UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
(Mark one)
X Annual Report Pursuant to Section 13 or 15(d) of the Securities
- -------------- Exchange Act of 1934 for the Fiscal Year Ended December 31, 1997
OR
Transition Report Pursuant to Section 13 or 15(d) of the
-------------- Securities Exchange Act of 1934 for the Transition Period from
____ to ____.
Commission File Number 0-26372
CELLEGY PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
California 82-0429727
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1065 E. Hillsdale Blvd., Suite 418, Foster City, California 94404
(Address of Principal Executive Offices) (zip code)
Registrant's telephone number, including area code: (650) 524-1600
Securities registered pursuant to Section 12(b) of the Act:
None None
(Title of each class) (Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock no par value
Common Stock Purchase Warrants
(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-KSB or any amendment to
this Form 10-KSB.
Registrant's revenues for the year ended December 31, 1997 were $827,695.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant as of March 23, 1998 was $60,734,333 (based on the closing price for
the Common Stock on The Nasdaq Stock Market on such date). This calculation does
not include a determination that persons are affiliates or non-affiliates for
any other purpose.
The number of shares of Common Stock outstanding as of March 23, 1998 was
10,164,865.
Documents Incorporated By Reference
The information called for by Part III is incorporated by reference to the
definitive Proxy Statement for the Annual Meeting of Shareholders of the Company
to be held May 28, 1998, which will be filed with the Securities and Exchange
Commission not later than 120 days after December 31, 1997.
Transitional Small Business Disclosure Format (Check one): Yes No XX
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PART I
ITEM 1: BUSINESS
Overview
Cellegy Pharmaceuticals, Inc. ("Cellegy" or the "Company") is a
biopharmaceutical company engaged in the development of prescription drugs and
cosmeceuticals to address a variety of diseases and conditions utilizing its
patented transdermal and topical delivery technologies. The Company was
incorporated in California in 1989. Cellegy is developing several prescription
drugs, including Anogesic(R), a nitroglycerin-based product for the treatment of
anal fissures and hemorrhoids, and a transdermal testosterone gel for the
treatment of hypogonadism, a condition that frequently results in lethargy and
reduced libido in men above the age of 40. Cellegy's Glylorin(TM) is a novel
treatment for certain forms of ichthyosis, a debilitating skin disease, as well
as for other severe dry skin conditions. Glylorin has been licensed by Cellegy
to Glaxo Wellcome Inc. ("Glaxo"), which is currently conducting clinical trials
in the United States. In addition to its prescription drugs, Cellegy is testing
and developing a line of non-prescription cosmeceutical products which the
Company believes will reverse the signs of skin aging and address the skin care
needs of an affluent and aging population.
The Company's principal technologies consist of PERMEATE and CELLEDIRM.
PERMEATE is a patented topical drug delivery system which has been found in
preclinical evaluations to permit delivery of larger or insoluble drugs into the
blood stream or into the skin itself. These drugs include peptides that the
Company believes are not deliverable using alternative methods employed in
currently approved transdermal systems. CELLEDIRM is a group of compounds
identified by Cellegy's scientists which have been found in preclinical
evaluations to reduce or eliminate irritation caused by many substances that
come into contact with the skin. The Company's CELLEDIRM technology is being
developed as an adjunct to the PERMEATE technology to mitigate skin irritation
problems associated with transdermal drug delivery and to improve existing
topically applied drugs and cosmeceutical products.
The Company has not yet completed the development nor has it commercialized
any of its products. In addition, the Company's business involves many risks and
uncertainties that could affect the Company's future financial positions or
results of operations. For further information regarding some of those factors,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Factors That May Affect Future Operating Results".
This Annual Report includes forward-looking statements. Words such as
"believes," "anticipates," "expects," "intends" and similar expressions are
intended to identify forward-looking statements, but are not the exclusive means
of identifying such statements. These forward-looking statements concern matters
that involve risks and uncertainties, including, but not limited to, those set
forth below, that could cause actual results to differ materially from those in
the forward-looking statements. The matters set forth below should be carefully
considered when evaluating the Company's business and prospects.
Background
Skin Biology
Cellegy's technologies and products have been developed based on an expert
knowledge of the biology and physical function of the skin, particularly the
epidermis. The epidermis is comprised mainly of cells known as keratinocytes
that are continually regenerated and move toward the skin surface where they
flatten, lose their nucleus, and become the outermost layer of the epidermis,
the stratum corneum. The stratum corneum acts as a protective barrier against
physical injuries and disease, and regulates the loss of moisture from the body.
It consists of an array of flattened cells suspended in highly organized lipid
structures, similar conceptually to a brick and mortar arrangement. Most
importantly, these lipids regulate the permeability properties of the skin and,
therefore, the movement of topically applied drugs into the body.
In addition to its physical role as barrier, the epidermis is biologically
active, capable of initiating a full inflammatory reaction (characterized by
redness and swelling). Normally, this process is a protective reaction in
response to various noxious stimuli such as sunlight, irritants or mechanical
injury (i.e. abrasions and burns). The same reaction, however, can result
following the topical application of many drugs.
Similarly, certain dermatologic diseases can also be linked to
environmental influences. Psoriasis, for example, which is characterized by
inflammation and accelerated growth of the epidermis, can sometimes be triggered
by a simple cut or abrasion to the skin. Nonetheless, despite material
differences in appearance and symptoms, this disease and the other inflammatory
reactions described above all share fundamental similarities in the underlying
biological processes mediated by the epidermis.
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Core Technology
Cellegy's focus on the biological functioning of the skin has permitted
development of two novel technologies: (i) PERMEATE, which appears to be capable
of enhancing the delivery of drugs applied to the skin for systemic delivery or
for the treatment of local skin conditions, and (ii) CELLEDIRM, which appears to
be capable of mitigating the irritation and inflammation caused when drugs,
solvents and other substances come into contact with the skin.
PERMEATE Drug Delivery Technology
PERMEATE is a patented technology which employs bioactive permeation
enhancers to permit the passage of larger molecule drugs into or through the
skin. This technology consists of a variety of methods to manipulate the three
primary lipids which characterize the properties of the stratum corneum:
cholesterol, ceramides and free fatty acids. Normal barrier function requires a
specific critical ratio of these three lipids. The Company has shown that its
newly identified enhancers can alter these lipid ratios to increase the
permeability of the skin by inhibiting specific enzymes responsible for the
synthesis of these lipids, or by inducing defects in the rigid lipid structures
of the stratum corneum.
Cellegy's PERMEATE system has the potential of being able to open the
stratum corneum barrier wider than previously believed possible, and to keep it
open longer than conventional solvent approaches. This has been found in
preclinical studies to facilitate the permeation of larger or more insoluble
drugs into the skin or into the bloodstream. Further, Cellegy's PERMEATE
technology potentially enables transdermal delivery of such drugs without using
energy dependent systems, such as iontophoresis, electroporation, ultrasound or
laser. Cellegy's studies to date have also shown that these enhancers can exert
their effect when formulated as topical creams or gels or in conventional
transdermal patches.
The Company's research findings include the evaluation of selected PERMEATE
systems in conjunction with the following drugs: testosterone, vasopressin,
luteinizing hormone releasing hormone ("LHRH"), lidocaine, cimetidine,
hydrocortisone and caffeine. Experimental findings with these drugs indicated
that in animal models PERMEATE was capable of delivering up to ten times more
drug than attainable using conventional solvent approaches. Further, two of
these compounds (LHRH and vasopressin), delivered using the Company's PERMEATE
technology, are peptides which, to the Company's knowledge, have never before
been delivered transdermally using conventional solvent technologies. The
molecular weights of LHRH and vasopressin (approximately 1000 and 1200,
respectively) are significantly greater than the molecular weights of drugs
delivered using currently approved transdermal patches (no more than
approximately 400 molecular weight).
