employees of the Company are as follows:
NAME AGE POSITION
- ---- --- --------
Haim Aviv, Ph.D 64 Chairman, Chief Executive Officer,
Chief Scientist and Director
Gad Riesenfeld, Ph.D 60 President, Chief Operating Officer
Robert W. Cook 48 Executive Vice President and
Chief Financial Officer
David Schlachet ** 58 Director
Mony Ben Dor 58 Director
Georges Anthony Marcel, M.D., Ph.D ** 63 Director
Elkan R. Gamzu, Ph.D ** 61 Director
Lawrence F. Marshall, M.D. 60 Director
** Members of the Audit Committee
Haim Aviv, Ph.D., is Chairman, Chief Executive Officer, Chief Scientist and a
Director of the Company. In 1990, he co-founded Pharmos Corporation, a New York
corporation ("Old Pharmos"), which merged into the Company in October 1992 (the
"Merger"). Dr. Aviv also served as Chairman, Chief Executive Officer, Chief
Scientist and a Director of Old Pharmos prior to the Merger. Dr. Aviv was the
co-founder in 1980 of Bio-Technology General Corp. ("BTG"), a publicly-traded
company engaged in the development of products using recombinant DNA, its
General Manager and Chief Scientist from 1980 to 1985, and a Director and Senior
Scientific Consultant until August 1993. Prior to that time, Dr. Aviv was a
professor of molecular biology at the Weizmann Institute of Science. Dr. Aviv is
the principal stockholder of Avitek Ltd. Dr. Aviv is also an officer and/or
significant stockholder of several privately held Israeli biopharmaceutical and
venture capital companies. Dr. Aviv is a member of the Board of Directors of Ben
Gurion University at Beer-Sheva, Israel and Yeda Ltd. the commercial arm of the
Weizmann Institute, Rehovot, Israel. Dr. Aviv holds a Ph.D. degree from the
Weizmann Institute of Science.
Gad Riesenfeld, Ph.D., was named President and Secretary in February 1997, and
has served as Chief Operating Officer since March 1995. He served as Executive
Vice President from December 1994 to February 1997, Vice President of Corporate
Development and General Manager of Florida Operations from October 1992 to
December 1994, and was employed by Pharmos from March 1992 until the Merger.
Prior thereto, he was engaged in a variety of Pharmaceutical and Biotechnology
business activities relating to the development and commercialization of
intellectual property, primarily in the pharmaceutical and medical fields. From
March 1990 through May 1991 Dr. Riesenfeld was a Managing Director of Kamapharm
Ltd., a private company specializing in human blood products. Prior thereto,
from May 1986, he was Managing Director of Galisar Ltd., a pharmaceutical
company involved in extracorporeal blood therapy. Dr. Riesenfeld holds a Ph.D.
degree from the Hebrew University of Jerusalem and held a scientist position, as
a post doctorate, at the Cedars Sinai Medical Center in Los Angeles, California.
Robert W. Cook was elected Vice President Finance and Chief Financial Officer of
Pharmos in January 1998 and became Executive Vice President in February 2001.
From May 1995 until his appointment as the Company's Chief Financial Officer, he
was a vice president in GE Capital's commercial finance subsidiary, based in New
York. From 1977 until 1995, Mr. Cook held a variety of corporate finance and
capital markets positions at The Chase Manhattan Bank, both in the U.S. and in
several overseas locations. He was named a managing director of Chase in January
1986. Mr. Cook holds a degree in international finance from The American
University, Washington, D.C.
24
David Schlachet, a Director of the Company from December 1994, served as the
Chairman of Elite Industries Ltd. from July 1997 until June 2000. From January
1996 to June 1997, Mr. Schlachet served as the Vice President of the Strauss
Group and Chief Executive Officer of Strauss Holdings Ltd, one of Israel's
largest privately owned food manufacturers. He was Vice President of Finance and
Administration at the Weizmann Institute of Science in Rehovot, Israel from 1990
to December 1995, and was responsible for the Institute's administration and
financial activities, including personnel, budget and finance, funding,
investments, acquisitions and collaboration with the industrial and business
communities. From 1989 to 1990, Mr. Schlachet was President and Chief Executive
Officer of YEDA Research and Development Co. Ltd., a marketing and licensing
company at the Weizmann Institute of Science. Mr. Schlachet is a member of the
Board of Directors of Harel Capital Markets (Israeli broker, underwriter and
asset management firm), Israel Discount Bank Ltd., Hapoalim Capital Markets Ltd,
Teldor Ltd. (software and computer company), Proseed Ltd., a Venture Capital
investment company, Compugen Ltd. and Taya Investment Company Ltd. Mr. Schlachet
also serves as the Managing Partner in Biocom, a V.C. Fund in the field of Life
Science.
Mony Ben Dor, a director of the Company since September 1997, has been managing
partner of Biocom, a V.C Fund in the field of Life Science since April 2000.
Prior to that he was Vice President of the Israel Corporation Ltd. from May
1997, and Chairman of two publicly traded subsidiaries: H.L. Finance and Leasing
and Albany Bonded International Trade. He was also a Director of a number of
subsidiary companies such as Israel Chemicals Ltd., Zim Shipping Lines, and
Tower Semi Conductors. From 1992-1997 Mr. Ben Dor was Vice President of Business
Development for Clal Industries Limited, which is one of the leading investment
groups in Israel. He was actively involved in the acquisition of companies
including a portfolio of pharmaceutical companies, Pharmaceutical Resources
Inc., Finetech Ltd., BioDar Ltd., to name a few. He served as a director
representing Clal Industries in all of the acquired companies as well as other
companies of Clal Industries. Prior to his position at Clal Industries, Mr. Ben
Dor served as Business Executive at the Eisenberg Group of companies.
Georges Anthony Marcel, M.D., Ph.D., a Director of the Company since September
1998, is President and Chairman of TMC Development S.A., a biopharmaceutical
consulting firm based in Paris, France. Prior to founding TMC Development in
1992, Dr. Marcel held a number of senior executive positions in the
pharmaceutical industry, including Chief Executive Officer of Amgen's French
subsidiary, Vice President of Marketing for Rhone-Poulenc Sante and Director of
Development for Roussel-Uclaf. Dr. Marcel is a member of the Board of Directors
of Hybridon, Inc., and of the Scientific Advisory Board of the Swiss Corporation
TECAN Ltd. Dr. Marcel teaches biotechnology industrial issues and European
regulatory affairs at the Faculties of Pharmacy of Paris and Lille as well as at
Versailles Law School. Dr. Marcel is also a member of the Gene Therapy Advisory
Committee at the French Medicines Agency.
Elkan R. Gamzu, Ph.D., a Director of the Company since February 2000, is a
consultant to the biotechnology and pharmaceutical industries and a Principal of
the due diligence company BioPharmAnanlysis, LLC. Prior to becoming a
consultant, Dr. Gamzu held a number of senior executive positions in the
biotechnology and pharmaceutical industries, including President and Chief
Executive Officer of Cambridge Neuroscience, Inc. from 1994 until 1998. Dr.
Gamzu also served as President and Chief Operating Officer and Vice President of
Development for Cambridge Neuroscience, Inc. from 1989 to 1994. Previously, Dr.
Gamzu held a variety of senior positions with Warner-Lambert and Hoffmann-La
Roche, Inc. In 2001 and 2002, Dr. Gamzu was part-time Interim VP, Development
Product Leadership for Millennium Pharmaceuticals, Inc. Dr. Gamzu is a member of
the Board of Directors of three other biotechnology companies: the publicly
traded XTL Biopharmaceuticals Ltd. and the privately held biotechnology
companies Neurotech S.A. of Paris, France and Hypnion, Inc. of Worcester, MA.
Dr. Gamzu recently was appointed the Chairman of the Board of Directors of
NeuroHealing Pharmaceuticals Incorporated.
Lawrence F. Marshall, M.D., a Director of the Company since June 2002, an
internationally recognized neurosurgeon and opinion leader in the field, is
currently Professor and Chair of the Division of Neurological Surgery at the
University of California, San Diego Medical Center. Dr. Marshall's 30-year
career as a scientist and neurosurgeon has been at the forefront in the search
for new and better treatment
25
measures to improve patient outcome. He has been principal investigator or
co-investigator in over two dozen preclinical and clinical trials primarily
relating to head and spinal cord injury, including projects funded by the
National Institutes of Health, the Insurance Institute for Highway Safety, and
several large pharmaceutical companies. Results of research undertaken by Dr.
Marshall, which cover a wide range of issues related to TBI and other conditions
of the brain, have been published in dozens of scientific journals. Among the
numerous board, committee, editorial and other positions Dr. Marshall has held
or holds are board and committee memberships with the American Brain Injury
Consortium, the National Head Injury Foundation, the American Association of
Neurological Surgeons and the Congress of Neurological Surgeons. Dr. Marshall is
the recipient of many distinguished medical prizes and awards.
ROLE OF THE BOARD; CORPORATE GOVERNANCE MATTERS
It is the paramount duty of the Board of Directors to oversee the Chief
Executive Officer and other senior management in the competent and ethical
operation of the Company on a day-to-day basis and to assure that the long-term
interests of the shareholders are being served. To satisfy this duty, the
directors set standards to ensure that the Company is committed to business
success through maintenance of the highest standards of responsibility and
ethics.
Members of the Board bring to the Company a wide range of experience, knowledge
and judgment. The governance structure in the Company is designed to be a
working structure for principled actions, effective decision-making and
appropriate monitoring of both compliance and performance. The key practices and
procedures of the Board are outlined in the Corporate Governance Code of Conduct
filed as an exhibit to this annual report on Form 10-K and are also available on
the Company's website at www.pharmoscorp.com/investors.
BOARD COMMITTEES
The Board has a standing Compensation Committee, Governance and Nominating
Committee and Audit Committee.
The Compensation Committee is primarily responsible for reviewing the
compensation arrangements for the Company's executive officers, including the
Chief Executive Officer, and for administering the Company's stock option plans.
Members of the Compensation Committee are Messrs. Ben Dor, Gamzu and Marshall.
The Governance and Nominating Committee, created by the Board in February 2004,
assists the Board in identifying qualified individuals to become directors,
determines the composition of the Board and its committees, monitors the process
to assess Board effectiveness and helps develop and implement the Company's
corporate governance guidelines. Members of the Governance and Nominating
Committee are Messrs. Ben Dor, Marcel and Schlachet.
The Audit Committee is primarily responsible for overseeing the services
performed by the Company's independent auditors and evaluating the Company's
accounting policies and its system of internal controls. Consistent with the
Nasdaq audit committee structure and membership requirements, the Audit
Committee is comprised of three members: Messrs. Gamzu, Marcel and Schlachet,
all of whom are independent directors. While more than one member of the
Company's Audit Committee qualifies as an "audit committee financial expert"
under Item 401(h) of Regulation S-K, Mr. David Schlachet, the Committee
chairperson, is the designated audit committee financial expert. Mr. Schlachet
is considered "independent" as the term is used in Item 7(d)(3)(iv) of Schedule
14A under the Exchange Act.
The Audit Committee, Compensation Committee and Governance and Nominating
Committee each operate under written charters adopted by the Board. These
charters are filed as exhibits to this annual report on Form 10-K and are also
available on the Company's website at www.pharmoscorp.com/investors.
26
CODE OF ETHICS
As part of our system of corporate governance, our Board of Directors has
adopted a Code of Ethics and Business Conduct that is applicable to all
employees and specifically applicable to our chief executive officer, president,
chief financial officer and controllers. The Code of Ethics and Business
Guidelines are filed as exhibits to this Annual Report on Form 10-K and is also
available on our website at www.pharmoscorp.com/investors. We intend to disclose
any changes in or waivers from our Code of Ethics and Business Conduct by filing
a Form 8-K or by posting such information on our website.
SECTION 16 FILINGS
No person who, during the fiscal year ended December 31, 2003, was a director,
officer or beneficial owner of more than ten percent of the Company's Common
Stock which is the only class of securities of the Company registered under
Section 12 of the Securities Exchange Act of 1934 (the "Act"), a "Reporting
Person" failed to file on a timely basis, reports required by Section 16 of the
Act during the most recent fiscal year. The foregoing is based solely upon a
review by the Company of Forms 3 and 4 during the most recent fiscal year as
furnished to the Company under Rule 16a-3(d) under the Act, and Forms 5 and
amendments thereto furnished to the Company with respect to its most recent
fiscal year, and any representation received by the Company from any reporting
person that no Form 5 is required.
ITEM 11. EXECUTIVE COMPENSATION
The following table summarizes the total compensation of the Chief Executive
Officer of the Company in 2003 and the two previous years, as well as all other
executive officers of the Company who received compensation in excess of
$100,000 for 2003.
ANNUAL COMPENSATION LONG TERM COMPENSATION
-------------------------- ----------------------
STOCK
NAME/ RESTRICTED UNDERLYING
PRINCIPAL POSITION YEAR SALARY BONUS OTHER STOCK OPTIONS
- ------------------ ---- -------- -------- ----------- ---------- ----------
Haim Aviv, Ph.D
Chairman, Chief 2003 $281,400 $ 50,000 $ 21,928(1) 200,000
Executive Officer, and 2002 $289,459 $100,000 $ 19,833(1) 150,000
Chief Scientist 2001 $268,000 $ 80,000 $ 2,844 100,000
Gad Riesenfeld, Ph.D
President and 2003 $234,965 $ 40,000 $ 60,743(2) 135,000
Chief Operating Officer 2002 $255,157 $ 80,000 $ 74,924(2) 100,000
2001 $209,790 $ 42,000 $ 56,556(2) 50,000
Robert W. Cook
Executive Vice President 2003 $222,264 $ 37,500 $ 24,608(1) 115,000
and Chief Financial Officer 2002 $222,264 $ 75,000 $ 15,338(1) 80,000
2001 $198,450 $ 40,000 $ 15,338(1) 40,000
- ----------
(1) Consists of contributions to insurance premiums and car allowance.
(2) Consists of housing allowance, contributions to insurance premiums, car
allowance and car expense.
The following tables set forth information with respect to the named executive
officers concerning the grant and exercise of options during the last fiscal
year and unexercised options held as of the end of the fiscal year.