CELLEDIRM Technology
CELLEDIRM (Cellegy's Dermal Inflammatory Response Modulators) is a group of
compounds identified by Cellegy's scientists that have been found to be capable
of reducing the inflammation associated with the topical application of drugs,
solvents or other physiologically active substances. These compounds consist of
specially processed or purified excipients that have been shown in preclinical
studies to significantly reduce skin inflammation following challenge with a
number of irritating or allergenic substances.
The Company has conducted a number of research studies investigating the
utility of CELLEDIRM in mitigating the symptoms of skin inflammation. These
compounds have been shown to reduce inflammation by up to 40% in animal models
challenged with either a potent irritant or an allergen. These effects are
comparable to those achieved with topical corticosteroids.
The Company expects its proprietary CELLEDIRM technology to complement its
PERMEATE drug delivery system and to provide a unique platform for the
development of novel topical products which could benefit from the
anti-inflammatory or anti-allergic activities of CELLEDIRM. Since the active
ingredients within CELLEDIRM are either GRAS (generally regarded as safe) or
used as excipients in various pharmaceutical or cosmetic products, the Company
believes the use of these compounds will not lengthen the United States Food and
Drug Administration ("FDA") review time of therapeutic drug products in which
they are used. Accordingly, the Company plans to utilize these compounds in the
near-term development of its testosterone and other prescription products.
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Product Opportunities
Drug Delivery
Transdermal delivery involves the topical administration of drugs to the
skin for the treatment of systemic diseases or localized skin conditions,
generally using patches. Transdermal delivery systems may offer significant
advantages over many conventional oral dosage forms and most parenteral
(injectable) dosage forms. Those advantages include increased convenience, less
pain (compared to injections), improved patient compliance, and potentially
reduced side effects. Transdermal delivery systems can also offer certain
advantages to pharmaceutical companies, including brand extension, product
differentiation and additional patent protection.
Transdermal delivery has historically been limited to those drugs which are
small in size, highly potent and can easily penetrate the skin due to their
physical and chemical characteristics. Specifically, the Company believes that
drugs with molecular weights larger than 400, or those drugs requiring daily
doses greater than five milligrams or that are too lipid soluble, will be
difficult to deliver transdermally. Although many companies have experimented
with different transdermal drug delivery methods, they have enjoyed only limited
success. Of all the prescription drugs in the United States, less than ten drugs
are currently approved by the FDA for transdermal administration. Although
reasonably successful compared with other non-oral routes of drug administration
(for example, nasal, implants or liposomal-based systems), transdermal delivery
has proved more difficult than initially anticipated.
The principal reason for the limited number of transdermal products relates
to irritation caused by solvents designed to ease the passage of drugs through
the skin. These solvents dissolve the lipid-rich stratum corneum membranes,
while many also damage the keratinocytes, permitting the passage of the
therapeutic agent into the lower levels of the skin, where it can be absorbed
into the bloodstream. However, the interaction of the solvents with the
metabolically active stratum corneum and the resulting inflammatory responses
have been greater than anticipated. Several currently marketed transdermal
patches utilize these solvents with, in many cases, high incidence of adverse
skin reactions.
Recent efforts to expand the number and type of drugs delivered
transdermally include the use of iontophoresis (mild electrical charges) or
ultrasound waves in order to help drive the drug through the skin. While these
approaches may prove successful for a few drugs, the Company believes that the
resulting inflammatory skin reactions and higher product costs are likely to
limit the use of these techniques.
With the advent of biotechnology, the discovery and development of larger
molecular size drugs (including proteins, peptides and oligonucleotides) has
increased significantly. As many of these potentially breakthrough new drugs are
amenable only to injectable administration, the Company believes that
transdermal methods to deliver these products represent an increasingly large
commercial opportunity. Cellegy's approach to this challenge has been to develop
novel technologies which (i) do not rely on solvent permeation enhancers, (ii)
increase the size of molecules deliverable through the skin and (iii) mitigate
skin irritation.
Prescription Products
Cellegy further seeks to capitalize on its knowledge of skin biology to
develop treatments for serious and most common skin diseases. The Company plans
to use its PERMEATE and CELLEDIRM technologies to develop products which it
believes will provide significant advantages over existing therapeutics.
Consumer and Cosmeceutical Products
Cellegy researchers are developing consumer and cosmeceutical products that
fortify the protective function of the skin barrier and may improve the skin's
ability to protect against environmental and occupational skin damage, thus
preventing and/or reversing the signs of aging. Studies conducted to date by
Cellegy and its collaborators suggest that these products may help alleviate
inflamed skin conditions, as well as help reverse signs of photoaging, including
pigmentation and wrinkling.
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Products Under Development
Prescription Topical Products
Glylorin
Glylorin is a product developed by Dr. Carl Thornfeldt, Cellegy's founder
and Chairman. The product is being developed for skin conditions which range
from mild to severe, including congenital primary ichthyosis ("CPI"), ichthyoses
vulgaris ("IV") and seborrheic dermatitis. After successfully completing Phase
II clinical trials and commencing Phase III clinical trials in January 1996,
Cellegy licensed Glylorin to Glaxo in November 1996. Glaxo is one of the world's
largest pharmaceutical companies and a leader in the field of dermatology.
Congenital Primary Ichthyosis
Ichthyosis is a family of related incurable skin diseases characterized by
a severe scaling of the skin that frequently affects large areas of the body. In
all forms of ichthyosis, skin cells form a rigid, thick surface layer of scales
that often discolor and crack. CPI is a group of the most severe and
debilitating forms of ichthyosis, affecting all age and ethnic groups. Many of
the most severely afflicted infants die shortly after birth from dehydration,
hypothermia and microbes, which enter through the damaged epidermis. Victims of
the disease are currently treated with greases, emollients and Lac-Hydrin (not
approved for treatment of CPI), which provide only limited benefits, or with
oral and topical retinoids, which have a risk of significant toxicity.
Approximately 100,000 people in the United States and at least an equal number
of persons outside the United States are afflicted with CPI. This treatment has
been granted Orphan Drug status by the FDA.
In March 1998, the Company announced the results of a double-blind, placebo
controlled Phase III clinical trial to evaluate the effectiveness of Glylorin in
non-bullous congenital ichthyosiform erythroderma ("n-CIE"), a form of CPI. The
study group included approximately 82 patients and was conducted at 23 clinical
sites in the United States. Utilizing the statistical method that was
established in the original protocol for the trial, improvement in scaling, the
primary outcome variable, did not show statistical significance compared with
the vehicle (or placebo) compound. However, in the trial, which was conducted by
Cellegy's licensee, Glaxo, the investigators' global assessment scores showed
that 43% of the patients improved overall by more than 50% over time compared
with only 19% of those receiving the vehicle. Moreover, when all the
observations of each patient over the 12 week study were analyzed using a
different statistical method, a significant improvement compared with vehicle
was observed for some outcome variables, including scaling at all timepoints.
Glaxo has not determined if it will repeat this Phase III study.
Ichthyosis Vulgaris
Glaxo is currently conducting clinical trials for the treatment of IV, a
milder form of ichthyosis, which affects approximately one million people in the
United States. The disease is characterized by severe dry skin and scaling
(although not as thick as the scaling present in CPI). Lac-Hydrin, the only
currently approved prescription product for the treatment of IV, has certain
side effects, including irritation and stinging on thinner skin areas such as
the face. In addition, the product is not indicated for pediatric use. Glaxo is
currently conducting a Phase II clinical trial for IV. The results of this trial
are expected by mid-year 1998.
Seborrheic Dermatitis
Another disease condition targeted by Glaxo for Glylorin is seborrheic
dermatitis, a condition characterized by skin redness, flaking and itching, It
is most commonly found on the scalp and afflicts approximately seven million
people in the United States, primarily among the very young and the elderly.
Pending the results of the IV program, Glaxo intends to initiate additional
trials to study Glylorin in the treatment of this very common, but difficult to
control, condition.
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Anogesic
One of the Company's leading product candidates is Anogesic, a topical
prescription product for the treatment of anal fissures and hemorrhoids.
Anogesic is a unique, nitroglycerin-based product which, based on published
studies for over 400 patients, appears to effectively heal anal fissures and is
capable of dramatically reducing the pain of hemorrhoids. In a clinical study
published in The Lancet it was shown that nitroglycerin promotes healing in over
two thirds of patients who would have required rectal surgery. The Company has
met with the FDA to finalize the Phase III clinical trial protocol and plans to
begin a Phase III trial for anal fissures by mid-year 1998 and a Phase III trial
for hemorrhoids by year-end 1998 or early in 1999.
Anal fissures are painful tears in the tissue of the anal mucosa and are
common conditions affecting men and women of all age groups. Of the
approximately 200,000 new cases of anal fissures each year, more than half
require painful and expensive surgical intervention to treat these conditions,
which sometimes leave patients incontinent. A thrombosed external hemorrhoid is
a dilated, swollen vein at the margin of the anus, resulting from clotting blood
formed within the dilated external hemorrhoidal veins. In the United States
alone, approximately nine million patients seek treatment from physicians for
hemorrhoids each year, and the Company believes that a significant number of
additional people suffering from this condition do not seek medical treatment.
Current drug therapies include anesthetics and anti-inflammatory agents
that only partially relieve the symptoms of the conditions. Even though current
treatments are only partially effective, sales of products currently used to
treat anal fissures and hemorrhoids are estimated to be more than $500 million
in the United States, Europe and Japan. Surgical procedures represent
substantial additional expenditures related to these conditions.
Anogesic is a proprietary formulation that includes nitroglycerin, a drug
that has been used for many years in the treatment of certain heart diseases.
Once administered, nitroglycerin results in relaxation of the sphincter muscles,
which rapidly relieves pain and promotes the healing of the anal fissure or
hemorrhoid. Anogesic also incorporates the Company's proprietary CELLEDIRM
technology to assist in mitigating the inflammation present in these conditions.
Anogesic is protected by two broad U.S. patents both of which were issued last
year, the most recent in December 1997. In addition, numerous patent
applications have been filed in overseas markets.
The Company expects that the Phase III trials, if successful, will generate
the data required for applying for regulatory approval in the United States and
Europe. The Phase III clinical trials for anal fissures will include about 350
patients in several study centers. Patients will receive one of three strengths
of Anogesic or placebo. The product will be administered on a daily basis until
the patient's fissure is cured, up to a maximum administration period of eight
weeks. The patient will then be observed for an additional period to determine
whether any relapse occurs.
Testosterone Gel (male hormone replacement therapy)
The Company is currently developing a transdermal testosterone gel to
address a condition increasingly referred to as "male andropause", which results
from an age-related decline in the body's production of the sex hormone
testosterone. Low levels of testosterone can result in such clinical symptoms as
lethargy, depression and a decline in libido. In severely deficient cases, loss
of muscle and bone mass can occur. Approximately 5 million men in the United
States, primarily in the aging (over 40) male population group, have lower than
normal levels of testosterone, a condition known as hypogonadism.
There are a number of companies currently marketing testosterone in several
different product forms in domestic and certain international markets. Cellegy
believes that a major market opportunity exists for an improved product, as the
side effects and patient inconveniences associated with the currently marketed
products have limited their use to less than 5% of potential patients. Current
product forms include orals, injectables and transdermal patches.
Cellegy's patchless testosterone gel will incorporate the Company's
CELLEDIRM technology. The gel product is expected to permit a once-a-day
application of a metered dose to a small area of the skin without the irritation
associated with current patch products. The gel is anticipated to be
transparent, rapid drying and non-staining. Based on preclinical studies to
date, the Company believes its proprietary transdermal gel formulation is
capable of delivering therapeutic levels of testosterone with reduced side
effects and in a more convenient dosage
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form compared with other currently marketed products. Preclinical and human
pharmacokinetic studies demonstrated transdermal testosterone delivery into the
bloodstream at levels comparable to a leading patch product.
The Company plans to commence an additional pharmacokinetic study during
1998, using various testosterone gel formulations. If the study is successful,
Phase III human trials for the treatment of hypogonadism are planned to begin
late in 1998. The Company believes that due to well documented toxicology and
efficacy data regarding the use of testosterone, regulatory approval of its
transdermal testosterone gel may be achieved more quickly than would normally be
associated with a new chemical entity.
Testosterone Gel (female hormone replacement therapy)
In women, the ovaries and adrenal glands continue to synthesize
testosterone after menopause, although the rate of production may diminish by as
much as 50%. Normal blood concentrations of testosterone in women range from 10
to 20 times less than that of men. Nevertheless, in both sexes, testosterone
plays a key role in building muscle or bone tissue, and the maintenance of
sexual drive.
Cellegy's testosterone gel product (for the treatment of hypogonadism) is
being designed so that the dose can be readily reduced and customized to restore
normal testosterone levels in women. The Company believes that this change may
be accomplished by reducing the amount of gel delivered via a metered dose
without a significant change in the product formulation. Thus, the Company
believes that the same formulation can be developed and tested for use in both
hypogonadism and menopause. Clinical studies for this indication are planned to
commence once the initial studies in hypogonadal males are completed.
Estrogen-Testosterone Gel (female hormone replacement therapy)
Cellegy's third planned product in the area of hormone replacement therapy
is a combination estrogen-testosterone gel utilizing the Company's proprietary
PERMEATE and CELLEDIRM technologies, designed to simultaneously restore the
natural levels of both hormones in elderly or menopausal women. The Company
believes that this product will offer significant advantages over the patches in
terms of reduced side effects and patient convenience. The combination
formulation is in the research stage with clinical trials planned following
development of the mono-therapy testosterone products.
Immunosuppressive Drug (psoriasis)
Psoriasis is a relatively common disease affecting approximately four
million people in the United States. This intractable condition is characterized
by inflammation and accelerated growth of the epidermis resulting in dull red,
scaly plaques distributed over various skin locations. The disease can be
activated by infection and barrier damage. A large percentage of patients on
extant therapies are not satisfactorily relieved of psoriatic symptoms and are
constantly seeking more effective therapy.
Cellegy is in preclinical development of a product for the treatment of
psoriasis that is expected to employ an FDA-approved immunosuppressive drug in a
topical formulation designed specifically for local delivery into psoriatic
lesions. This product will utilize the Company's proprietary PERMEATE technology
to keep the barrier of psoriatic lesions open for delivery of the therapeutic
agent. If successfully developed, healing will be accomplished with minimal
systemic effect and without the toxicities generally associated with
immunosuppressive drugs.