27
OPTION GRANTS FOR THE YEAR ENDED DECEMBER 31, 2003
COMMON
STOCK % OF TOTAL
UNDERLYING OPTIONS EXERCISE
OPTIONS GRANTED TO PRICE PER
GRANTED EMPLOYEES SHARE EXPIRATION DATE
---------- ----------- --------- ---------------
Haim Aviv, Ph.D 187,500 24.4% $ 1.02 Feb 18, 2013
Gad Riesenfeld, Ph.D 125,000 16.3% $ 1.02 Feb 18, 2013
Robert W. Cook 100,000 13.0% $ 1.02 Feb 18, 2013
AGGREGATED OPTION EXERCISES FOR THE YEAR ENDED DECEMBER 31, 2003 AND OPTION
VALUES AS OF DECEMBER 31, 2003:
VALUE OF UNEXERCISED
NUMBER OF NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS AT
SHARES OPTIONS AT DECEMBER 31, 2003 DECEMBER 31, 2003
ACQUIRED ON VALUE ---------------------------- -------------------------
NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- -------------------- ----------- -------- ----------- ------------- ----------- -------------
Haim Aviv, Ph.D -- -- 555,001 346,875 $635,276 $681,250
Gad Riesenfeld, Ph.D 50,000 $62,500 273,083 221,250 $269,978 $440,625
Robert W. Cook 40,000 $50,000 188,750 176,250 $199,450 $352,500
STOCK OPTION PLANS
It is currently the Company's policy that all full time key employees are
considered annually for the possible grant of stock options, depending upon
employee performance. The criteria for the awards are experience, uniqueness of
contribution to the Company and level of performance shown during the year.
Stock options are intended to generate greater loyalty to the Company and help
make each employee aware of the importance of the business success of the
Company.
As of December 31, 2003, 3,791,449 options to purchase shares of the Company's
Common Stock were outstanding under various option plans, 723,942 of which are
non-qualified options. During 2003, the Company granted 967,500 options to
purchase shares of its Common Stock to employees and directors, of which 200,000
are non-qualified options.
A summary of the various established stock option plans is as follows:
1992 PLAN. The maximum number of shares of the Company's Common Stock available
for issuance under the 1992 Plan is 750,000 shares, subject to adjustment in the
event of stock splits, stock dividends, mergers, consolidations and the like.
Common Stock subject to options granted under the 1992 Plan that expire or
terminate would again be available for options to be issued under the 1992 Plan.
As of December 31, 2003, there were 277,086 options outstanding to purchase the
Company's Common Stock under this plan. Each option granted which is outstanding
under the 1992 plan as of December 31, 2003 expires on October 31, 2005.
1997 PLAN AND 2000 PLAN. The 1997 Plan and the 2000 Plan are each administered
by a committee appointed by the Board of Directors (the "Compensation
Committee"). The Compensation Committee will designate the persons to receive
options, the number of shares subject to the options and the terms of the
options, including the option price and the duration of each option, subject to
certain limitations.
The maximum number of shares of Common Stock available for issuance under the
1997 Plan is 1,500,000 shares, as amended, and under the 2000 Plan is 3,500,000
shares. Each plan is subject to adjustment in the event of stock splits, stock
dividends, mergers, consolidations and the like. Common Stock subject to
28
options granted under the 1997 Plan and the 2000 Plan that expire or terminate
will again be available for options to be issued under each Plan.
The price at which shares of Common Stock may be purchased upon exercise of an
incentive stock option must be at least 100% of the fair market value of Common
Stock on the date the option is granted (or at least 110% of fair market value
in the case of a person holding more than 10% of the outstanding shares of
Common Stock (a "10% Stockholder")).
The aggregate fair market value (determined at the time the option is granted)
of Common Stock with respect to which incentive stock options are exercisable
for the first time in any calendar year by an optionee under the 1997 Plan, the
2000 Plan or any other plan of the Company or a subsidiary, shall not exceed
$100,000. The Compensation Committee will fix the time or times when, and the
extent to which, an option is exercisable, provided that no option will be
exercisable earlier than one year or later than ten years after the date of
grant (or five years in the case of a 10% Stockholder). The option price is
payable in cash or by check. However, the Board of Directors may grant a loan to
an employee, pursuant to the loan provision of the 1997 Plan or the 2000 Plan,
for the purpose of exercising an option or may permit the option price to be
paid in shares of Common Stock at the then current fair market value, as defined
in the 1997 Plan or the 2000 Plan.
Under the 1997 Plan, upon termination of an optionee's employment or
consultancy, all options held by such optionee will terminate, except that any
option that was exercisable on the date employment or consultancy terminated
may, to the extent then exercisable, be exercised within three months thereafter
(or one year thereafter if the termination is the result of permanent and total
disability of the holder), and except such three month period may be extended by
the Compensation Committee in its discretion. If an optionee dies while he is an
employee or a consultant or during such three-month period, the option may be
exercised within one year after death by the decedent's estate or his legatees
or distributees, but only to the extent exercisable at the time of death. The
2000 Plan provides that the Compensation Committee may in its discretion
determine when any particular stock option shall expire. A stock option
agreement may provide for expiration prior to the end of its term in the event
of the termination of the optionee's service to the Company or death or any
other circumstances.
The 1997 Plan and the 2000 Plan each provides that outstanding options shall
vest and become immediately exercisable in the event of a "sale" of the Company,
including (i) the sale of more than 75% of the voting power of the Company in a
single transaction or a series of transactions, (ii) the sale of substantially
all assets of the Company, (iii) approval by the stockholders of a
reorganization, merger or consolidation, as a result of which the stockholders
of the Company will own less than 50% of the voting power of the reorganized,
merged or consolidated company.
The Board of Directors may amend, suspend or discontinue the 1997 Plan, but it
must obtain stockholder approval to (i) increase the number of shares subject to
the 1997 Plan, (ii) change the designation of the class of persons eligible to
receive options, (iii) decrease the price at which options may be granted,
except that the Board may, without stockholder approval accept the surrender of
outstanding options and authorize the granting of new options in substitution
therefore specifying a lower exercise price that is not less than the fair
market value of Common Stock on the date the new option is granted, (iv) remove
the administration of the 1997 Plan from the Compensation Committee, (v) render
any member of the Compensation Committee eligible to receive an option under the
1997 Plan while serving thereon, or (vi) amend the 1997 Plan in such a manner
that options issued under it intend to be incentive stock options, fail to meet
the requirements of Incentive Stock Options as defined in Section 422 of the
Code.
The Board of Directors may amend, suspend or discontinue the 2000 Plan, but it
must obtain stockholder approval to (i) increase the number of shares subject to
the 2000 Plan or (ii) change the designation of the class of persons eligible to
receive options.
29
In February 2003, the 2000 Plan was amended by the Board of Directors to provide
that options to be granted to those employees of Pharmos or its subsidiary
Pharmos Ltd. who are residents of Israel will be issued to a trustee for their
benefit instead of to them directly. This amendment is to afford recipients more
favorable tax treatment under the laws of the State of Israel. Since this change
is not material to the Plan, stockholder approval is not required.
Under current federal income tax law, the grant of incentive stock options under
the 1997 Plan or the 2000 Plan will not result in any taxable income to the
optionee or any deduction for the Company at the time the options are granted.
The optionee recognizes no gain upon the exercise of an option. However the
amount by which the fair market value of Common Stock at the time the option is
exercised exceeds the option price is an "item of tax preference" of the
optionee, which may cause the optionee to be subject to the alternative minimum
tax. If the optionee holds the shares of Common Stock received on exercise of
the option at least one year from the date of exercise and two years from the
date of grant, he will be taxed at the time of sale at long-term capital gains
rates, if any, on the amount by which the proceeds of the sale exceed the option
price. If the optionee disposes of the Common Stock before the required holding
period is satisfied, ordinary income will generally be recognized in an amount
equal to the excess of the fair market value of the shares of Common Stock at
the date of exercise over the option price, or, if the disposition is a taxable
sale or exchange, the amount of gain realized on such sale or exchange if that
is less. If, as permitted by the 1997 Plan or the 2000 Plan, the Board of
Directors permits an optionee to exercise an option by delivering already owned
shares of Common Stock valued at fair market value) the optionee will not
recognize gain as a result of the payment of the option price with such already
owned shares. However, if such shares were acquired pursuant to the previous
exercise of an option, and were held less than one year after acquisition or
less than two years from the date of grant, the exchange will constitute a
disqualifying disposition resulting in immediate taxation of the gain on the
already owned shares as ordinary income. It is not clear how the gain will be
computed on the disposition of shares acquired by payment with already owned
shares.
2001 EMPLOYEE STOCK PURCHASE PLAN. The 2001 Plan is intended to qualify as an
employee stock purchase plan under Section 423 of the Code. All employees of the
Company, its Pharmos Ltd. subsidiary or any other subsidiaries or affiliated
entities who have completed 180 consecutive days of employment and who
customarily work at least 20 hours per week will be eligible to participate in
the 2001 Plan, except for any employee who owns five percent or more of the
total combined voting power or value of all classes of stock of the Company or
any subsidiary on the date a grant of a right to purchase shares under the 2001
Plan (Right) is made. There currently are no such employees with such large
holdings. Participation by officers in the 2001 Plan will be on the same basis
as that of any other employee. No employee will be granted a Right which permits
such employee to purchase shares under the 2001 Plan at a rate which exceeds
$25,000 of fair market value of such shares (determined at the time such Right
is granted) for each calendar year in which such Right is outstanding. Each
Right will expire if not exercised by the date specified in the grant, which
date will not exceed 27 months from the date of the grant. Rights will not be
assignable or transferable by a participating employee, other than in accordance
with certain qualified domestic relations orders, as defined in the Code, or by
will or the laws of descent and distribution.
The total number of shares reserved for issuance under the 2001 Plan is 500,000
shares. Under the 2001 Plan, for any given calendar year, a participating
employee can only be granted Rights to purchase that number of shares which,
when multiplied by the exercise price of the Rights, does not exceed more than
10% of the employee's base pay. The Company contemplates that payroll deductions
generally will be used by participating employees to acquire the shares covered
by their Rights. From inception to December 31, 2003, the Company issued 53,303
shares of its common stock through the 2001 Plan. During 2003, the Company
issued 29,919 shares of its common stock through the 2001 Plan.
From time to time, the Board of Directors may fix a date or a series of dates on
which the Company will grant Rights to purchase shares of Common Stock under the
2001 Plan at prices not less than 85% of the lesser of (i) the fair market value
of the shares on the date of grant of such Right or (ii) the fair market value
of the shares on the date such Right is exercised.
30
The 2001 Plan also provides that any shares of Common Stock purchased upon the
exercise of Rights cannot be sold for at least six months following exercise, to
avoid potential violations of the "short swing" trading provisions of Section 16
of the Securities Exchange Act of 1934, as amended.
The Board of Directors or a committee to which it delegates its authority under
the 2001 Plan will administer, interpret and apply all provisions of the 2001
Plan. The Board has delegated such authority to the Compensation and Stock
Option Committee.
The Board of Directors may amend, modify or terminate the 2001 Plan at any time
without notice, provided that no such amendment, modification or termination may
adversely affect any existing Rights of any participating employee, except that
in the case of a participating employee of a foreign subsidiary of the Company,
the 2001 Plan may be varied to conform with local laws. In addition, subject to
certain appropriate adjustments to give effect to relevant changes in the
Company's capital stock, no amendments to the 2001 Plan may be made without
stockholder approval if such amendment would increase the total number of shares
offered under the 2001 Plan or would render Rights "unqualified" for special tax
treatment under the Code.
No taxable income will be recognized by a participant either at the time a Right
is granted under the 2001 Plan or at the time the shares are purchased. Instead,
tax consequences are generally deferred until a participant disposes of the
shares (e.g., by sale or gift). The federal income tax consequences of a sale of
shares purchased under the 2001 Plan will depend on the length of time the
shares are held after the relevant date of grant and date of exercise, as
described below.
If shares purchased under the 2001 Plan are held for more than one year after
the date of purchase and more than two years from the date of grant, the
participant generally will have taxable ordinary income on a sale or gift of the
shares to the extent of the lesser of: (i) the amount (if any) by which the fair
market value of the stock at the date of grant exceeds the exercise price paid
by the participant; or (ii) the amount by which the fair market value of the
shares on the date of sale or gift exceeds the exercise price paid by the
participant for the shares. In the case of a sale, any additional gain will be
treated as long-term capital gain. If the shares are sold for less than the
purchase price, there will be no ordinary income, and the participant will have
a long-term capital loss for the difference between the purchase price and the
sale price.
If the stock is sold or gifted within either one year after the date of purchase
or two years after the date of grant (a "disqualifying disposition"), the
participant generally will have taxable ordinary income at the time of the sale
or gift to the extent that the fair market value of the stock at the date of
exercise was greater than the exercise price. This amount will be taxable in the
year of sale or disposition even if no gain is realized on the sale, and the
Company would be entitled to a corresponding deduction. A capital gain would be
realized upon the sale of the shares to the extent the sale proceeds exceed the
fair market value of those shares on the date of purchase. A capital loss would
be realized to the extent the sales price of the shares disposed of is less than
the fair market value of such shares on the date of purchase. Special tax
consequences may follow from dispositions other than a sale or gift.
1997 EMPLOYEES AND DIRECTORS WARRANTS PLAN
The 1997 Employees and Directors Warrants Plan was approved by the Stock Option
Committee as of February 12, 1997 and March 19, 1997. 1,030,000 Warrants to
purchase 1,030,000 shares of Common Stock were granted to certain employees of
the Company. Of such warrants, 955,000 were granted at an exercise price of
$1.59 per share and 75,000 were granted and an exercise price of $1.66 per share
(together, the "1997 Employees Warrants"). The 1997 Employees Warrants become
exercisable in increments of 25% each on their first, second, third and fourth
anniversaries, respectively, and shall expire in the year 2007. 100,000 Warrants
to purchase 100,000 shares of Common Stock were granted to directors of the
Company at an exercise price of $1.59 per share (the "1997 Directors Warrants")
on February 12, 1997. The 1997 Directors Warrants become exercisable in
increments of 25% each on the
31
first, second, third and fourth anniversaries of February 12, 1997 and shall
expire on February 12, 2007. At December 31, 2003, there were 486,500 1997
Employees Warrants at $1.59, no 1997 Employees Warrants at $1.66 and 5,000 1997
Directors Warrants at $1.59 outstanding.
Upon termination of a Warrant Holder's employment, consultancy or affiliation
with the Company, all Warrants held by such Warrant Holder will terminate,
except that any Warrant that was exercisable on the date which the employment,
consultancy or affiliation terminated may, to the extent then exercisable, be
exercised within three months thereafter (or one year thereafter if the
termination is the result of permanent and total disability of the holder). If a
Warrant Holder dies while he or she is an employee, consultant or affiliate of
the Company, or during such three month period, the Warrant may be exercised
within one year after death by the decedent's estate or his legatees or
distributees, but only to the extent exercisable at the time of death.
EMPLOYMENT/CONSULTING CONTRACTS/DIRECTORS' COMPENSATION
Haim Aviv, Ph.D. In April 2001, the Compensation and Stock Option Committee of
the Board of Directors recommended, and the Board approved, a one-year
employment/consulting agreement for Dr. Aviv, as Chairman of the Board and Chief
Executive Officer of the Company. Dr. Aviv has agreed to devote a majority of
his business time to the Company and to Pharmos Ltd. The agreement provides for
automatic one year renewals unless either the Company terminates the agreement
at least 180 days prior to the scheduled expiration date during the initial one
year term (and 90 days for subsequent terms) or Dr. Aviv terminates the
agreement at least 60 days prior to the scheduled expiration date. Dr. Aviv's
base compensation for 2003 was $281,400, to be allocated between the Company and
Pharmos Ltd., and his base salary for 2004, effective January 1, is $298,284, to
be allocated between the Company and Pharmos Ltd. The Company also agreed to
make available for Dr. Aviv's benefit following his death, termination of
employment for disability or retirement at the age of at least 62 an amount
equal to the cost of insurance premiums the Company would otherwise have
incurred to obtain and maintain a "split-dollar" life insurance policy on his
life (approximately $10,000 per year, accruing interest at 8% per year). In
addition, the Company agreed to pay, in lieu of contributing to other benefits
plans on his behalf, an amount equal to an aggregate of approximately 21% of his
base compensation toward the "Management Insurance Scheme" managed by the
government of Israel for members of management of Israeli companies.
Dr. Aviv's employment agreement also provides that if his employment is
terminated within one year following a "change of control," he will receive
severance pay of 18 months of base salary for the then-current year, accelerated
vesting of all unvested stock options and extended exercisability of all stock
options until their respective expiration dates. A "change of control" involves
an acquisition of at least 50% of the voting power of the Company's securities,
a change in at least 51% of the composition of the current Board of Directors,
or approval by the Board of Directors or stockholders of the Company of a
transaction where such change of voting control or composition of the Board
would occur, where the Company would be liquidated or where all or substantially
all of its assets would be sold.
If Dr. Aviv's employment is terminated by the Company, after notice, other than
for a change in control, death, disability or for "cause," as defined in his
employment agreement, or if he terminates his employment within one year of a
change in control or otherwise for "good reason," as defined in his employment
agreement, he will receive severance pay of 12 months of base salary for the
then-current year, accelerated vesting of all unvested stock options and
extended exercisability of all stock options until their respective expiration
dates.
The employment agreement also contains customary confidentiality and
non-competition undertakings by Dr. Aviv.
Gad Riesenfeld, Ph.D. In April 2001, the Compensation and Stock Option Committee
of the Board of Directors recommended, and the Board approved, a one year
employment agreement for Dr. Riesenfeld, as full-time President and Chief
Operating Officer of the Company. Dr. Riessenfeld's base compensation for 2003
was $234,965, and his base salary for 2004, effective January 1, is 249,063.
32
The other provisions of Dr. Riesenfeld's employment agreement relating to
benefits, severance arrangements, automatic renewal and confidentiality and
non-competition obligations are substantially similar to those included in Dr.
Aviv's employment agreement, as described above, except that the Company's
contribution to the "Management Insurance Scheme" on Dr. Riesenfeld's behalf is
approximately 16%. In addition, the Compensation Committee and the Board of
Directors in April 2001 also authorized an amendment to Dr. Riesenfeld's
employment agreement to provide that if the Company hires a new Chief Executive
Officer, Dr. Riesenfeld will be awarded, at the time of commencement of
employment, a one-time stock option grant equal to the highest grant he received
during the previous three years, in addition to his annual stock option awards.
In addition, any termination by the Company within 12 months after such
commencement of employment will require 180 days' prior written notice to Dr.
Riesenfeld and will entitle him to severance pay equal to 12 months of base
salary. In such circumstances, any resignation by Dr. Riesenfeld within 12
months thereafter other than for "good reason" (as defined in his employment
agreement) will require 90 days' prior written notice by Dr. Riesenfeld and will
entitle him to 12 months of base salary. The amendment to his employment
agreement also provides that Dr. Riesenfeld will act as an unpaid consultant to
the Company for a one year period following any such termination or resignation.
Robert W. Cook. In April 2001, the Compensation and Stock Option Committee of
the Board of Directors recommended, and the Board approved, a one year
employment agreement for Mr. Cook, as full-time Vice President Finance and Chief
Operating Officer of the Company. Mr. Cook's base compensation for 2003 was
$222,264, and his base salary for 2004, effective January 1, is $235,600. The
other provisions of Mr. Cook's employment agreement relating to benefits,
severance arrangements, automatic renewal and confidentiality and
non-competition obligations are substantially similar to the those included in
Dr. Aviv's employment agreement, as described above, except that Mr. Cook does
not participate in the "Management Insurance Scheme" of the Company's Israeli
subsidiary. In October 2003 the Company and Mr. Cook agreed to an amendment of
his employment agreement that terminated a related Split Dollar Agreement dated
September 20, 2000. The Company forgave the loans made to Mr. Cook used to pay
"whole life" insurance premiums for his benefit covered by such Agreement,
granted him a one-time cash bonus of $8,500 to partially offset the income tax
effects of such forgiveness, and agreed to pay or reimburse future insurance
premium payments and the income tax effects thereof via an annual executive
bonus, provided that each such executive bonus payment shall not exceed the
annual payment of $10,538 previously made by the Company on Mr. Cook's behalf
under the Split Dollar Agreement.
Elkan R. Gamzu, Ph.D. In January 2000, the Company entered into a consulting
agreement with Dr. Gamzu with a term of one year (subject to extension by
written agreement of the Company and Dr. Gamzu), pursuant to which Dr. Gamzu may
provide certain assistance and consulting services to the Company as and when
needed. The agreement provides for compensation on a per diem basis in
connection with the provision of such assistance and consulting services at the
rate of $3,000 per day. In 2003, the Company paid $7,500 to Dr. Gamzu pursuant
to the consulting agreement.
The Company also entered into a consulting agreement with another of our
Directors, Dr. Georges Anthony Marcel, pursuant to which Dr. Marcel may provide
certain assistance and consulting services to the Company as and when needed. In
2003, the Company paid $15,844 to Dr. Marcel pursuant to the consulting
agreement.
Drs. Gamzu and Marcel are not currently providing any consulting services to the
Company and are not receiving any remuneration other than the customary fees
received by all Directors of the Company.
Directors' Compensation. In 2001, Directors did not receive any compensation for
service on the Board or for attending Board meetings. In March 2002, the Board
of Directors of the Company adopted a compensation policy with respect to
outside members of the Board. Specifically, the board approved:
CASH COMPENSATION
1) Two payments of $2,500 each per annum, the first due on January 1,
and the second immediately after the earlier of the director's
initial appointment to the board or election by the shareholders;
and
33
2) $1,000 per each board or committee meeting attended in person or by
conference call; no payment for a committee meeting if it occurs on
the same day as the board meeting.
STOCK COMPENSATION
1) An initial grant of 30,000 options, awardable on the earlier of the
director's initial appointment to the board or election by the
shareholders; and
2) 20,000 options annually thereafter, awardable on the earlier of the
date of the director's re-election by the shareholders or the date
on which a general option grant is made by the Company for its key
employees and directors; and
3) Special, one-time awards may be granted for attaining certain
corporate achievements at the recommendation of the Chairman.
In February 2004, the Board of Directors adopted the recommendation of the
Compensation Committee to increase Board compensation to two payments of $4,000
each per annum (a total of $8,000), to increase attendance at board, committee
or shareholder meetings to $1,500 per meeting (only one payment per day,
regardless of the number of meetings attended), to provide for separate
additional payments to members of the Audit Committee of $2,000 per meeting,
even if other meetings are held on the same day, to increase the initial stock
option grants for new independent directors to 35,000 options and to increase
the annual option grant to such directors to 25,000.
34
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information with respect to the
beneficial ownership of the Company's Common Stock as of February 23, 2004, by
(i) each person who was known by the Company to own beneficially more than 5% of
any class of the Company's Common Stock, (ii) each of the Company's Directors,
and (iii) all current Directors and executive officers of the Company as a
group. Except as otherwise noted, each person listed below has sole voting and
dispositive power with respect to the shares listed next to such person's name.
AMOUNT OF
NAME AND ADDRESS OF BENEFICIAL PERCENTAGE OF
BENEFICIAL OWNERSHIP OWNERSHIP TOTAL (1)
- -------------------- ---------- -------------
Haim Aviv, Ph.D. (2) 1,601,008 1.8%
c/o Pharmos Ltd.
Kiryat Weitzman
Rehovot 76326, Israel
David Schlachet (3) 61,250 *
BioCom (Management) Limited
40 Einstein St., Ramat Aviv Tower
Tel-Aviv 69102, Israel
Mony Ben Dor (3) 60,000* *
BioCom (Management) Limited
40 Einstein St., Ramat Aviv Tower
Tel-Aviv 69102, Israel
Georges Anthony Marcel M.D., Ph.D.(3) 53,750* *
TMC Development
9, rue de Mesnil
75116 Paris, France
Elkan R. Gamzu, Ph.D. (3) 50,000* *
enERGetics
199 Wells Avenue, Suite 302
Newton, MA 02459
Lawrence F. Marshall, M.D. (3) 18,125 *
University of California, San Diego
Regents Court Bldg., Suite 200
4130 LaJolla Village Drive
LaJolla, CA 92037-1480
All Directors and 2,425,216 2.8%
Executive Officers as a group
(8 persons)(4)
- ----------
* Indicates ownership of less than 1%.
(1) Based on 87,913,692 shares of Common Stock outstanding, plus each
individual's currently exercisable warrants or options. Assumes that no
other individual will exercise any warrants and/or options.
(2) Includes of currently exercisable options and warrants to purchase 710,626
shares of Common Stock, plus 276,153 shares of Common Stock
(3) Consists of currently exercisable options and warrants to purchase Common
Stock.
35
(4) Based on the number of shares of Common Stock outstanding, plus 1,6657,084
currently exercisable warrants and options held by the Directors and
executive officers.
Drs. Gamzu and Marcel are not currently providing any consulting services to the
Company and are not receiving any remuneration other than the customary fees
received by all Directors of the Company.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In January 2000, the Company entered into a consulting agreement with one of our
Directors, Dr. Elkan Gamzu, for a term of one year (subject to extension by
written agreement of the Company and Dr. Gamzu), pursuant to which Dr. Gamzu may
provide certain assistance and consulting services to the Company as and when
needed. The agreement provides for compensation on a per diem basis in
connection with the provision of such assistance and consulting services at the
rate of $3,000 per day. In 2003, the Company paid $7,500 to Dr. Gamzu pursuant
to the consulting agreement.
The Company also entered into a consulting agreement with another of our
Directors, Dr. Georges Anthony Marcel, pursuant to which Dr. Marcel may provide
certain assistance and consulting services to the Company as and when needed. In
2003, the Company paid $15,844 to Dr. Marcel pursuant to the consulting
agreement.
In December 2001, the Company's Pharmos Ltd. subsidiary renewed a License
Agreement with Herbamed, Ltd., a company controlled by Dr. Haim Aviv, the
Company's Chairman and Chief Executive Officer. The License Agreement,
originally entered into in May 1997, licenses to Herbamed the Company's patent
rights for the oral delivery of lipophilic substances in the limited field of
nutraceuticals, which include food and dietary supplements, food additives,
vitamins and herbs. Under the terms of the revised License Agreement, Herbamed
will pay to Pharmos Ltd. royalties of 6% on net sales of up to $20 million, 5%
on net sales between $20 million and $50 million and 4% on net sales in excess
of $50 million. During 2003, the Company recognized royalties of a non-material
amount per the licensing agreement with Herbamed.
Neither the Company nor its Pharmos Ltd. subsidiary is involved in the field of
nutraceuticals generally, and specifically in developing improved oral delivery
of nutraceuticals. Pharmos Ltd., therefore, licensed its technology in this
narrow non-pharmaceutical field of use to Dr. Aviv's company as a way of seeking
to benefit from a potential stream of royalty payments without having to devote
any resources to the development of an application it otherwise would not have
pursued. In addition, if the technology proves to be successful for the delivery
of nutraceuticals, Pharmos hopes that it could be able to interest potential
strategic partners in licensing the technology for pharmaceuticals applications.
Dr. Aviv was not involved with either party in negotiating the terms of the
License Agreement with Herbamed. Pharmos Ltd. concluded that the royalty rates
and other terms of the License Agreement are commercially reasonable to it, and
the Board of the Company ratified the License Agreement.
In October 2003 and in accordance with provisions of the Sarbanes-Oxley
legislation circumscribing the practice of company loans to executive officers,
Pharmos entered into an agreement with Robert W. Cook, Executive Vice President
and Chief Financial Officer, forgiving the loans made to him since 2001 used to
pay "whole life" insurance premiums for his benefit and granting Mr. Cook a
special one-time cash bonus of no more than $8,500 in recognition of the fact
that such loan forgiveness resulted in Mr. Cook recognizing additional non-cash
taxable income in 2003 of approximately $21,000. The Company also agreed either
to pay directly or reimburse Mr. Cook for future premium payments on his
existing "whole life" insurance policy acquired in 2001 for his benefit by the
Corporation and to grant to him an annual special cash bonus, in addition to his
regular annual bonus, sufficient to account for the tax effects to him of such
reimbursement or direct payment by the Corporation; provided that the sum of
such premium payments and special cash bonus in each year does not exceed the
aggregate annual payments previously made by the Company on Mr. Cook's behalf
for his split-dollar insurance policy.
36
The Herbamed License Agreement was approved by Pharmos' Board of Directors and
the Cook loan forgiveness agreement were approved by Pharmos' Compensation
Committee. Both agreements also were subsequently ratified by the Audit
Committee.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
RATIFICATION OF SELECTION OF INDEPENDENT AUDITORS
The Audit Committee has selected PricewaterhouseCoopers LLP
("PricewaterhouseCoopers") as the Company's independent auditors for the fiscal
year ending December 31, 2003, and our Board of Directors has directed that
management submit the selection of independent auditors for ratification by the
stockholders at the Meeting. PricewaterhouseCoopers has audited the financial
statements of the Company and its predecessors for more than ten years and has
advised the Company that it does not have any material financial interests in,
or any connection with (other than as independent auditors, tax advisors and
management consultants), the Company.
AUDIT FEES
Aggregate fees for professional services rendered by PricewaterhouseCoopers in
connection with its audit of the Company's consolidated financial statements as
of and for the years ended December 31, 2003 and 2002, its reviews of the
Company's unaudited condensed consolidated interim financial statements, and for
SEC consultations and filings were $353,000 and $240,000, respectively.
TAX FEES
Aggregate fees for professional services rendered by PricewaterhouseCoopers in
connection with its income tax compliance and related tax services for the years
ended December 31, 2003, and 2002 were $80,000 and $15,000, respectively.
ALL OTHER FEES
There were no other professional services rendered by PricewaterhouseCoopers.
Stockholder ratification of the selection of PricewaterhouseCoopers as the
Company's independent auditors is not required by the Bylaws or otherwise.
However, the Board is submitting the selection of PriceWaterhouseCoopers to the
stockholders for ratification as a matter of corporate practice. If the
stockholders fail to ratify the selection, the Audit Committee or the Board will
reconsider whether or not to retain that firm. Even if the selection is
ratified, the Audit Committee or the Board in its discretion may direct the
appointment of a different independent accounting firm at any time during the
year if the Audit Committee or the Board determines that such a change would be
in the best interests of the Company and its stockholders.