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Cosmeceutical Products
Cosmeceuticals (a hybrid of the words cosmetics and pharmaceuticals) are
products that contain active ingredients which, when applied to the skin, will
enhance appearance. Cosmeceuticals that satisfy the legal definition of a
cosmetic under the Food Drug & Cosmetic Act, and that are not also drugs under
that statute, are not subject to the same FDA regulations as drug products. Such
cosmeceuticals may be marketed to consumers without prior approval by the FDA
and without requiring a prescription from a physician. Cellegy also intends to
use its formulation expertise to improve existing non-prescription topical
medications.
Anti-Wrinkling Products*
The Company's most advanced cosmeceutical is an anti-wrinkling product
which, based on human studies to date, appears to mitigate the visible effects
of photoaging and skin wrinkling. Cellegy's anti-wrinkling product will be
included in a line of products that the Company believes has a different
mechanism of action which is expected to produce greater improvement to the
skin's appearance and cause less irritation than current market leading
products.
Signs of aging and photoaging usually become visible when people reach
their early thirties, with fine wrinkling, loss of suppleness and elasticity of
the skin becoming apparent. In subsequent decades, there is further
deterioration marked by coarse wrinkles, irregular increased pigmentation, and
thinning of the skin. Many of the skin changes associated with aging are due to
ultraviolet light exposure, referred to as "photoaging." At the retail level,
the non-prescription market for products which are used to mitigate the effects
of aging and photodamage upon the skin is estimated to be in excess of $1
billion in annual sales in the United States and growing at approximately 14%
per year. The current high performance cosmeceutical anti-wrinkling market in
the United States consists of a few broad categories of products, utilizing the
following actives: retinoids, alpha and beta hydroxy acids and anti-oxidants.
Many of the currently marketed cosmeceutical products contain low
concentrations of one or more of the above mentioned active ingredients and, to
the Company's knowledge, their efficacy has not generally been supported by
clinical studies. Low concentrations of the active ingredients are frequently
employed in order to avoid side effects which can include stinging, redness and
skin irritation, which generally increase with the concentration of active
ingredient used. However, the low concentrations of the active ingredient
generally limit the efficacy of the products.
Cellegy's high performance anti-wrinkling products incorporate CELLEDIRM,
together with an active ingredient having multi-action capability exhibiting
many of the attributes of the cosmeceutical products with the active ingredients
listed above. Certain human studies already completed and others in progress
will provide comparative data versus certain leading cosmeceutical products. If
development continues successfully, the Company believes the product line could
be available for launch late this year or early in 1999. Cellegy will focus its
marketing efforts on the professional market segment (dermatologists, cosmetic
and plastic surgeons), capitalizing on the Company's research and human studies
and its expertise in skin biology.
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* References in this Report to "anti-wrinkling," "anti-wrinkling products" or
the "anti-wrinkling market" are intended to refer to a product category that the
Company believes is generally understood in the marketplace or to products in
that category, and are not intended to describe any claims that the Company's
cosmeceutical products act in any way other than as cosmetics as defined under
applicable laws. The term "cosmeceuticals" refers to products that, if they
satisfy the definition of a cosmetic under applicable federal laws and if they
are not also drugs under those laws, are not subject to the same requirements as
drug products. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Factors That May Affect Future Operating Results --
Possible FDA Regulation of Cosmeceutical Products as Drugs" and "Government
Regulation."
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Consumer Products for the Skin
The Company has completed development of certain other consumer skin care
and non-prescription therapeutic products, including moisturizers and body
creams, and is continuing to develop formulations in other related skin care
consumer product categories. These products utilize certain of the Company's
proprietary formulations. These formulations were tested for their moisturizing
properties in humans compared with a leading commercial product. Results showed
that the Cellegy formulations had more than a 50% higher moisturization effect
12 hours after application than the leading product tested. The Company may
incorporate these products in its cosmeceutical line for dispensing physicians
or sell the products to consumer products companies who will market them under
their own brand names through traditional, non-physician channels.
The Company's research and development expenses were $3,786,000 in 1997 and
$2,712,000 in 1996. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Results of Operations."
Marketing and Commercialization Strategy
Cellegy intends to become a leader in the field of transdermal drug
delivery and in the development and marketing of specialty pharmaceutical and
cosmeceutical products that are applied to the skin. Key elements of its
business and commercialization strategy include the following:
Lower Risk Strategy for Selecting Product Candidates for Development. The
Company does not intend to focus its product development efforts on development
of new chemical entities. Instead, the Company will focus on applying its
proprietary technologies in the following three areas:
(1) development of improved topical and transdermal formulations or new
uses of FDA-approved pharmaceutical compounds for which marketing exclusivity or
patent rights have expired or are near expiration;
(2) development of topical or transdermal formulations of new chemical
entities in partnership with pharmaceutical or biotechnology companies; and
(3) development of new cosmeceutical products that address the skin care
needs of an increasing number of affluent middle-aged and older people.
Leveraging of Corporate Alliances. Cellegy plans to enter into strategic
alliances with established pharmaceutical companies for the development of
certain products. These alliances generally will provide research or clinical
funding and other support during the product development process. Cellegy's
partners generally will provide established and trained marketing and sales
forces.
Internal Focus on the Dermatology Market. Cellegy plans to retain exclusive
or co-marketing/co-promotion rights in the United States to dermatological and
related uses of the products it develops, while out-licensing rights for other
uses. It may retain commercial rights to dermatological and other specialty
pharmaceutical uses of products developed under partner sponsored research
collaborations. The Company ultimately plans to market the dermatologic and
cosmeceutical products it develops, either through the utilization of contract
sales representatives or through the establishment of its own sales force.
Acquisition of Complementary Products. Although Cellegy is focusing
primarily on the development of its own products and technologies, the Company
may opportunistically acquire products, technologies or companies with products
and distribution capabilities consistent with its commercial objectives.
Patents and Trade Secrets
The Company's success depends, in part, on its ability to obtain patent
protection for its products and methods, both in the United States and in other
countries. The patent position of companies engaged in businesses such as the
Company's business generally is uncertain and involves complex legal and factual
questions. There is a substantial backlog of patent applications at the USPTO.
Patents in the United States are issued to the party that is first to invent the
claimed invention. Since patent applications in the United States are maintained
in secrecy until
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patents issue, the Company cannot be certain that it was the first inventor of
the invention covered by its pending patent applications or patents or that it
was the first to file patent applications for such inventions. Further, issued
patents can later be held invalid by the patent office issuing the patent or by
a court. There can be no assurance that any patent applications relating to the
Company's products or methods will issue as patents, or, if issued, that the
patents will not be challenged, invalidated, or circumvented or that the rights
granted thereunder will provide a competitive advantage to the Company. In
addition, many other entities are engaged in research and product development
efforts in drug delivery, skin biology and cosmeceutical fields that may overlap
with the Company's currently anticipated and future products. A substantial
number of patents have been issued to such companies, and such companies may
have filed applications for, or may have been issued patents or may obtain
additional patents and proprietary rights relating to, products or processes
competitive with those of the Company. Such entities may currently have, or may
obtain in the future, legally blocking proprietary rights, including patent
rights, in one or more products or methods under development or consideration by
the Company. These rights may prevent the Company from commercializing
technology, or may require the Company to obtain a license from the entity to
practice the technology. There can be no assurance that the Company will be able
to obtain any such licenses that may be required on commercially reasonable
terms, if at all, or that the patents underlying any such licenses will be valid
or enforceable. Moreover, the laws of certain foreign countries do not protect
intellectual property rights relating to United States patents as extensively as
those rights are protected in the United States. The issuance of a patent in one
country does not assure the issuance of a patent with similar claims in another
country, and claim interpretation and infringement laws vary among countries, so
the extent of any patent protection is uncertain and may vary in different
countries. As with other companies in the pharmaceutical industry, the Company
is subject to the risk that persons located in such countries will engage in
development, marketing or sales activities of products that would infringe the
Company's patent rights if such activities were in the United States.
Several of the Company's products are based on existing compounds with a
history of use in humans but which are being developed by the Company for new
therapeutic use in skin diseases unrelated to the systemic diseases for which
the compounds were previously approved. The Company cannot obtain composition
patent claims on the compound itself, and will instead need to rely on patent
claims, if any, directed to use of the compound to treat certain conditions or
to specific formulations. The Company will not be able to prevent a competitor
from using that formulation or compound for a different purpose. No assurance
can be given that any additional patents will be issued to the Company, that the
protection of any patents that may be issued in the future will be significant,
or that current or future patents will be held valid if subsequently challenged.
The agreements with the University of California pursuant to which the
Company has exclusive license rights to certain barrier repair and drug delivery
and other technology contain certain development and performance milestones
which the Company must satisfy in order to retain such rights. While the Company
currently believes it will be able to satisfy the revised milestone dates, a
loss of rights to these technologies could have a material adverse effect on the
Company.
The Company has thirteen issued and three allowed United States patents,
many issued foreign patents and pending patent applications for the use of
certain compounds to treat common or severe inflammatory dermatologic diseases
including dermatitis, psoriasis, rosacea and acne, as well as disorders such as
various ichthyoses, signs and symptoms of skin aging and premalignant actinic
keratoses. Three issued United States patents and more than twenty patent
applications relate to the Company's Glylorin product for the treatment of
ichthyosis and certain other skin diseases and conditions. Two allowed United
States patent and more than ten patent applications relate to the drug delivery
technology licensed from the University of California, and one issued United
States patent and at least ten patent applications relate to the barrier repair
technology licensed from the University of California. Additional patent
applications are being prepared for filing that will cover methods or products
currently under development. Corresponding patent applications for most of the
Company's issued United States patents have been filed in countries of
importance to the Company located in major world markets, including certain
countries in Europe, Australia, South Korea, Japan, Mexico and Canada.
Federal patent law provides that for any inventions that have been
developed with government funding that are the subject of a license, the
government has the right to require the assignor or the licensee to grant a
license to third parties upon the occurrence of certain events, such as if the
government determines that no effective steps have been taken to achieve
practical application of the invention, or if health or safety needs or
requirements for public use are not reasonably satisfied.
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The Company's policy is to protect its technology by, among other things,
filing patent applications for technology that it considers important to the
development of its business. The Company intends to file additional patent
applications, when appropriate, relating to its technology, improvements to its
technology and to specific products that it develops. It is impossible to
anticipate the breadth or degree of protection that any such patents will
afford, or whether the Company can meaningfully protect its rights to its
unpatented trade secrets. The Company also relies upon unpatented trade secrets
and know-how, and no assurance can be given that others will not independently
develop substantially equivalent proprietary information and techniques, or
otherwise gain access to the Company's trade secrets or disclose such
technology, or that the Company can meaningfully protect its rights to its
unpatented trade secrets. It is the Company's policy to require its employees to
execute an invention assignment and confidentiality agreement upon employment.
Cellegy's consultants are required to execute a confidentiality agreement upon
the commencement of their consultancy to the Company. Each agreement provides
that all confidential information developed or made known to the employee or
consultant during the course of employment or consultancy will be kept
confidential and not disclosed to third parties except in specific
circumstances. The invention assignment generally provides that all inventions
conceived by the employee shall be the exclusive property of the Company. In
addition, it is the Company's policy to require the collaborators and potential
collaborators to enter into confidentiality agreements. There can be no
assurance, however, that these agreements will provide meaningful protection for
the Company's trade secrets.
Product Acquisitions
In December 1997, the Company acquired patent and related intellectual
property rights relating to Anogesic (the "Agreement"), a topical product
candidate for the treatment of anal fissures and hemorrhoids from Neptune
Pharmaceutical Corporation. Under the terms of the Agreement, the Company issued
429,752 shares of Common Stock to Neptune on December 31, 1997. Upon the signing
of a letter of intent on November 3, 1997, 33,057 shares of Common Stock had
been issued to Neptune. The Agreement calls for a series of additional payments,
payable in shares of Common Stock, upon successful completion of various
milestones which, if achieved, would occur over the next several years. The
Agreement does not provide for the payment by the Company of any future product
royalties in connection with sales of Anogesic.
Principal License Agreements
Glaxo. In November 1996, the Company entered into an agreement with Glaxo
for licensing rights to Glylorin, Cellegy's lipid compound for the treatment of
ichthyosis. Under the terms of the agreement, Cellegy provided Glaxo with an
exclusive license of patent rights and know-how covering Glylorin in most of the
world's major markets. In exchange for this license, Cellegy received from Glaxo
an initial license fee payment and could potentially receive future milestone
payments (upon achievement of the specified milestones), as well as a royalty on
net sales assuming successful completion of product development and market
launch. The agreement provides that Glaxo will assume responsibility for and the
associated costs of all future development and commercialization, including
certain development costs incurred prior to the date of the agreement. Through
December 31, 1997, the Company had recognized total revenues of approximately
$1.1 million relating to licensing fees and development funding under the
agreement. There can be no assurances, however, that the Company will receive
any additional payments from Glaxo.
University of California. In October 1993, the Company entered into a
license agreement with the University of California (the "Licensor") providing
for an exclusive, worldwide, royalty bearing license, subject to customary
government rights, for patent rights relating to barrier repair formulations
jointly held by the Licensor and the Company, in consideration of the issuance
to the Licensor of certain shares of preferred stock (which subsequently
converted into shares of Common Stock) and the payment by the Company of a
licensing fee. In March 1994, the Company entered into a second exclusive,
worldwide, royalty bearing license agreement with the Licensor for patent
rights, jointly held by the Licensor and Cellegy, relating to drug delivery
technologies, in consideration of the payment by the Company of a licensing fee,
and an annual maintenance fee payable each year until the Company is
commercially selling a licensed product. Both agreements require the Company to
pay the Licensor royalties based on net sales of consumer and prescription
products (with minimum annual royalty payment). The Company has the right to
grant sublicenses to third parties under both agreements. In May and October
1997, the Licensor and the Company amended these agreements. The amendments,
among other things, modified and extended certain development and
commercialization milestones contained in the original agreements. The revised
milestones are tied to the achievement of certain clinical, regulatory or
product commercialization goals over the
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next several years. Although there can be no assurance that such goals will be
achieved, the Company believes its development programs in place will result in
the satisfaction of such milestones.
Neutrogena. In April 1992, the Company entered into the License Option
Agreement (the "License Option Agreement"), the Azelaic Acid OTC License
Agreement (the "Azelaic Acid Agreement") and the Metabolic Moisturizer OTC
License Agreement (the "Metabolic Moisturizer Agreement"), with Neutrogena
Corporation ("Neutrogena"). The Azelaic Acid Agreement was terminated and
replaced by the Patent License Agreement effective June 1, 1994 (the "Patent
License Agreement"). Pursuant to the Patent License Agreement, Neutrogena paid
the Company $1.0 million for an exclusive, royalty-free license for certain
azelaic acid uses for both prescription and consumer products in most major
markets of the world. In July 1997, Neutrogena and the Company terminated the
Metabolic Moisturizer Agreement and the License Option Agreement (except as it
related to azelaic acid), and the metabolic moisturizer technology that had been
licensed to Neutrogena was returned to the Company. The Company agreed to
continue prosecution of patents related to azelaic acid on behalf of Neutrogena
and will be reimbursed by Neutrogena for legal costs, up to a certain limit.