37
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements and Exhibits
(1) FINANCIAL STATEMENTS
Report of Independent Auditors
Consolidated Balance Sheets at December 31, 2003 and 2002
Consolidated Statements of Operations for the years ended December 31,
2003, 2002 and 2001
Consolidated Statements of Changes in Shareholders' Equity for the
years ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the years ended December 31,
2003, 2002 and 2001
Notes to Consolidated Financial Statements
(2) FINANCIAL STATEMENT SCHEDULES
All financial statement schedules are omitted because they are not
applicable or the required information is shown in the financial
statements or notes thereto.
(3) EXHIBITS
3 Articles of Incorporation and By-Laws
3(a) Restated Articles of Incorporation (Incorporated by reference
to Appendix E to the Joint Proxy Statement/Prospectus included
in the Form S-4 Registration Statement of the Company dated
September 28, 1992 (No. 33-52398) (the "Joint Proxy
Statement/Prospectus").
3(b) Certificate of Amendment of Restated Articles of Incorporation
dated January 30, 1995 (Incorporated by reference to Annual
Report on Form 10-K for the year ended December 31, 1994).
3(c) Certificate of Amendment of Restated Articles of Incorporation
dated January 16, 1998 (Incorporated by reference to the
Company's Current Report on Form 8-K, dated February 6, 1998).
3(d) Certificate of Amendment of Restated Articles of Incorporation
dated October 21, 1999 (Incorporated by reference to Form S-3
Registration Statement of the Company dated September 28, 2000
(No. 333-46818).
3(e) Certificate of Amendment of Restated Articles of Incorporation
dated July 12, 2002 (Incorporated by reference to Exhibit 3 to
the Company's Report on Form 10-Q for the quarter ended June
30, 2002)
3(f) Amended and Restated By-Laws (Incorporated by reference to
Exhibit 99.4 to the Company's Current Report on Form 8-K filed
on October 24, 2002.
38
4 Instruments defining the rights of security holders, including indentures
4(a) Form of Employee Warrant Agreement, dated April 11, 1995,
between the Company and Oculon Corporation (Incorporated by
reference to the Company's Current Report on Form 8-K, dated
April 11, 1995, as amended).
4(b) Form of Warrant Agreement dated as of April 30, 1995 between
the Company and Charles Stolper (Incorporated by reference to
Form S-3 Registration Statement of the Company dated November
14, 1995, as amended [No. 33-64289]).
4 (c) Form of Stock Purchase Warrant dated as of March 31, 1997
between the Company and the Investor (Incorporated by
reference to Form S-3 Registration Statement of the Company
dated March 5, 1998 [No. 333-47359]).
4(d) Form of Common Stock Purchase Warrant exercisable until
September 1, 2005 (Incorporated by reference to Exhibit 4.4 to
the Company's Current Report on Form 8-K filed on September
11, 2000).
4(e) Form of placement agent warrant with Ladenburg Thalmann & Co.
Inc. (Incorporated by reference to Form S-3 Registration
Statement of the Company dated September 28, 2000 (No.
333-46818).
4(f) Form of placement agent warrant with SmallCaps OnLine LLC
(Incorporated by reference to Form S-3 Registration Statement
of the Company dated September 28, 2000 (No. 333-46818).
4(g) Form of consulting warrant with SmallCaps OnLine LLC
(Incorporated by reference to Form S-3 Registration Statement
of the Company dated September 28, 2000 (No. 333-46818).
4(h) Certificate of Designation, Rights Preferences and Privileges
of Series D Preferred Stock of the Company (Incorporated by
reference to Exhibit 99.3 to the Company's Current Report on
Form 8-K filed on October 24, 2002).
4(i) Rights Agreement dated as of October 23, 2002 between the
Company and American Stock Transfer & Trust Company, as Rights
Agent (Incorporated by reference to Exhibit 99.2 to the
Company's Current Report on Form 8-K filed on October 24,
2002).
4(j) Form of Investor Warrant dated March 4, 2003 (Incorporated by
reference to Exhibit 99.2 to the Company's Current Report on
Form 8-K filed on March 4, 2003).
4(k) Form of Placement Agent's Warrant dated March 4, 2003
(Incorporated by reference to Exhibit 99.1 to the Company's
Current Report on Form 8-K filed on March 4, 2003).
4(l) Registration Rights Agreement dated as of May 30, 2003 between
the Company and the purchasers. (Incorporated by reference to
Exhibit 4.2 to the Company's Current Report on Form 8-K filed
on June 3, 2003).
4(m) Form of Investor Warrant dated June 2, 2003 (Incorporated by
reference to Exhibit 4.3 to the Company's Current Report on
Form 8-K filed on June 3, 2003).
4(n) Securities Purchase Agreement dated as of September 26, 2003
between the Company and the purchasers identified on the
signature pages thereto 2003 (Incorporated by reference to
Exhibit 4.1 to the Company's Current Report on Form 8-K filed
on September 30, 2003).
4(o) Form of 4% convertible debenture due March 31, 2005
(Incorporated by reference to Exhibit 4.2 to the Company's
Current Report on Form 8-K filed on September 30, 2003).
4(p) Registration Rights Agreement dated as of September 26, 2003
between the Company and the purchasers signatory thereto
(Incorporated by reference to Exhibit 4.3 to the Company's
Current Report on Form 8-K filed on September 30, 2003).
39
4(q) Form of Common Stock Purchase Warrant (Incorporated by
reference to Exhibit 4.4 to the Company's Current Report on
Form 8-K filed on September 30, 2003).
4(r) Escrow Agreement dated as of September 26, 2003 between the
Company, the purchasers signatory thereto and Feldman
Weinstein LLP (Incorporated by reference to Exhibit 4.5 to the
Company's Current Report on Form 8-K filed on September 30,
2003).
4(s) Form of Placement Agent Common Stock Purchase Warrant
(Incorporated by reference to Exhibit 4.6 to the Company's
Current Report on Form 8-K filed on September 30, 2003).
10 Material Contracts
10(a) Agreement between Avitek Ltd. ("Avitek") and Yissum Research
Development Company of the Hebrew University of Jerusalem
("Yissum") dated November 20, 1986 (Incorporated by reference
to Annual Report on Form 10-K, as amended by Form10-K/A, for
year ended December 31, 1992). (1)
10(a)(1) Supplement to Agreement (Incorporated by reference to Annual
Report on Form 10-K, as amended by Form 10-K/A, for year ended
December 31, 1992). (1)
10(a)(2) Hebrew language original executed version of Agreement
(Incorporated by reference to Annual Report on Form 10-K, as
amended by Form 10-K/A, for year ended December 31, 1992). (1)
10(b) Agreement between Avitek and Yissum dated January 25, 1987
(Incorporated by reference to Annual Report on Form 10-K, as
amended by Form 10-K/A, for year ended December 31, 1992). (1)
10(b)(1) Schedules and Appendixes to Agreement (Incorporated by
reference to Annual Report on Form 10-K, as amended by Form
10-K/A, for year ended December 31, 1992). (1)
10(b)(2) Hebrew language original executed version of Agreement
(Incorporated by reference to Annual Report on Form 10-K, as
amended by Form 10-K/A, for year ended December 31, 1992). (1)
10(c) Research, Development and License Agreement between Pharmos
Ltd., Pharmos Corporation ("Old Pharmos") and Yissum dated
February 5, 1991 (Incorporated by reference to Annual Report
on Form 10-K, as amended by Form 10-K/A, for year ended
December 31, 1992). (1)
10(c)(1) Schedules and Appendixes to Agreement (Incorporated by
reference to Annual Report on Form 10-K, as amended by Form
10-K/A, for year ended December 31, 1992). (1)
10(d) 1992 Incentive and Non-Qualified Stock Option Plan (Annexed as
Appendix F to the Joint Proxy Statement/Prospectus). **
10(e) 1997 Incentive and Non-Qualified Stock Option Plan (Annexed as
Appendix B to the Proxy Statement on Form 14A filed November
5, 1997). **
10(f) Employment Agreement dated as of April 2, 2001, between
Pharmos Corporation and Haim Aviv.**
10(g) Employment Agreement dated as of April 2, 2001, between
Pharmos Corporation and Gad Riesenfeld.**
10(h) Amendment of Employment Agreement dated as of April 23, 2001,
between Pharmos Corporation and Gad Riesenfeld.**
10(i) Employment Agreement dated as of April 2, 2001, between
Pharmos Corporation and Robert W. Cook.**
10(j) 2001 Employee Stock Purchase Plan (Incorporated by reference
to Exhibit B to the Company's Definitive Proxy Statement on
Form 14A filed on June 6, 2001).**
40
10(k) Asset Purchase Agreement between Bausch & Lomb Incorporated
and Pharmos Corporation dated October 9, 2001 (Incorporated by
reference to Exhibit 2.1 to the Company's Current Report on
Form 8-K filed on October 16, 2001).
10(l) License Assignment and Amendment Agreement dated as of October
9, 2001 by and among Dr. Nicholas S. Bodor, Pharmos
Corporation and Bausch & Lomb Incorporated (Incorporated by
reference to Exhibit 2.2 to the Company's Current Report on
Form 8-K filed on October 16, 2001).
10(m) Amendment No. 1 to Asset Purchase Agreement dated as of
December 28, 2001 between Bausch & Lomb Incorporated and
Pharmos Corporation
10(n)*** License Agreement dated as of December 18, 2001 between
Pharmos Ltd. and Herbamed Ltd. (Incorporated by reference to
Exhibit 10(p) to the Annual Report on Form 10-K for year ended
December 31, 2002).
10(o)*** Amended and Restated 2000 Incentive and Non-Qualified Stock
Option Plan (Incorporated by reference to Exhibit 10(q) to the
Annual Report on Form 10-K for year ended December 31,
2002).**
10(p) Underwriting Agreement dated as of December 16, 2003 between
the Company and C.E. Unterberg, Towbin and Harris Nesbitt
Corp. LLP (Incorporated by reference to Exhibit 1.1 to the
Company's Current Report on Form 8-K filed on December 19,
2003).
14 Code of Ethics
14(a)*** Pharmos Corporation Code of Ethics and Business Conduct
21 Subsidiaries of the Registrant
21(a) Subsidiaries of the Registrant (Incorporated by reference to
Annual Report on Form 10-K, as amended by Form 10-K/A, for
year ended December 31, 1992).
23 Consents of Experts and Counsel
23(a) *** Consent of PricewaterhouseCoopers LLP
31 Rule 13a-14(a)/15d-14(a) Certifications
31(a)*** Certification of Chief Executive Officer
31(b)*** Certification of Chief Financial Officer
32 Section 1350 Certifications
32(a)*** Section 1350 Certification of Chief Executive Officer and
Chief Financial Officer
99 Additional Exhibits
99(a)*** Pharmos Corporation Corporate Governance Guidelines
99(b)*** Amended and Restated Charter, Audit Committee
99(c)*** Charter, Compensation and Stock Option Committee
99(d)*** Charter, Governance and Nominating Committee
- ----------
(1) Confidential information is omitted and identified by a * and filed
separately with the SEC.
(**) This document is a management contract or compensatory plan or arrangement.
(***) Filed herewith.
41
(b) Reports on Form 8-K
1. Current Report filed on December 16, 2003; Item 5 was reported.
2. Current Report filed on December 19, 2003; Item 5 was reported.
3. Current Report filed on January 5, 2004; Item 5 was reported.
42
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PHARMOS CORPORATION
By: /s/ Haim Aviv
----------------------------------------------
Dr. Haim Aviv, Chairman of the Board and Chief
Executive Officer (Principal Executive Officer)
Date: March 15, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
SIGNATURE TITLE DATE
- --------- ----- ----
/s/ Robert W. Cook Chief Financial Officer (Principal March 15, 2004
- ------------------------- Financial and Accounting Officer),
Robert W. Cook and Secretary
/s/ David Schlachet Director March 15, 2004
- -------------------------
David Schlachet
/s/ Mony Ben Dor Director March 15, 2004
- -------------------------
Mony Ben Dor
/s/ Georges Anthony Marcel Director March 15, 2004
- -------------------------
Georges Anthony Marcel, M.D., Ph.D.
/s/ Elkan R. Gamzu Director March 15, 2004
- -------------------------
Elkan R. Gamzu, Ph.D.
/s/ Lawrence F. Marshall Director March 15, 2004
- -------------------------
Lawrence F. Marshall, M.D.
43
PHARMOS CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Auditors F-2
Consolidated balance sheets as of December 31, 2003 and 2002 F-3
Consolidated statements of operations for the years ended
December 31, 2003, 2002 and 2001 F-4
Consolidated statements of changes in shareholders' equity
for the years ended December 31, 2003, 2002 and 2001 F-5
Consolidated statements of cash flows for the years ended
December 31, 2003, 2002 and 2001 F-6
Notes to consolidated financial statements F-7
F-1
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and
Shareholders of Pharmos Corporation:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, shareholders' equity and of cash flows
present fairly in all material respects, the financial position of Pharmos
Corporation and its subsidiary at December 31, 2003 and 2002, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2003 in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
New York, New York
February 6, 2004, except for the last paragraph of Note 19 which is dated March
3, 2004.
F-2
PHARMOS CORPORATION
CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------
DECEMBER 31,
------------------------------
2003 2002
------------- -------------
Assets
Current assets
Cash and cash equivalents $ 49,369,250 $ 19,579,287
Restricted cash 11,192,312 2,199,999
Other receivables 681,245 698,800
Debt issuance costs 967,402 --
Prepaid expenses and other current assets 585,020 323,991
------------- -------------
Total current assets 62,795,229 22,802,077
Fixed assets, net 1,255,096 1,792,322
Restricted cash 4,907,686 60,000
Other assets 20,589 32,283
Debt issuance costs 29,471 --
------------- -------------
Total assets $ 69,008,071 $ 24,686,682
============= =============
Liabilities and Shareholders' Equity
Current liabilities
Accounts payable $ 3,005,461 $ 3,742,460
Accrued expenses 1,751,200 3,241,581
Warrant liability 823,029 --
Accrued wages and other compensation 1,486,529 999,647
Convertible debentures, net 13,702,412 3,446,658
------------- -------------
Total current liabilities 20,768,631 11,430,346
Other liability 10,000 10,000
Convertible debentures, net 4,773,339 --
------------- -------------
Total liabilities 25,551,970 11,440,346
------------- -------------
Commitments and Contingencies (Note 15)
Shareholders' equity
Preferred stock, $.03 par value, 1,250,000 shares authorized,
none issued and outstanding
Common stock, $.03 par value; 110,000,000 shares authorized,
85,554,016 and 56,560,660 shares outstanding
(excluding $426 (14,189 shares in 2003 and in 2002
held in Treasury) in 2003 and 2002, respectively 2,566,621 1,696,820
Deferred compensation (66,660) (119,988)
Paid in capital 161,960,059 114,187,558
Accumulated deficit (121,003,919) (102,518,054)
------------- -------------
Total shareholders' equity 43,456,101 13,246,336
------------- -------------
Total liabilities and shareholders' equity $ 69,008,071 $ 24,686,682
============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
PHARMOS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
Revenues
Product sales -- -- $ 4,218,441
License fee -- -- 80,000
------------ ------------ ------------
Total Revenues -- -- 4,298,441
Cost of Goods Sold (exclusive of depreciation
and amortization shown below) -- -- 1,268,589
------------ ------------ ------------
Expenses
Research and development, net $ 11,632,959 $ 12,337,840 9,349,025
Selling, general and administrative 3,746,570 3,828,750 3,666,293
Depreciation and amortization 654,617 691,824 773,973
------------ ------------ ------------
Total operating expenses 16,034,146 16,858,414 13,789,291
------------ ------------ ------------
Loss from operations (16,034,146) (16,858,414) (10,759,439)
------------ ------------ ------------
Other (expense) income
Interest income 1,051,242 534,229 979,234
Other (expense) income, net (56,362) 12,218 28,509
Derivative loss (1,759,183) -- --
Interest expense (1,915,214) (972,856) (1,713,806)
Gain from sale of LE product line (Note 4) -- -- 16,285,324
------------ ------------ ------------
Other (expense) income, net (2,679,517) (426,409) 15,579,261
------------ ------------ ------------
(Loss) income before income taxes (18,713,663) (17,284,823) 4,819,822
Income tax benefit (227,798) (215,223) (226,033)
------------ ------------ ------------
Net (loss) income $(18,485,865) $(17,069,600) $ 5,045,855
------------ ------------ ------------
Net (loss) income per share - basic $ (.27) $ (.30) $ .09
============ ============ ============
Net (loss) income per share - diluted $ (.27) $ (.30) $ .09
============ ============ ============
Weighted average shares outstanding - basic 67,397,175 56,520,041 54,678,932
============ ============ ============
Weighted average shares outstanding - diluted 67,397,175 56,520,041 55,298,063
============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
PHARMOS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (NOTES 9 & 10)
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
- --------------------------------------------------------------------------------
PAID-IN
COMMON STOCK DEFERRED CAPITAL IN ACCUMULATED
SHARES AMOUNT COMPENSATION EXCESS OF PAR DEFICIT
------------- ------------- ------------- ------------- -------------
December 31, 2000 54,082,253 $ 1,622,467 $ 0 $ 108,965,351 $ (90,494,309)
Warrant and option exercises 1,109,446 33,283 2,384,259
Option issuances for consultant compensation (50,175) 189,893
Stock option issuances below fair market value (172,969) 207,563
Issuance of Common Stock and adjustments in
connection with private equity sale, net
of fees of $5,924 182,964 5,489 (595,308)
Net income 5,045,855
------------- ------------- ------------- ------------- -------------
December 31, 2001 55,374,663 1,661,239 (223,144) 111,151,758 (85,448,454)
Option issuances for consultant compensation 50,175 13,362
Amortization of stock option issuances below
fair market value 52,981
Accretion of fair value of refinanced debt 420,221
Stock adjustment (40,583) (1,217) 1,092
Issuance of Common Stock - Employee
Stock Purchase Plan 23,284 699 20,057
Conversion of convertible debt and interest
to equity 1,217,485 36,525 2,581,068
Net loss (17,069,600)
------------- ------------- ------------- ------------- -------------
December 31, 2002 56,574,849 1,697,246 (119,988) 114,187,558 (102,518,054)
Warrant and option exercises 3,992,845 119,785 6,178,229
Warrant derivative adjustments 936,156
Option issuances for consultant compensation 56,866
Amortization of stock option issuances below
fair market value 53,328
Accretion of fair value of refinanced debt 68,808
Reversal of benefit conversion feature (786,000)
Issuance of Common Stock - Employee
Stock Purchase Plan 29,919 898 38,993
Issuance of Common Stock - public offering
sales, net of fees of $2,012K 10,500,000 315,000 26,548,131
Issuance of warrants with Convertible
Debenture offering, net of fees of $277K 3,663,949
Issuance of Common Stock - private equity
sales, net of fees of $892K 14,470,592 434,118 11,067,369
Net loss (18,485,865)
------------- ------------- ------------- ------------- -------------
December 31, 2003 85,568,205 $ 2,567,047 $ (66,660) $ 161,960,059 $(121,003,919)
============= ============= ============= ============= =============
TOTAL
TREASURY STOCK SHAREHOLDERS'
SHARES AMOUNT EQUITY
------------- ------------- -------------
December 31, 2000 18,356 $ (551) $ 20,092,958
Warrant and option exercises 2,417,542
Option issuances for consultant compensation 139,718
Stock option issuances below fair market value 34,594
Issuance of Common Stock and adjustments in
connection with private equity sale, net
of fees of $5,924 (589,819)
Net income 5,045,855
------------- ------------- -------------
December 31, 2001 18,356 (551) 27,140,848
Option issuances for consultant compensation 63,537
Amortization of stock option issuances below
fair market value 52,981
Accretion of fair value of refinanced debt 420,221
Stock adjustment (4,167) 125 --
Issuance of Common Stock - Employee
Stock Purchase Plan 20,756
Conversion of convertible debt and interest
to equity 2,617,593
Net loss (17,069,600)
------------- ------------- -------------
December 31, 2002 14,189 (426) 13,246,336
Warrant and option exercises 6,298,014
Warrant derivative adjustments 936,156
Option issuances for consultant compensation 56,866
Amortization of stock option issuances below
fair market value 53,328
Accretion of fair value of refinanced debt 68,808
Reversal of benefit conversion feature (786,000)
Issuance of Common Stock - Employee
Stock Purchase Plan 39,891
Issuance of Common Stock - public offering
sales, net of fees of $2,012K 26,863,131
Issuance of warrants with Convertible
Debenture offering, net of fees of $277K 3,663,949
Issuance of Common Stock - private equity
sales, net of fees of $892K 11,501,487
Net loss (18,485,865)
------------- ------------- -------------
December 31, 2003 14,189 $ (426) $ 43,456,101
============= ============= =============
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
PHARMOS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
--------------------------------------------
2003 2002 2001
------------ ------------ ------------
Cash flows from operating activities:
Net (loss) income $(18,485,865) $(17,069,600) $ 5,045,855
Adjustments to reconcile net (loss) income to net
cash flow used in operating activities:
Depreciation and amortization 654,617 691,824 773,973
Reversal of beneficial conversion feature (786,000) -- --
Change in the value of warrants 1,759,184 -- --
Amortization of debt discount and issuance costs 1,431,425 312,391 1,216,398
Amortization of fair value of change in convertible debt 68,808 420,221 --
Option issuances - consultant compensation 56,866 63,537 139,718
Stock options issued below fair market value 53,328 52,981 34,594
Gain from sale of LE product line -- -- (16,285,324)
Changes in operating assets and liabilities
Inventories -- -- 322,620
Other receivables 17,555 (8,733) (862,542)
Prepaid expenses and other current assets (261,029) 673,704 (116,586)
Prepaid royalties -- -- 6,591
Other assets 11,694 (10,250) (3,947)
Accounts payable (736,999) 1,545,161 (113,179)
Accrued expenses (1,490,381) (2,450,469) 25,820
Accrued wages & other compensation 486,882 (318,287) 548,959
Other liabilities -- 10,000 (100,000)
------------ ------------ ------------
Net cash used in operating activities (17,219,915) (16,087,520) (9,367,050)
------------ ------------ ------------
Cash flows from investing activities:
Purchases of fixed assets (117,391) (565,865) (859,174)
(Increase) decrease in restricted cash (13,839,999) 3,105,802 (1,330,390)
Proceeds from sale of LE business, net -- -- 23,136,930
------------ ------------ ------------
Net cash (used in) provided by
investing activities (13,957,390) 2,539,937 20,947,366
------------ ------------ ------------
Cash flows from financing activities:
Advances against future sales, net -- -- (619,702)
Proceeds from issuance of common stock
and exercise of options and warrants, net 44,702,523 20,756 2,417,542
Proceeds from issuance of convertible debentures
and warrants, net 19,764,745 -- --
Repayment from convertible debentures, net (3,500,000) (2,000,000) --
Fees related to refinancing convertible debt -- (163,000) --
Pricing adjustments for private placement, net -- -- (589,819)
------------ ------------ ------------
Net cash provided by (used in)
financing activities 60,967,268 (2,142,244) 1,208,021
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 29,789,963 (15,689,827) 12,788,337
Cash and cash equivalents at beginning of year 19,579,287 35,269,114 22,480,777
------------ ------------ ------------
Cash and cash equivalents at end of year $ 49,369,250 $ 19,579,287 $ 35,269,114
============ ============ ============
Supplemental Information:
Interest paid $ 765,448 $ 175,165 $ 243,983
------------ ------------ ------------
Supplemental disclosure of non-cash financing activities:
Conversion of convertible debt and interest to equity $ -- $ 2,617,593 --
Non-cash fees for equity financings $ 663,266 -- --
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The Company
Pharmos Corporation (the "Company" or "Pharmos") is a bio-pharmaceutical
company that discovers and develops new drugs to treat a range of
neuro-inflammatory disorders. The Company has executive offices in Iselin,
New Jersey and conducts research and development and pilot manufacturing
through its wholly owned subsidiary, Pharmos, Ltd., in Rehovot, Israel.
In October 2001, the Company sold its ophthalmic product line that included
Lotemax(R) and Alrex(R), two products that were being marketed, and future
extensions of loteprednol etabonate (see Note 4). As a result of the sale,
the Company is exclusively in the drug candidate development stage.
2. Liquidity and Business Risks
The Company incurred operating losses since its inception through the year
ended December 31, 2000 and was not profitable in 2003 and 2002. At
December 31, 2003, the Company had an accumulated deficit of $121.0
million. Such losses have resulted principally from costs incurred in
research and development and from general and administrative expenses. The
Company has funded its operations through the use of cash obtained
principally from third party financing. Management believes that the
current cash and cash equivalents of $49.4 million as of December 31, 2003,
will be sufficient to support the Company's continuing operations beyond
December 31, 2004.
The Company is continuing to actively pursue various funding options,
including additional equity offerings, strategic corporate alliances,
business combinations and the establishment of product related research and
development limited partnerships, to obtain additional financing to
continue the development of its products and bring them to commercial
markets. Should the Company be unable to raise adequate financing in the
future, long-term projects will need to be scaled back or discontinued (See
Note 19 for subsequent events).
3. Significant Accounting Policies
Basis of consolidation
The accompanying consolidated financial statements include the Company's
wholly owned subsidiary, Pharmos Ltd. All significant intercompany balances
and transactions are eliminated in consolidation.
Use of estimates
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires the Company to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues, costs and
expenses during the reporting period. The most significant estimates and
assumptions related to asset impairments and the tax valuation allowance.
Actual results could differ from those estimates.
Net (loss)/ income per common share
Basic net (loss)/income per common share is computed by dividing net (loss)
income for the period, by the sum of the weighted average number of shares
of common stock issued and outstanding. Diluted earnings per share is
computed by dividing net (loss) income for the period by the sum of the
weighted average number of shares of common stock issued and outstanding,
increased to include the number of common shares that would have been
issued if all outstanding stock options, stock warrants, and convertible
debt that are dilutive are converted.
F-7
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In accordance with FASB 128 "Earnings per Share," for the years ended
December 31, 2003 and 2002, there were 16,712,467 and 6,803,278,
respectively, of outstanding options, warrants and convertible debt which
were excluded from the dilutive EPS calculation due to the fact that the
results of the exercise of such would be antidilutive.
A reconciliation of the basic and diluted earnings per share computations
for net income for the year ended December 31, 2001 is as follows:
EARNINGS
INCOME SHARES PER SHARE
---------- ---------- ---------
Basic EPS Net Loss $5,045,855 54,678,932 $.09
Effect of Dilutive Securities:
Warrants 314,738
Options 304,393
---------- ---------- ----
Dilutive EPS Loss applicable to common
shareholders plus assumed conversion $5,045,855 55,298,063 $.09
========== ========== ====
In accordance with FASB 128 "Earnings per Share," 1,811,961 options,
warrants and the convertible debt were not included in the calculation
above as the results of the exercise of such would be antidilutive.
Cash and cash equivalents
The Company considers all highly liquid instruments purchased with an
original maturity of three months or less to be cash equivalents. Cash
equivalents primarily consist of commercial paper and money market accounts
in 2003 and 2002.
Revenue recognition
The Company earns license fees from the transfer of drug technology and the
related preclinical research data. License fee revenue is recognized when
all performance obligations are completed and the amounts are considered
collectible. Up-front license fees are deferred and recognized when all
performance obligations are completed. The Company had no product sales
revenue during 2003 or 2002 due to the sale of its ophthalmic product line
in October 2001 and does not expect product sale revenues for the next few
years and may never have such sales if products currently under development
fail to be commercialized.
Other receivables
As of December 31, 2003 and 2002, other receivables consist primarily of
grants for research and development relating to certain projects.
Restricted cash
In connection with the September 2003 Convertible Debenture offering, the
terms of the agreement required the Company to establish an escrow account.
The escrowed account is shown as Restricted Cash on the Company's balance
sheet and will be released to the Company in proportion to the amount of
Convertible Debentures converted into common shares or upon the repayment
of the debt beginning March 2004. The terms of the debentures further
stipulates that the restricted cash can only be used to fund acquisitions
upon the approval of the investors. The short-term balance represents debt
repayment due within 12 months. The long-term balance represents debt
repayment due greater than 12 months.
F-8
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Fixed assets
Fixed assets are recorded at cost and are depreciated on a straight-line
basis over their estimated useful lives. The Company uses the following
estimated useful lives:
Laboratory, pilot plant and other equipment 7 years to 14 years
Leasehold improvements 5 years to 14 years
Office furniture and fixtures 3 years to 17 years
Computer equipment 3 years
Vehicles 7 years
Leasehold improvements are amortized on a straight-line basis over the
shorter of the lease term or the estimated lives of the related assets.
Maintenance and repairs are expensed as incurred.
Long-lived assets
The Company periodically evaluates potential impairments of its long-lived
assets. When the Company determines that the carrying value of long-lived
assets may not be recoverable based upon the existence of one or more
indicators of impairment, the Company evaluates the projected undiscounted
cash flows related to the assets and other factors. If these cash flows are
less than the carrying value of the assets, the Company measures the
impairment using discounted cash flows or other methods of determining fair
value.
Research and development costs
All research and development costs are expensed when incurred. The Company
accounts for reimbursements of research and development costs as a
reduction of research and development expense.
Income taxes
The Company accounts for income taxes in accordance with the provisions of
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes" ("SFAS 109"). Under the asset and liability method of SFAS 109,
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective
tax bases and operating loss and tax credit carryforwards. Deferred tax
assets and liabilities, if any, are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Under SFAS 109, the
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Foreign exchange
The Company's foreign operations are principally conducted in U.S. dollars.