Government Regulation
FDA Requirements for Human Drugs. The research, testing, manufacturing,
labeling, distribution, and marketing of drug products are extensively regulated
by numerous governmental authorities in the United States and other countries.
In the United States, drugs are subject to rigorous FDA regulation. The Food,
Drug and Cosmetic Act (the "FD&C Act") and the regulations promulgated
thereunder, and other federal and state regulations govern, among other things,
the research, development, testing, manufacture, distribution, storage, record
keeping, labeling, advertising, promotion and marketing of pharmaceutical
products. The process of developing and obtaining approval for a new
pharmaceutical product within this regulatory framework requires a number of
years and the expenditure of substantial resources. There can be no assurance
that necessary approvals will be obtained on a timely basis, if at all.
Moreover, additional government regulations may be established that could
prevent or delay regulatory approval of the Company's products. Delays in
obtaining regulatory approvals could have a material adverse effect on the
Company. If the Company fails to comply with applicable regulatory requirements
for marketing drugs, or if the Company's cosmeceutical products are deemed to be
drugs by the FDA, the Company could be subject to administrative or judicially
imposed sanctions such as warning letters, fines, products recalls or seizures,
injunctions against production, distribution, sales, or marketing, delays in
obtaining marketing authorizations or the refusal of the government to grant
such approvals, suspensions and withdrawals of previously granted approvals,
civil penalties and criminal prosecution of the Company, its officers or its
employees.
The steps ordinarily required before a new pharmaceutical product may be
marketed in the United States include: (i) preclinical laboratory tests, animal
studies and formulation studies; (ii) the submission to the FDA of an
Investigational New Drug Application ("IND") , which must become effective
before clinical testing may commence; (iii) adequate and well-controlled
clinical trials to establish the safety and efficacy of the product for its
proposed indication; (iv) the submission of a New Drug Application ("NDA") to
the FDA; and (v) FDA review and approval of the NDA prior to any commercial sale
or shipment of the drug. Preclinical tests include laboratory evaluation of
product chemistry and formulation, as well as animal studies to assess the
potential safety and functionality of the product. Compounds must be produced
according to the FDA's current Good Manufacturing Practice ("cGMP")
requirements, and preclinical tests must be conducted in compliance with the
FDA's Good Laboratory Practice regulations. The results of preclinical testing
are submitted to the FDA as part of an IND. A 30-day waiting period after the
filing of each IND is required prior to the commencement of clinical testing in
humans. If the FDA has not commented upon or questioned the IND within this
30-day period, clinical studies may begin. If the FDA has comments or questions,
the questions must be answered to the satisfaction of the FDA before initial
clinical testing can begin. In addition, the FDA may, at any time, impose a
clinical hold on ongoing clinical trials. If the FDA imposes a clinical hold,
clinical trials may not commence or recommence without FDA authorization and
then only under terms authorized by the FDA. In some instances, the IND
application process can result in substantial delay and expense.
Clinical trials involve the administration of the investigational product
to healthy volunteers or patients under the supervision of a qualified
investigator. Clinical trials must be conducted in accordance with good clinical
practice ("GCP") requirements under protocols detailing the objectives of the
study, the parameters to be used in monitoring safety and the effectiveness
criteria to be evaluated. Each protocol must be submitted to the FDA as part of
the IND. Further, each clinical study must be conducted under the auspices of an
independent Institutional
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Review Board ("IRB") at the institution at which the study will be conducted.
The IRB will consider, among other things, ethical issues, the safety of human
subjects and the possible liability of the institution. Clinical trials to
support NDAs are typically conducted in three sequential phases, which may
overlap. In Phase I, the initial introduction of the drug into healthy human
subjects or patients, the drug generally is tested to assess metabolism,
pharmacokinetics, pharmacological action and safety, including side effects
associated with increasing doses, and if possible, to gain early evidence on
effectiveness. Phase II usually involves studies in a limited patient population
to (i) determine the efficacy of the drug for a specific indication, (ii)
determine dosage tolerance and optimal dosage and (iii) identify possible
short-term adverse effects and safety risks. If a compound is found to be
effective and to have an acceptable safety profile in Phase II evaluations,
Phase III trials are undertaken to further evaluate clinical efficacy, usually
(although not necessarily) in comparison with a placebo or approved treatment
and to further test for safety within an expanded patient population at
geographically dispersed clinical study sites. A clinical trial may combine the
elements of more than one phase, and typically two or more Phase III studies are
required. The designation of a clinical trial as being in a particular phase is
not necessarily indicative that such a trial will be sufficient to satisfy the
requirements of a particular phase. For example, no assurance can be given that
a Phase III clinical trial will be sufficient to support an NDA without further
clinical trials. There can be no assurance that Phase I, Phase II or Phase III
testing will be completed within any specific time period, if at all, with
respect to any of the Company's products subject to such testing.
New and Abbreviated New Drug Applications. After completion of the required
clinical testing, generally an NDA is submitted. FDA approval of the NDA (or, in
the alternative, an Abbreviated New Drug Application ("ANDA"), as described
below) is required before marketing may begin in the United States. The NDA must
include the results of extensive clinical and other testing and the compilation
of data relating to the product's chemistry, pharmacology and manufacture, the
cost of all of which is substantial. The FDA reviews all NDAs submitted before
it accepts them for filing and may request additional information rather than
filing an NDA. In such an event, the NDA must be resubmitted with the additional
information and, again, is subject to review before filing. Once the submission
is accepted for filing, the FDA begins an in-depth review of the NDA. Under the
FD&C Act, the FDA has 180 days in which to review the NDA and respond to the
applicant, although in practice the process generally takes longer. The review
process is often extended significantly by FDA requests for additional
information or clarification. The FDA may refer the application to the
appropriate advisory committee, typically a panel of clinicians, for review,
evaluation and a recommendation as to whether the application should be
approved. The FDA is not bound by the recommendation of an advisory committee.
During the review process, the FDA generally will conduct an inspection of the
relevant drug manufacturing facilities and clinical sites to ensure that the
facilities are in compliance with applicable cGMP and GCP requirements. If FDA
evaluations of the NDA application, manufacturing facilities, and clinical sites
are favorable, the FDA may issue either an approval letter or an approvable
letter, which contains a number of conditions that must be met in order to
secure approval of the NDA. When and if those conditions have been met to the
FDA's satisfaction, the FDA will issue an approval letter, authorizing
commercial marketing of the drug for certain specific indications. If the FDA's
evaluation of the NDA submission or manufacturing facilities is not favorable,
the FDA may refuse to approve the NDA or issue a not approvable letter,
outlining the deficiencies in the submission and often requiring additional
testing or information. Notwithstanding the submission of any requested
additional data or information in response to an approvable or not approvable
letter, the FDA ultimately may decide that the application does not satisfy the
regulatory criteria for approval. Even if FDA approval is obtained, a marketed
drug product and its manufacturer are subject to continual review and
inspection, and later discovery of previously unknown problems with the product
or manufacturer may result in restrictions or sanctions on such product or
manufacturer, including withdrawal of the product from the market, and other
enforcement actions. The FDA may also require postmarketing testing and
surveillance programs to continuously monitor the drug's usage and effects. Side
effects resulting from the use of drug products may prevent or limit the further
marketing of products.