Any transactions or balances in currencies other than U.S. dollars are
remeasured and any resultant gains and losses are included in other
(expense) income. To date, such gains and losses have been insignificant.
Concentration of credit risk
Financial instruments that potentially expose the Company to concentrations
of credit risk consist primarily of cash and cash equivalents. The Company
maintains some of its cash balances in accounts that exceed federally
insured limits. The Company has not experienced any losses to date
resulting from this practice.
F-9
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Substantially all product sales in 2001 were to a single customer, as a
result of the Company's marketing agreement with that customer.
Fair value of financial instruments
The carrying amounts of the Company's financial instruments, including cash
and cash equivalents, other receivables, other assets, accounts payable,
accrued liabilities, and convertible debentures approximate fair value due
to their short maturities.
Equity based compensation
The Company accounts for its employee stock option plans in accordance with
the provisions of Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees", and related interpretations. As such,
compensation expense related to employee stock options is recorded only if,
on the date of grant, the fair value of the underlying stock exceeds the
exercise price. The Company adopted the disclosure-only requirements of
SFAS No. 123, "Accounting for Stock-Based Compensation", which allows
entities to continue to apply the provisions of APB Opinion No. 25 for
transactions with employees and provide pro forma operating results and pro
forma per share disclosures for employee stock grants as if the
fair-value-based method of accounting in SFAS No. 123 had been applied to
these transactions. Options issued to non-employees are valued using the
fair value methodology under SFAS No. 123.
The following table illustrates the effect on net (loss) income and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS No. 123 to stock-based employee compensation. The
estimated fair value of each option is calculated using the Black-Scholes
option-pricing model.
Year Ended December 31,
-------------------------------------------
2003 2002 2001
------------ ------------ -----------
Net (loss) income as reported $(18,485,865) $(17,069,600) $ 5,045,855
Add: Stock-based employee compensation
expense included in reported net (loss)
income 53,328 52,981 34,594
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards (1,017,000) (1,108,000) (923,000)
------------ ------------ -----------
Pro forma net (loss) income $(19,449,537) $(18,124,619) $ 4,157,449
============ ============ ===========
Earnings per share:
Basic - as reported $(0.27) $(0.30) $0.09
Basic - pro forma $(0.29) $(0.32) $0.08
Diluted - as reported $(0.27) $(0.30) $0.09
Diluted - pro forma $(0.29) $(0.32) $0.08
Other disclosures required by SFAS No. 123 have been included in Note 12.
Reclassifications
Certain amounts for 2002 and 2001 have been reclassified to conform to the
fiscal 2003 presentation. Such reclassifications did not have an impact on
the Company's financial position or results of operations.
F-10
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recent Accounting Pronouncements
In May 2003, the Financial Accounting Standards Board issued Statement No.
150 ("FAS 150"), Accounting for Certain Financial Instruments with
Characteristics of Both Liabilities and Equity. FAS 150 specifies that
instruments within its scope embody obligations of the issuer and that the
issuer must classify them as liabilities. SFAS 150 requires issuers to
classify as liabilities the following three types of freestanding financial
instruments: (1) mandatorily redeemable financial instruments; (2)
obligations to repurchase the issuer's equity shares by transferring assets
and (3) certain obligations to issue a variable number of shares. SFAS 150
defines a "freestanding financial instrument" as a financial instrument
that (1) is entered into separately and apart from any of the entity's
other financial instruments or equity transactions or (2) is entered into
in conjunction with some other transaction and can be legally detached and
exercised on a separate basis. For all financial instruments entered into
or modified after May 31, 2003, SFAS 150 is effective immediately. For all
other instruments of public companies, SFAS 150 went into effect at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have an impact on the Company's financial
statements for the third quarter of 2003.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities ("SFAS No. 149"). SFAS No.
149 clarifies under what circumstances a contract with an initial net
investment meets the characteristics of a derivative as discussed in
Statement No. 133. It also specifies when a derivative contains a financing
component that warrants special reporting in the Consolidated Statement of
Cash Flows. SFAS No. 149 amends certain other existing pronouncements in
order to improve consistency in reporting these types of transactions. The
new guidance is effective for contracts entered into or modified after June
30, 2003, and for hedging relationships designated after June 30, 2003.
This standard did not have an impact on the Company's consolidated
financial statements.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51". FIN 46 requires an
investor to consolidate a variable interest entity if it is determined that
the investor is a primary beneficiary of that entity, subject to the
criteria set forth in FIN 46. Assets, liabilities, and non-controlling
interests of newly consolidated variable interest entities will be
initially measured at fair value. After initial measurement, the
consolidated variable interest entity will be accounted for under the
guidance provided by Accounting Research Bulletin No. 51, "Consolidated
Financial Statements." FIN 46 is effective for variable interest entities
created or entered into after January 31, 2003. For variable interest
entities created or acquired before February 1, 2003, FIN 46 applies in the
first fiscal year or interim period beginning after December 15, 2003. The
Company does not believe that the adoption of this standard will have a
material impact on its consolidated financial statements.
In November 2002, the FASB issued FASB Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (`FIN 45"), which clarifies disclosure
and recognition/measurement requirements related to certain guarantees. The
disclosure requirements are effective for financial statements issued after
December 15, 2002 and the recognition/measurement requirements are
effective on a prospective basis for guarantees issued or modified after
December 31, 2002. This standard did not have a material impact on the
Company's consolidated financial statements.
4. Collaborative Agreements
In June 1995, the Company entered into a marketing agreement (the
"Marketing Agreement") with Bausch & Lomb Pharmaceuticals, Inc. ("Bausch &
Lomb"), a shareholder of the Company, to market Lotemax and Alrex, on an
exclusive basis in the United States following receipt of FDA approval. The
Marketing Agreement also covered the Company's other loteprednol etabonate
based product, LE-T. Under the Marketing Agreement, Bausch & Lomb purchased
the active drug substance (loteprednol
F-11
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
etabonate) from the Company. A second agreement, covering Europe, Canada
and other selected countries, was signed in December 1996 ("the New
Territories Agreement"). In October 2001, the Company sold its ophthalmic
product line, including the Company's rights under the above agreements to
Bausch & Lomb.
Through October 2001, Bausch & Lomb provided the Company with $5 million in
cash advances against future sales. Bausch & Lomb recouped the advances by
withholding a certain percentage of payments to the Company against
payments for purchases of the active drug substance. With the completion of
the sale of the ophthalmic business to Bausch & Lomb in October 2001, all
such advances have been repaid.
Sale of Ophthalmic Product line
In October 2001, Bausch & Lomb purchased all rights to the Company's
loteprednol etabonate (LE) ophthalmic product line for cash and assumption
of certain ongoing obligations. The Company received gross proceeds of
approximately $25 million in cash for its rights to Lotemax(R) and
Alrex(R), prescription products that were manufactured and marketed by
Bausch & Lomb under a 1995 Marketing Agreement with the Company. Bausch &
Lomb also acquired future extensions of LE formulations including LE-T, a
product candidate that was submitted to the FDA for marketing approval in
September 2003. Bausch & Lomb will pay the Company additional fees
depending on the approval date with the FDA as follows: If the earlier of
(a) commercial launch or (b) 6 months after FDA approval of LE-T (the
"Triggering Event") occurs before January 1, 2002 the Company was initially
to receive $15.4 million. That amount has been decreasing by $90,000 for
each month of 2002 and 2003 to a minimum amount of $13.3 million (if the
Triggering Event occurs on December 31, 2003). Since the Triggering Event
had not occurred as of December 31, 2003, the Company and Bausch & Lomb
will negotiate in good faith to agree upon the amount of additional
consideration that Bausch & Lomb will pay the Company but not to exceed
$13.3 million. The Company can not be assured that FDA approval of LE-T
will be obtained. The patent owner of LE-T is entitled to 11% of the
additional fees that the Company receives as a result of the contingent
payment, which will be netted against any additional gain recorded.
Under the terms of the October 2001 agreement, which is subject to
renegotiation, upon FDA approval the Company may receive a milestone
payment of up to $10 million if the following occurs: (a) net sales of LE-T
in the first 12 months after commercial launch are at least $7.5 million
and (b) net sales of LE-T in the second twelve consecutive months after
commercial launch (i) exceed $15.0 million and (ii) are greater than net
sales in (a) above. Future payments will be included in the Company's
income when all contingencies are resolved. The patent owner is also
entitled to 14.3% of the additional fees that the Company receives as a
result of these contingent payments.
Pharmos agreed to pay up to $3.75 million of the costs of developing LE-T,
of which $600,000 was deducted from the purchase price paid by Bausch &
Lomb in October 2001. Another $1.57 million was paid to Bausch & Lomb in
October 2003, leaving an additional $1.56 million as Pharmos' share of
these research and development related LE-T expenses. This amount is
included in accounts payable and represents the maximum amount Pharmos owes
Bausch & Lomb for their project development under the terms of the 2001
agreement.
As of October 2001, the Company received $925,780 from the Israel-U.S.
Binational Industrial Research and Development Foundation to develop
Lotemax(R) and LE-T. During October 2001, in connection with the sale of
the Company's existing ophthalmic business, the Company paid the foundation
royalties for Lotemax(R) which concluded its' obligation to the foundation
in respect to Lotemax(R). The Company retains its' obligation to repay that
portion of funding it received from the foundation with respect to LE-T of
$308,350. The Company's contingent obligation to the foundation is due only
when LE-T is approved by the FDA.
F-12
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As a result of the sale of its ophthalmic product line, the Company
recorded a net gain of $16.3 million. The Company incurred transaction and
royalty costs of approximately $2.0 million. The Company also compensated
the LE patent owner approximately $2.7 million ($1.5 million paid upon
closing and $1.2 million of this amount was paid in October 2002) from the
proceeds of the sale of Lotemax and Alrex in return for his consent to the
Company's assignment of its rights under the license agreement to Bausch &
Lomb.
5. Fixed Assets
Fixed assets consist of the following:
DECEMBER 31,
--------------------------
2003 2002
----------- -----------
Laboratory, pilot plant and other equipment $ 2,961,815 $ 3,003,672
Leasehold improvements 733,325 725,221
Office furniture and fixtures 515,595 479,626
Computer equipment 919,031 860,252
Vehicles 88,231 88,231
----------- -----------
5,217,997 5,157,002
Less - Accumulated depreciation and amortization (3,962,901) (3,364,680)
----------- -----------
$ 1,255,096 $ 1,792,322
=========== ===========
Depreciation and amortization of fixed assets was $654,617, $691,824 and
$622,283 in 2003, 2002 and 2001, respectively.
6. Accrued expenses
Accrued expenses consist of the following:
DECEMBER 31,
-----------------------
2003 2002
---------- ----------
Accrued expenses, other $ 419,022 $ 524,506
Accrued interest -- 341,000
Research & development cost relating to traumatic
brain injury project 1,332,178 814,000
Research & development cost relating to LE-T
(Note 4) -- 1,562,075
---------- ----------
Total accrued expenses $1,751,200 $3,241,581
========== ==========
7. Grants for Research and Development
The Company has entered into agreements with the State of Israel, which
provide for grants for research and development relating to certain
projects. Amounts received pursuant to these agreements have been reflected
as a reduction of research and development expense. Such reductions
amounted to $3,295,819, $2,755,882 and $1,336,566 during 2003, 2002 and
2001, respectively. The agreements with agencies of the State of Israel
place certain legal restrictions on the transfer of the technology and
manufacture of resulting products outside Israel. The Company will be
required to pay royalties, at rates ranging from 3% to 5%, to such agencies
from the sale of products, if any, developed as a result of the research
activities carried out with the grant funds.
As of December 31, 2003, the total amounts received under such grants
amounted to $10,905,358. Aggregate future royalty payments related to sales
of products developed, if any, as a result of these grants are limited to
$9,203,583 based on grants received through December 31, 2003.
F-13
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In April 1997, the Company signed an agreement with Consortium Magnet for
developing generic technologies for design and development of drugs and
diagnostic kits which consortium is operated by the Office of the Chief
Scientist of Israel. Under such agreements the Company is entitled to a
non-refundable grant amounting to approximately 60% of actual research and
development and equipment expenditures on approved projects. No royalty
obligations are required within the framework. As of December 31, 2003, the
Company received cumulative grants totaling $1,659,549 for this program
which was completed and closed.
During 2003, the Company signed an agreement with Consortium Magnet to
develop a supply of water-soluble prodrugs of lipophilic compounds that
improve their bioavailability and biopharmaceutical properties. Under such
agreement the Company is entitled to a non-refundable grant amounting to
approximately 60% of actual research and development and equipment
expenditures on approved projects. No royalty obligations are required
within the framework. During 2003, Pharmos was awarded a grant of $220,000.
8. Licensing Arrangements
The Company is a licensee of certain research technologies and has various
license agreements wherein the Company has acquired exclusive or
co-exclusive rights to develop and commercialize certain research
technologies. These agreements generally require the Company to pay
royalties on the sale of products developed and contingent royalties based
upon milestones from the licensed technologies and fees on revenues from
sublicenses, where applicable. The royalty rates, as defined in the
respective license agreements, are customary and usual in the
pharmaceutical industry. The royalties will be payable for periods up to
fifteen years from the date of specified events, including the date of the
first sale of such products, or the date from which the first registered
patent from the developed technologies is in force, or the year following
the date on which approval from the FDA is received for a developed
product. No amounts have been recorded as a liability with respect to any
contingent royalties as of December 31, 2003 and 2002.
Certain of the license agreements, which include agreements related to
Lotemax and Alrex, required annual payments for periods extending through
2012. Minimum annual payments under licensing agreements are $103,500.
License fee expense amounted to approximately $0, $0, and $103,500 in 2003,
2002, and 2001, respectively. With the completion of the sale of the
ophthalmic business to Bausch & Lomb in October 2001, the obligations under
these agreements have been assumed by Bausch & Lomb.
9. Private Placement
Convertible Debentures
On September 26, 2003, the Company completed a private placement of
convertible debentures and warrants to six institutional investors,
generating total gross proceeds of $21.0 million. $5.0 million of the
proceeds will be used for working capital purposes, and $16.0 million will
be available to fund acquisitions upon the approval of the investors. The
convertible debentures are convertible into common stock of the Company at
a fixed price of $4.04, 205% above the closing bid price of the stock for
the five days preceding the closing date. The debentures, which bear an
interest rate of 4%, will be redeemed in 13 substantially equal monthly
increments beginning March 31, 2004. Amounts converted into shares of
Pharmos common stock will reduce the monthly redemption amount in inverse
order of maturity. The $16.0 million earmarked for acquisition activity
will be held in escrow until used or repaid. In connection with the
financing, the Company also issued 5,514,705 three-year warrants (including
514,705 placement agent warrants) to purchase 5,514,705 shares of common
stock at an exercise price of $2.04 per share. Total issuance costs related
to this financing were approximately $1,229,000 in cash and $434,000 for
the value of the placement agent warrants. The Company
F-14
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
calculated the value of the warrants at the date of the transaction,
including the placement agent warrants, at approximately $4,652,877 under
the Black-Scholes option-pricing method (assumption: volatility 75%, risk
free rate 1.59% and zero dividend yield). The Company allocated the $19.34
million in net proceeds between the convertible debentures and the warrants
based on their fair values. The Company is reporting the debt discount of
approximately $3.5 million as a direct reduction to the face amount of the
debt in accordance with APB 21. The discount is being accreted over the
life of the outstanding debentures. Total accretion of the debt discount in
2003 was approximately $988,664. The issuance costs allocated to the
convertible debentures of approximately $1.4 million are being deferred and
amortized to interest expense over the life of the debt in proportion to
the principal balance outstanding allocated to the convertible debentures.