Certain of the Company's mid and late term products utilize its drug
delivery technology formulated with an active ingredient that is included in a
drug product that is already the subject of an NDA approved by the FDA. In
connection with obtaining FDA approval of such Company products which require an
NDA, it is possible in certain instances that clinical and preclinical testing
requirements may not be as extensive. Limited additional data about the safety
or effectiveness of the proposed new drug formulation, along with chemistry and
manufacturing information and public information about the active ingredient,
may be satisfactory for product approval. Consequently, the new product
formulation may receive marketing approval more rapidly than a traditional full
NDA, although there can be no assurance that a product will be granted such
treatment by the FDA.
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Once patent and other statutory protections covering a drug approved under
an NDA have expired or have been demonstrated not to apply, a generic equivalent
to that drug may be approved under an ANDA. An ANDA is ordinarily based upon
bioequivalence data that demonstrate that the rate and extent of absorption of
the active drug ingredient of the generic drug, usually measured in the blood
stream, is equivalent to that of the drug approved under an NDA. The
demonstration of bioequivalence and, therefore, ANDA approval, generally
requires less time than safety and efficacy studies and NDA approval.
Until an NDA or ANDA is actually approved, there can be no assurance that
the information requested and submitted will be considered adequate by the FDA
to justify approval. It is impossible to anticipate the amount of time that will
be required to obtain approval from the FDA to market any product.
Orphan Drug Designation. Under the Orphan Drug Act, the FDA may grant
orphan drug designation to drugs intended to treat a "rare disease or
condition," which generally is a disease or condition that affects populations
of fewer than 200,000 individuals in the United States. Orphan drug designation
must be requested before submitting an NDA. After the FDA grants orphan drug
designation, the generic identity of the therapeutic agent and its potential
orphan use are publicized by the FDA. Under current law, orphan drug designation
confers upon the first company to receive FDA approval to market such designated
drug United States marketing exclusivity for the designated drug and indication
for a period of seven years following approval of the NDA, subject to certain
limitations.
Orphan drug designation does not convey any advantage in, or shorten the
duration of, the regulatory approval process. Although obtaining FDA approval to
market a product with an orphan drug designation can be advantageous, there can
be no assurance that the scope of protection or the seven years of market
exclusivity that is currently afforded by orphan drug designation and marketing
approval will remain in effect in the future.
Possible Regulation of Cosmeceutical Products as Drugs. "Cosmeceuticals"
are not defined in the FD&C Act. The FDA has not defined the term by regulation
and may consider use of the term to imply drug- like qualities. The FDA will
regulate a particular cosmeceutical product as a drug or a cosmetic (or both a
drug and a cosmetic) depending primarily upon the manufacturer's intended use
for such product. Such intent may be determined from labeling, advertising,
promotional and marketing materials, and any other source attributable to the
manufacturer or its employees, representatives or agents. Under the FD&C Act,
drugs are articles intended for use in the diagnosis, cure, mitigation,
treatment or prevention of disease or to affect the structure or function of the
body. By comparison, cosmetic products are defined as articles intended to be
rubbed, poured, sprinkled or sprayed on, introduced into or otherwise applied to
the body for cleansing, beautifying, promoting attractiveness or altering its
appearance. Some products, however, may satisfy the definition of a drug and a
cosmetic, and the FDA has generally regulated as drugs products that are
intended to have a physiological effect on the body, for example, to alter the
skin in more than a temporary way. Unlike drugs, products that constitute
cosmetics (but not drugs as well) under the FD&C Act do not require premarket
review or approval of the FDA, but cosmetics must be safe under normal
conditions of use, and comply with FDA labeling and manufacturing requirements.
Furthermore, the Federal Trade Commission ("FTC"), as well as state and local
authorities, oversees the advertising of cosmetic products and prohibits false,
misleading, deceptive or unsubstantiated advertising. The FTC has the authority
to seek a number of remedies against a company that it believes fails to comply
with its requirements, including, but not limited to, preliminary injunctive
relief.
The Company plans to label, market, promote, advertise and distribute its
cosmeceutical products with claims intended to be within the statutory
definition of cosmetic. There can be no assurance, however, that the FDA will
not determine that some or all of the Company's cosmeceutical products are
drugs, and are therefore subject to more stringent regulatory oversight,
including premarket approval, based on their intended use or ingredients.
The FDA has at times in the past contended, and may in the future contend,
that one or more cosmeceutical products, including the Company's or competitors'
anti-wrinkling products that are currently marketed or may in the future be
marketed, are not cosmetics but instead are subject to regulation as drugs. Even
if the FDA were not ultimately to prevail with regard to such a contention, such
a claim by the FDA could have a material adverse effect on the Company's ability
to market its proposed cosmeceutical products and could significantly delay or
prohibit marketing of such products. The extent to which different kinds of
current or future cosmeceutical products of the Company or its competitors are
subject to FDA regulation as drugs, and the extent to which the FDA will seek to
become more active in regulating cosmeceutical products, such as products that
compete in the
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anti-wrinkling market, is uncertain, but will depend in part on the claims made
for the cosmeceuticals by their manufacturers and marketers. See "Business --
Government Regulation." The inability of the Company to market its proposed
cosmeceutical products as cosmetics without prior FDA approval could have a
material adverse effect on the Company's business and financial condition.
OTC Monograph. Most over the counter ("OTC") drug products marketed in the
United States are not subjected to the FD&C Act's premarket approval
requirements. In 1972, the FDA instituted the ongoing OTC Drug Review to
evaluate the safety and effectiveness of OTC drugs then on the market. Through
this process, the FDA issues monographs that set forth the specific active
ingredients, dosages, indications and labeling statements for OTC drugs that the
FDA will consider generally recognized as safe and effective and therefore not
subject to premarket approval. For certain categories of OTC drugs not yet
subject to a final monograph, the FDA usually will not take regulatory action
against such a product unless failure to do so poses a potential health hazard
to consumers. OTC drugs not covered by pending or final OTC monographs, however,
are subject to premarket review and approval by the FDA through the NDA/ANDA
mechanism. Even if the Company seeks FDA approval of a product for OTC consumer
sales, the FDA could instead require that the product be distributed by
prescription only. Such a requirement could delay for several years, or
indefinitely, distribution of the Company's products directly to consumers.
Manufacturing. Each domestic drug manufacturing facility must be registered
with the FDA. Domestic drug and, to a lesser extent, cosmetic manufacturing
establishments are subject to routine inspection by the FDA and other regulatory
authorities and must comply with cGMP requirements (albeit less extensive ones
for cosmetics than for drugs). Drug manufacturing facilities located in
California must be licensed by the State of California in compliance with local
regulatory requirements. The Company intends to use contract manufacturers that
operate in conformance with these requirements to produce its compounds and
finished products in commercial quantities. There can be no assurance that
manufacturing or quality control problems will not arise at the manufacturing
plants of the Company's contract manufacturers or that such manufacturers will
be able to maintain the compliance with the FDA's cGMP requirements necessary to
continue manufacturing the Company's products.
Foreign Regulation of Drugs. Whether or not FDA approval has been obtained,
approval of a product by comparable regulatory authorities may be necessary in
foreign countries before the commencement of marketing of the product in such
countries. The approval procedure varies among countries, can involve additional
testing, and the time required may differ from that required for FDA approval.