During 2003, the Company amortized $389,418 of issuance costs allocated to
the convertible dentures. The issuance costs allocated to the warrants of
approximately $277,000 were recorded as a debit to additional paid in
capital. As of December 31, 2003, 1,307,000 of the total warrants issued
were exercised for approximately $2,666,280.
As of December 31, 2003, the Convertible Debenture repayment schedule was
as follows:
2004 2005 Total
------------ ----------- ------------
Principal Amount $ 16,153,846 $ 4,846,154 $ 21,000,000
Applicable Discount: (2,451,434) (72,815) (2,524,249)
------------ ----------- ------------
Total, Net $ 13,702,412 $ 4,773,339 $ 18,475,751
============ =========== ============
The financing also addressed a possible concern Nasdaq raised informally
relating to a violation of one of Nasdaq's corporate governance rules.
Specifically, Nasdaq expressed a concern that the May 2003 private
placement, when aggregated with Pharmos' March 2003 registered private
placement, would have resulted in the possible issuance of more than 20% of
Pharmos' outstanding securities at a price less than the applicable fair
market value for such shares. Completion of the $21.0 million convertible
debt financing had the effect of resolving any such Nasdaq concerns.
If after the effective date, November 4, 2003, the closing price of the
Company's common stock for ten out of any twenty consecutive trading days
exceeds $5.50, subject to adjustment for reverse and forward stock splits,
stock dividends, stock combinations and other similar transactions of the
Common Stock that occur after the original issue date, the Company may on
one occasion, within three trading days of any such period, deliver notice
to the holder to cause the holder to immediately convert all or part of up
to 50% of the original aggregate principal amount of the debenture. If the
Company elects to exercise its right to a $5.50 forced conversion, it shall
exercise such right ratably among all holders of debentures. In addition,
if after the effective date, November 4, 2003, the closing price of the
Company's common stock for ten out of any twenty consecutive trading days
exceeds $6.50, the Company may deliver notice to the holder to immediately
convert all or part of up to the remaining 50% of the original aggregate
principal amount of the debentures.
In September 2000, the Company completed a private placement of Convertible
Debentures, common stock and warrants to purchase shares of common stock
with institutional investors, generating gross proceeds of $11 million. The
September 2000 Convertible Debentures, which generated gross proceeds of $8
million, were due in February 2002 and carried a 6% interest payable
semiannually in cash or common stock. In connection with the September 2000
Convertible Debentures, the institutional investors also received warrants
for the purchase of 276,259 common shares with a relative fair value of
$725,000. The September 2000 Convertible Debentures were convertible into
common shares of the Company at the conversion price of $3.83 per share (or
2,088,775 common shares) and were convertible beginning October 31, 2000.
Under certain limited anti-dilutive conditions, the conversion price could
change. Until converted into common stock or the outstanding principal is
repaid, the terms of the September 2000 Convertible Debentures required the
Company to deposit $4 million in an escrow account. The escrowed capital is
shown as Restricted Cash on the Company's balance sheet at
F-15
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002 and was released to the Company in proportion to the
amount of September 2000 Convertible Debentures converted into common
shares or upon the repayment of the debt.
The holders of the September 2000 Convertible Debentures and the Company
agreed to modify the repayment and conversion terms in December 2001. The
holders of $5.8 million convertible debt (book value on December 31, 2001,
including accrued interest) extended the maturity date to June 30, 2003 in
exchange for a reduction in the conversion price from $3.83 to $2.63 for
half of the outstanding balance and $ 2.15 for the other half of the
outstanding balance. The convertible debt with a maturity date of June 2003
was convertible beginning December 31, 2001. The holder of the remaining
outstanding debt of $1.9 million (including accrued interest) changed the
maturity date from February 28, 2002 to January 31, 2002 in exchange for
lowering the conversion price for the other holders. As the modification
was not significant in accordance with EITF 96-19 the change in the fair
value between the original convertible debt and the modified convertible
debt was accreted over the remaining term of the convertible debt with a
corresponding charge interest expense. During the first quarter of 2002,
the Company issued 1,217,485 shares of its common stock upon the conversion
of $2.5 million principal of the September 2000 Convertible Debenture
offering and repaid $2 million of the September 2000 Convertible
Debentures. During the first quarter of 2003, the remaining balance of the
$3.5 million was redeemed for approximately $4.0 million, which included
accrued interest.
Emerging Issues Task Force Issue No. 98-5, Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios, required the Company to compute the Beneficial
Conversion Feature ("BCF") of the convertible debt from the private
placement of September 2000. The BCF must be capitalized and amortized from
the closing date until the earliest date that the investors have the right
to convert the debt into common shares. The BCF in 2000 was computed at
approximately $1.8 million, all of which was amortized and included as
interest expense in the year ending December 31, 2000. Two of the eight
investors of the March 2003 private placement were also holders of the
remaining $3.5 million September 2000 Convertible Debenture offering, which
was ultimately redeemed for approximately $4.0 million, which includes
accrued interest. The September 2000 Convertible Debenture holders chose
not to convert the existing debt to common equity. Instead, the September
2000 Convertible Debenture holders opted to be repaid early and participate
in a new round of financing. For the two investors, the sale of the common
stock and warrants reduced the conversion price of the outstanding debt,
which resulted in an additional BCF charge of approximately $2.7 million
during the first quarter ending March 31, 2003. The total related BCF
charge since inception of the debt of $3.5 million was redeemed in the
first quarter of 2003 as a result of the debt being repaid. The impact of
the reversal of the total BCF charge since inception of the debt resulted
in a net credit of $786,000 recorded as interest income during the first
quarter ending March 31, 2003. This accounting treatment is in accordance
with EITF 00-27.
During 2001, the Company paid $589,819 and issued 182,964 shares of the
common stock of the Company to the investors in the convertible debenture.
The payments of cash and stock were the options chosen by the Company and
represent adjustments to the pricing based upon the Company's stock price
during the adjustment period. Additional shares were issued for no
additional consideration resulting in an increase in common stock of $5,489
and a corresponding decrease in additional paid in capital.
Common Stock
On May 30, 2003, the Company completed a private placement to sell common
shares and warrants to ten investors, generating total gross proceeds of
$8.0 million. The Company filed a registration statement with the
Securities and Exchange Commission to permit resales of the common stock by
the investors. The private placement offering was completed by issuing
9,411,765 shares of common stock at a price of $0.85 per share
(representing an approximate 20% discount to a ten-day trailing average of
the closing price of the stock ending May 28, 2003) and 3,264,706 warrants
at an exercise price of $1.40 per share, which includes 441,177 placement
agent warrants. Issuance costs of approximately
F-16
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
$525,000 in cash and $240,000 for the value of the placement agent warrants
were recorded as a debit to additional paid in capital. The Company
calculated the value of the warrants, including the placement agent
warrants, being approximately $1,773,000 under the Black-Scholes option
pricing method (assumption: volatility 75%, risk free rate 3.15% and zero
dividend yield). As of December 31, 2003, six of the twelve warrant holders
(ten investors and two placement agents) have exercised 1,700,000 warrants
totaling approximately $2,380,000.
On March 4, 2003, the Company completed a private placement to sell common
shares and warrants to eight investors, generating total gross proceeds of
$4.3 million under a shelf registration. The private placement offering was
completed by issuing 5,058,827 shares of common stock at a price of $0.85
per share (the fair market value on March 4, 2003) and 1,141,182 warrants
at an exercise price of $1.25 per share, which includes 129,412 placement
agent warrants. Issuance costs of approximately $127,000 in cash and
$45,000 for the value of the placement agent warrants were recorded as a
debit to additional paid in capital. As of December 31, 2003, five of the
nine warrant holders (eight investors and one placement agent) have
exercised 823,533 warrants totaling approximately $1,029,416.
According to EITF 00-19, the warrants issued in March 2003 meet the
requirements of and will be accounted for as a liability since registered
shares must be delivered upon settlement. The Company calculated the
initial value of the warrants at the date of the transaction, including the
placement agent warrants, being approximately $394,000 under the
Black-Scholes option-pricing method (assumption: volatility 75%, risk free
rate 2.88% and zero dividend yield). The value of the warrants is being
marked to market each reporting period as a derivative loss until exercised
or expiration and has a value of $823,029 at December 31, 2003.
Upon exercise of each of the warrants, the related liability is removed by
recording an adjustment to additional paid-in-capital. A total of $936,156
was recorded as a credit to additional paid-in-capital in 2003 as result of
exercises totaling approximately $1.3 million and the recording of the
initial value of the warrants of approximately $394,000.
One common stock investor from a private placement in September 2000 had an
option ("Call Warrant"), in the form of a warrant, to purchase an
additional $2 million of common shares for a period of one year from the
closing dateprovided that the future purchase price is greater than the
initial closing price of $3.65 per share. The maximum number of shares that
could be issued from this warrant was 547,945 and was part of the maximum
number of warrants issued for the total private placement of 1,115,730,
including placement agent warrants at prices ranging from $3.65 to $6.08
per share. The warrants to the one investor for the purchase of an
additional $2 million of common stock were valued using the Black Scholes
option-pricing model (assumptions: volatility of 78%, risk free rate of
5.89% and a zero dividend yield). The warrants to the placement agents were
valued using the Black Scholes option-pricing model using the same
assumptions as above. Both warrant issuances were recorded upon issuance as
additional paid-in-capital. The investor exercised the Call Warrant in the
third quarter of 2001, with the Company issuing 542,299 common shares.
During the fourth quarter of 2001, the Company issued 281,659 shares as an
adjustment to the pricing of the Call Warrant based upon the Company's
stock price during the adjustment period as defined in the Call Warrant
agreement.
10. Common and Preferred Stock Transactions
2003 Transactions
The Company issued 3,992,845 shares of its common stock upon the exercise
of stock options and warrants, and received consideration of $6,298,014.
In December 2003, the Company completed a public offering. Pharmos sold
10,500,000 common shares at a purchase price of $2.75 per share for gross
proceeds of $28,875,000. The stock was offered
F-17
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
in a firm commitment underwriting pursuant to an existing shelf
registration statement. The net proceeds of this offering to Pharmos were
approximately $26.9 million.
During, 2003, the Company issued 29,919 shares of common stock with gross
proceeds of $39,891 pursuant to the Pharmos Corporation 2001 Employee Stock
Purchase Plan. All full-time and part-time employees of the Company who
have completed a minimum of 6 months of employment are eligible to
participate. The price of the Common Stock is calculated at 85% of the
lower of either the mean between the highest and lowest prices at which
Pharmos common stock trades on the first business day of the month, or the
mean between the highest and lowest trading prices on the day of exercise
(the last day of the month). A participant can purchase shares not to
exceed 10% of one's annualized base pay; $25,000; or 5% or more of shares
outstanding. The total number of shares reserved for issuance under the
2001 Plan is 500,000 shares. As of December 31, 2003, there were 446,697
shares remaining for issuance under the 2001 Plan.
As of December 31, 2003, the Company had reserved 5,198,020 common shares
for the possible conversion of the convertible debentures issued in
September 2003, 3,771,968 for outstanding stock options and 7,722,997 for
outstanding warrants.
2002 Transactions
During, 2002, the Company issued 23,384 shares of common stock with gross
proceeds of $20,756 pursuant to the Pharmos Corporation 2001 Employee Stock
Purchase Plan
On October 23, 2002, the Board of Directors of the Company approved a
stockholder rights plan as set forth in the Rights Agreement, dated as of
October 23, 2002, between the Company and American Stock Transfer & Trust
Company, as Rights Agent. Under the Rights Agreement, each common
stockholder of record as of the close of business on November 6, 2002,
received a dividend of one right for each share of common stock held. Each
right entitled the holder to purchase from the Company one one-thousandth
of a share of a new series of participating preferred stock at an initial
purchase price of $15.00. The plan is designed to impose a significant
penalty upon any person or group that acquires 15% or more of our
outstanding common stock without the approval of our board. The stockholder
rights are triggered either ten days after a third party announces its
acquisition of 15% or more of the Company's common stock or ten business
days after someone starts a tender offer to acquire such amount of shares.
At that time, all stockholders, other than the person who acquired the
block or started the tender offer, will have the right for 60 days, upon
payment of $15, to purchase $30 worth of common stock of the Company, in
substitution for the new preferred stock authorized by the stockholder
rights plan, at the time current market price. As a result, the
stockholders of the Company will be able to purchase a large number of
shares at a discount, significantly diluting the interest of the acquiring
person and making it significantly more expensive for that person to
acquire control of the Company.
2001 Transactions
The Company issued 1,109,446 shares of its common stock upon the exercise
of stock options and warrants, and received consideration of $2,417,542.
On January 1, 2001 the Company terminated the employment contract for two
employees, who became independent consultants. In accordance with the
incentive option plan, all terminated employees who are extended a
consulting contract may continue to vest their options. Since the employees
became consultants on a prospective basis, the options outstanding on the
date of termination are marked to market each quarter until the options
vest. The Company is recording the value of the services being received
based on the fair market value of the options using the Black-Scholes
option-pricing model, which was more reliable than the value of the
services provided. The fair value of these options has been estimated based
on the following weighted average assumptions: volatility of 78%, risk free
rate
F-18
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of 5.89% and a zero dividend yield. For the year ended December 31, 2001
the Company recorded professional fees relating to these terminated
employees of $139,718.
F-19
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
11. Warrants
Some of the warrants issued in connection with various equity financing and
related transactions during 1991 through 2001 contain anti-dilution
provisions requiring adjustment. The following table summarizes the common
shares issuable upon exercise of warrants outstanding at December 31, 2003
as adjusted for the events which have triggered anti-dilution provisions
contained in the respective warrant agreements:
COMMON SHARES
ISSUABLE EXERCISE
ISSUANCE DATE EXPIRATION DATE UPON EXERCISE PRICE
------------- --------------- ------------- --------
April 1995 April 2005 340,600 $ 2.75
April 2005 10,000 $ 0.78
February 1997 February 2007 486,500 $ 1.59
March 1997 March 2008 171,052 $ 1.38
January 1998 October 2005 17,000 $ 1.66
November 1999 November 2004 4,000 $ 1.19
December 1999 December 2004 4,000 $ 1.19
January 2000 January 2005 4,000 $ 1.19
February 2000 February 2005 4,000 $ 1.19
March 2000 March 2005 4,000 $ 1.19
April 2000 April 2005 4,000 $ 1.19
May 2000 May 2005 4,000 $ 1.19
June 2000 June 2005 4,000 $ 1.19
July 2000 July 2005 4,000 $ 1.19
August 2000 August 2005 4,000 $ 1.19
September 2000 September 2005 95,843 $ 4.56
September 2005 92,086 $ 4.34
September 2005 379,856 $ 4.95
March 2003 March 2007 317,649 $ 1.25
May 2003 May 2008 1,564,706 $ 1.40
September 2003 September 2006 4,207,705 $ 2.04
--------- --------
Total shares and average
exercise price 7,722,997 $ 2.06
========= ========
F-20
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. Stock Option Plans
The Company's shareholders have approved incentive stock option plans for
officers and employees. Options granted are generally exercisable over a
specified period, not less than one year from the date of grant, generally
expire ten years from the date of grant and vest evenly over four years.
A summary of the various established stock options plans is as follows:
1992 Plan. The maximum number of shares of the Company's Common Stock
available for issuance under the 1992 Plan was 750,000 shares, subject to
adjustment in the event of stock splits, stock dividends, mergers,
consolidations and the like. As of December 31, 2003, there were 277,086
options outstanding to purchase the Company's Common Stock under this plan.
Each option granted which is outstanding under the 1992 plan as of December
31, 2003 expires on October 31, 2005.
1997 Plan and 2000 Plan. The 1997 Plan was and the 2000 Plan is
administered by a committee appointed by the Board of Directors (the
"Compensation Committee"). The Compensation Committee will designate the
persons to receive options, the number of shares subject to the options and
the terms of the options, including the option price and the duration of
each option, subject to certain limitations.
The maximum number of shares of Common Stock available for issuance under
the 1997 Plan was 1,500,000 shares, as amended, and under the 2000 Plan is
3,500,000 shares. Each plan is subject to adjustment in the event of stock
splits, stock dividends, mergers, consolidations and the like. Common Stock
subject to options granted under the 1997 Plan and the 2000 Plan that
expire or terminate will again be available for options to be issued under
each Plan.
All incentive stock option grants during 2003 were made from the Pharmos
Corporation 2000 Incentive and Non-Qualified Stock Option Plan. The Company
does not plan to issue any additional options under the 1992 and 1997
Plans.
F-21
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes activity in approved incentive stock options
approved by the Company's Board of Directors:
WEIGHTED
UNDER AVERAGE
OPTION EXERCISE PRICE
---------- --------------
Options Outstanding at 12/31/00 1,519,838 $2.71
Granted at fair market value 57,000 $2.56
Granted below fair market value 453,500 $1.88
Exercised (12,500) $1.25
Cancelled (3,000) $4.03
---------- -----
Options Outstanding at 12/31/01 2,014,838 $2.53
Granted 692,000 $1.90
Cancelled (135,575) $2.41
---------- -----
Options Outstanding at 12/31/02 2,571,263 $2.36
---------- -----
Granted 767,500 $1.02
Exercised (165,062) $1.36
Cancelled (106,194) $2.33
---------- -----
Options Outstanding at 12/31/03 3,067,507 $2.08
========== =====
Options exercisable at 12/31/03 1,639,100 $2.52
========== =====
Options exercisable at 12/31/02 1,282,837 $2.51
========== =====
Options exercisable at 12/31/01 898,399 $2.47
========== =====
Additional information with respect to the outstanding incentive stock options
as of December 31, 2003 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- ---------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF EXERCISE OPTIONS REMAINING AVERAGE OPTIONS AVERAGE
PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ----------------- ----------- ---------------- -------------- ----------- --------------
$1.02 - $1.88 1,295,150 7.5 years $ 1.31 327,000 $ 1.62
$1.90 - $2.09 801,769 6.7 years $ 1.92 455,325 $ 1.93
$2.44 - $4.03 970,588 7.5 years $ 3.26 856,775 $ 3.18
--------- --------- --------- --------- ---------
3,067,507 7.0 years $ 2.08 1,639,100 $ 2.52
F-22
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company's Board of Directors approved nonqualified stock options for
key employees, directors and certain non-employee consultants. All
nonqualified stock option grants during 2003 were made from the Pharmos
Corporation 2000 Incentive and Non-Qualified Stock Option Plan.
The following table summarizes activity in Board-approved nonqualified
stock options:
WEIGHTED
UNDER AVERAGE
OPTION EXERCISE PRICE
---------- --------------
Options Outstanding at 12/31/00 504,180 $2.97
Granted below fair market value 100,000 $1.88
Exercised (136,988) $2.20
Cancelled (30,000) $2.77
------- -----
Options Outstanding at 12/31/01 437,192 $2.97
Granted 180,000 $1.74
Cancelled (93,250) $3.59
------- -----
Options Outstanding at 12/31/02 523,942 $2.41
------- -----
Granted 200,000 $1.66
------- -----
Options Outstanding at 12/31/03 723,942 $2.01
======= =====
Options exercisable at 12/31/03 411,775 $2.46
======= =====
Options exercisable at 12/31/02 253,568 $2.72
======= =====
Options exercisable at 12/31/01 184,756 $3.18
======= =====
Additional information with respect to the outstanding nonqualified stock
options as of December 31, 2003 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- ---------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF EXERCISE OPTIONS REMAINING AVERAGE OPTIONS AVERAGE
PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
----------------- ----------- ---------------- -------------- ----------- --------------
$0.79 - $1.88 400,000 7.9 years $ 1.23 162,083 $ 1.54
$1.90 - $3.69 188,194 6.7 years $ 2.24 129,131 $ 2.33
$4.00 - $5.20 135,748 7.5 years $ 4.01 120,561 $ 4.01
------- --------- -------- ------- --------
723,942 7.4 years $ 2.01 411,775 $ 2.46
As of December 31, 2003, there were 1,855,825 shares remaining available
for issuance under these plans.
The Company applies Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations in accounting
for its plans. During 2001, the Company issued 453,500 incentive stock
options and 100,000 non-qualified stock options to employees and directors
at an exercise price of $1.88 per share. The exercise price of $1.88 was
representative of the average price during the month the options were
granted, but was below the closing market price on the date of the grant.
Accordingly, the Company recorded an initial compensation expense of
$34,594 and deferred compensation expense of $207,563 to reflect the
difference between the exercise price and the closing market price on the
date of the grant. The deferred compensation expense is being amortized
over the
F-23
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
four-year vesting period. Total compensation expense was $53,328, $52,981,
and $34,594 for the years ending 2003, 2002, and 2001, respectively.
Fair value of options:
For disclosure purposes under SFAS No. 123, the fair value of each option
grant was estimated on the date of grant using the Black-Scholes option
valuation model with the following weighted-average assumptions:
Year Ended December 31,
---------------------------------------------
2003 2002 2001
------------ ------------ ------------
Risk-interest rates 2.37 - 2.88% 2.63 - 4.39% 3.90 - 4.94%
Expected lives (in years) 5 1 to 5 1 to 5
Dividend yield 0% 0% 0%
Expected volatility 89% 75% 78%
13. Related Parties
In December 2001, the Company's Pharmos Ltd. subsidiary renewed a License
Agreement with Herbamed, Ltd., a company controlled by the Company's
Chairman and Chief Executive Officer. The License Agreement, originally
entered into in May 1997, licenses to Herbamed the Company's patent rights
for the oral delivery of lipophilic substances in the limited field of
nutraceuticals, which include food and dietary supplements, food additives,
vitamins and herbs. Under the terms of the revised License Agreement,
Herbamed will pay to Pharmos Ltd. royalties of 6% on net sales of up to $20
million, 5% on net sales between $20 million and $50 million and 4% on net
sales in excess of $50 million. During the year ended December 31, 2003,
the Company recognized revenue of $4,355 per the licensing agreement with
Herbamed.
14. Income Taxes
No provision for federal income taxes was recorded for the years ended
December 31, 2003 and 2002 due to net operating losses incurred. No
provision for income taxes was recorded for the year ended December 31,
2001 since the Company was able to utilize its net operating loss
carryforwards and offset the taxes due. Net operating loss carryforwards
for U.S. tax purposes of approximately $99,670,603 expire from 2006 through
2023.
During 2003 and 2002, the Company sold a portion of its New Jersey net
operating loss carryforwards to a third party under the New Jersey's
Technology Business Tax Certificate Transfer Program and, as a result,
recorded a tax benefit of $227,798 and $215,223, respectively.
The Company's gross deferred tax assets of $38,962,000 and $34,251,000 at
December 31, 2003 and 2002, respectively, represented primarily the tax
effect of both the net operating loss carryforwards ($36 million in 2003
and $30.4 million in 2002), deferred research and development costs ($0.6
million in 2003 and $1.3 million in 2002) and research and development tax
credit carryforwards ($2.2 million in 2003 and $1.7 million in 2002). As a
result of previous business combinations and changes in stock ownership,
substantially all of these net operating losses and tax credit
carryforwards are subject to significant restriction with regard to annual
utilization. A full valuation allowance has been established with regard to
the gross deferred tax assets due to management's uncertainty of the
recoverability of the deferred tax assets.
F-24
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
15. Commitments and Contingencies
Leases
The Company leases research and office facilities in Israel and New Jersey.
The facilities in Israel are used in the operation of the Company's
research and development activities.
All of the leases and subleases described above call for base rentals,
payment of certain building maintenance costs (where applicable) and future
increases based on the consumer price indices.
At December 31, 2003, the future minimum lease commitments with respect to
non-cancelable operating leases (including office and equipment leases),
net of sublease agreements, with initial terms in excess of one year are as
follows:
LEASE
COMMITMENTS
-----------
2004 $377,736
2005 81,375
2006 57,978
2007 12,212
2008 0
--------
$529,301
========
Rent expense during 2003, 2002 and 2001 amounted to $501,665, $467,879 and
$353,793, respectively. In 2003, 2002 and 2001, rent expense is net of
sublease income of $97,630, $81,358 and $86,454, respectively.
Clinical service fees
The Company has certain professional clinical service fees relating to the
Phase III clinical study for dexanabinol for traumatic brain injury. Upon
the completion of certain agreed upon milestones, additional fees will be
paid. The fees that the Company is obligated to pay upon the reaching of
the agreed upon milestones is not included in the above table due to
uncertainties in timing. The maximum amount that could be paid is
approximately $10.9 million and is not committed beyond 2004. Through
December 31, 2003, the Company has recorded $9.0 million as an expense.
During 2003 and 2002, the Company recorded expenses of $4.2 million and
$2.5 million, respectively.
Consulting contracts and employment agreements
In the normal course of business, the Company enters into annual employment
and consulting contracts with various employees and consultants.
Dividend restrictions
Dividends may be paid by the Company's subsidiary, Pharmos Limited, only
out of retained earnings as determined for Israeli statutory purposes.
There are no retained earnings in Israel available for distribution as
dividends as of December 31, 2003, 2002 or 2001. The Company does not
intend to pay a cash dividend in the foreseeable future.
F-25
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
16. Employee Benefit Plan
The Company has a 401-K defined contribution profit-sharing plan covering
certain employees. Contributions to the plan are based on salary reductions
by the participants, matching employer contributions as determined by the
Company, and allowable discretionary contributions, as determined by the
Company's Board of Directors, subject to certain limitations. Contributions
by the Company to the plan amounted to $51,893, $45,296 and $39,637 in
2003, 2002 and 2001, respectively.
17. Segment and Geographic Information
The Company is active in one business segment: designing, developing,
selling and marketing pharmaceutical products. The Company maintains
development operations in the United States and Israel. The Company's
selling operations are maintained in the United States.
Geographic information for the years ending December 31, 2003, 2002 and
2001 are as follows:
2003 2002 2001
------------ ------------ ------------
Net revenues
United States -- -- $ 4,298,441
Israel -- -- --
------------ ------------ ------------
-- -- $ 4,298,441
============ ============ ============
Net income (loss)
United States $(17,943,150) $(16,514,635) $ 5,564,634
Israel (542,715) (554,965) (518,779)
------------ ------------ ------------
$(18,485,865) $(17,069,600) $ 5,045,855
============ ============ ============
Total assets
United States $ 66,203,358 $ 20,656,322 $ 40,648,880
Israel 2,804,713 4,030,360 3,614,111
------------ ------------ ------------
$ 69,008,071 $ 24,686,682 $ 44,262,991
============ ============ ============
Long lived assets, net
United States $ 139,443 $ 232,734 $ 164,517
Israel 1,115,653 1,559,588 1,753,764
------------ ------------ ------------
$ 1,255,096 $ 1,792,322 $ 1,918,281
============ ============ ============
Capital expenditures, net
United States $ 32,396 $ 155,467 $ 138,424
Israel 84,995 410,398 720,750
------------ ------------ ------------
$ 117,391 $ 565,865 $ 859,174
============ ============ ============
F-26
PHARMOS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
18. Quarterly Information (Unaudited)
YEAR ENDED
DECEMBER 31, 2003 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
- ----------------- ----------- ----------- ----------- -----------
Revenues -- -- -- --
Gross Margin -- -- -- --
Operating Expenses $ 5,063,580 $ 3,238,173 $ 3,695,117 $ 4,037,276
Loss from Operations (5,063,580) (3,238,173) (3,695,117) (4,037,276)
Other Income (Expense), net 564,375 (1,075,946) (493,899) (1,674,047)
Net loss $(4,499,205) $(4,314,119) $(4,189,016) $(5,483,525)
Netloss
per share - basic & diluted* $ (.08) $ (.07) $ (.06) $ (.07)
*The addition of earnings per share by quarter may not equal total earnings per
share for the year.
YEAR ENDED
DECEMBER 31, 2002 1ST QUARTER 2ND QUARTER 3RD QUARTER 4TH QUARTER
- ----------------- ----------- ----------- ----------- -----------
Revenues -- -- -- --
Gross Margin -- -- -- --
Operating Expenses $ 4,752,088 $ 3,293,525 $ 5,394,968 $ 3,417,883
Loss from Operations (4,752,088) (3,293,525) (5,394,968) (3,417,833)
Other Income (Expense), net (215,981) (57,498) (53,596) (99,334)
Net loss $(4,968,069) $(3,351,023) $(5,448,564) $(3,517,167)
Net income loss
per share - basic & diluted* $ (.09) $ (.06) $ (.10) $ (.06)
*The addition of earnings per share by quarter may not equal total earnings per
share for the year.
19. Subsequent events
During January 2004, the underwriters of the December 2003 public offering
exercised their over-allotment option in full to purchase an aggregate of
1,575,000 shares of Pharmos' common stock at a purchase price of $2.75 per
share, less the underwriting discount. Total net proceeds from the exercise
of the over-allotment option was $4.07 million.
During the first quarter of 2004, one of the investors from the September
2003 Convertible Debentures private placement converted a total of $2
million plus interest. The Company issued 497,662 shares of common stock.
As part of the escrow agreement, approximately $1,524,000 of restricted
cash was released to the Company.
F-27