Although there are some procedures for unified filings for certain European
countries, in general each country has its own procedures and requirements, many
of which are time consuming and expensive. Thus, there can be substantial delays
in obtaining required approvals from both the FDA and foreign regulatory
authorities after the relevant applications are filed. The Company expects to
rely principally on corporate partners, licensees and contract research
organizations, along with Company expertise, to obtain foreign governmental
approval in foreign countries of drug formulations utilizing its compounds.
Other Government Regulation. In addition to regulations enforced by the
FDA, the Company also is subject to regulation under the Occupational Safety and
Health Act, the Environmental Protection Act, the Toxic Substances Control Act,
the Resource Conservation and Recovery Act and other similar federal and state
laws regarding, among other things, occupational safety, the use and handling of
radioisotopes, environmental protection and hazardous substance control. In
connection with its research and development activities and any manufacturing of
clinical trial materials in which the Company may engage, the Company is subject
to federal, state and local laws, rules, regulations and policies governing the
use, generation, manufacture, storage, air emission, effluent discharge,
handling and disposal of certain materials and wastes. Although the Company
believes that it has complied with these laws and regulations in all material
respects and has not been required to take any action to correct any
noncompliance, there can be no assurance that the Company will not be required
to incur significant costs to comply with environmental and health and safety
regulations in the future. The Company's research and development involves the
controlled use of hazardous materials, chemicals, and various radioactive
compounds. Although the Company believes that its safety procedures for handling
and disposing of such materials comply with the standards prescribed by state
and federal regulations, the risk of accidental contamination or injury from
these materials cannot be completely eliminated. In the event of such an
accident, the Company could be held liable for any damages that result and any
such liability could exceed the resources of the Company. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Factors That May Affect Future Operating Results - Environmental Regulation."
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Health Care Reform. In the United States, there have been, and the Company
expects there will continue to be, a number of federal and state proposals to
implement cost controls and other health care regulatory measures. Future
legislation could result in a substantial restructuring of the health care
delivery system. Nevertheless, the Company believes that employer-driven reform
with managed care and capitation will continue even without government
intervention and may significantly affect health care delivery and costs. While
the Company cannot predict whether any legislative or regulatory proposals will
be adopted or the effect such proposals may have on its business, the
uncertainty of such proposals could have an adverse effect on the Company's
ability to raise capital and to identify and reach agreements with potential
partners, and the adoption of such proposals could have an adverse effect on the
Company. For example, such changes could have the effect of reducing the number
of independent practicing dermatologists, which might reduce the number of
prescriptions written for products such as some of the Company's potential
products. In addition, the Company believes that many high-volume purchasers and
consumers of health care are demanding changes in the pricing and delivery of
products and services. The effect of any such changes on the Company's business
are unpredictable. One of the Company's potential products, such as its drug
delivery products, might have the effect of reducing the overall cost of
delivering therapeutic compounds compared to existing delivery techniques, and
sales of such products might benefit from regulatory changes focusing on
controlling health care costs. Nevertheless, any such reform, if adopted, and
ongoing changes in the industry, could adversely affect the pricing of
therapeutic products in the United States or the amount of reimbursement
available from governmental agencies or third-party insurers, and consequently
could have a material adverse effect upon the Company. In both domestic and
foreign markets, sales of the Company's therapeutic products, if any, will
depend in part on the availability of reimbursement from third-party payors,
such as government and private insurance plans and other organizations.
Third-party payors and others increasingly are challenging the prices charged
for medical products and services. There can be no assurance that the Company's
products will be considered cost effective, that reimbursement will be available
or, if available, that the payor's reimbursement policies will not adversely
affect the Company's ability to sell its products on a profitable basis. Other
aspects of the business in which the Company is engaged could also be affected.
The Company cannot predict the outcome of any government or industry reform
initiatives or the impact thereof on the Company's financial position or results
of operations.
Competition
The pharmaceutical industry is subject to rapid and significant
technological change. In the development and marketing of topical prescription
drugs, cosmeceutical and skin care products, and drug delivery systems, Cellegy
faces intense competition. Competitors of the Company in the United States and
abroad are numerous and include, among others, major pharmaceutical, cosmetic,
chemical, consumer product, and biotechnology companies, specialized firms,
universities and other research institutions. There can be no assurance that the
Company's competitors will not succeed in developing technologies and products
that are more effective than any which are being developed by the Company or
that would render the Company's technology and potential products obsolete and
noncompetitive. Many of these competitors have substantially greater financial
and technical resources, production and marketing capabilities and regulatory
experience than the Company. In addition, many of the Company's competitors have
significantly greater experience than the Company in preclinical testing and
human clinical trials of pharmaceutical products and in obtaining FDA and other
regulatory approvals of products for use in health care. The Company also
competes with universities developing drug delivery technologies and with
several companies which have been formed to develop unique delivery systems. In
addition, these companies and academic and research institutions compete with
Cellegy in recruiting and retaining highly qualified scientific and management
personnel.
Competition in the markets in which the Company expects to compete is
generally based on performance characteristics and, to a lesser extent, price.
There can be no assurance that the Company's products under development will be
able to compete successfully with existing or new commercial products.
Employees
As of March 23, 1998, the Company had twenty-three full-time and three
part-time employees. Eighteen of these employees, of whom three are M.D.s and
another six are Ph.D.s, are engaged in research and development. In addition,
the Company utilizes the services of several professional consultants, as well
as contract manufacturing and research organizations to supplement its internal
staff's activities. None of the Company's
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<PAGE>
employees is represented by a labor union. The Company has experienced no work
stoppages and believes that its employee relations are good.
ITEM 2: PROPERTIES
The Company occupies approximately 4,300 square feet at its executive
offices in Foster City, located near San Francisco, California. The Company's
lease has a term expiring July 31, 2001. The Company also occupies approximately
5,600 square feet of research and laboratory facilities in San Carlos,
California under a lease with a term expiring November 30, 1998. The Company
believes its current facilities will be adequate for at least this year. The
Company has signed a letter of intent to lease a new facility, currently under
construction, in the proximity of its current facilities. If finalized, the
lease term is for ten years. The facility size is approximately 65,000 square
feet, of which a significant portion may be sublet by Cellegy during its initial
years of occupancy. The Company plans to consolidate its laboratory and
administrative operations into the new facility by the end of this year or early
in 1999. If the Company relocates its administrative offices, as planned, it
believes that its current space can be sublet or its lease cancelled, subject to
approval by its landlord. Recent new rentals within the multi-tenant Foster City
building Cellegy occupies are significantly above its current rate.
ITEM 3: LEGAL PROCEEDINGS
The Company is not a party to any material legal proceedings.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the Company's shareholders during
the fourth quarter of the year ended December 31, 1997.
ITEM 4A: EXECUTIVE OFFICERS OF THE REGISTRANT
MANAGEMENT
<TABLE>
The executive officers, directors, and other significant employees of the
Company are as follows:
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
K. Michael Forrest 54 President, Chief Executive Officer, and Director
Carl R. Thornfeldt, M.D. 46 Medical Director and Chairman of the Board
Daniel L. Azarnoff, M.D. 71 Vice President, Clinical and Regulatory Affairs
Michael L. Francoeur, Ph.D. 45 Vice President, Research and Development
A. Richard Juelis 49 Vice President, Finance and Chief Financial Officer
Jack L. Bowman (1) 65 Director
Denis R. Burger, Ph.D. (2) 54 Director
Tobi B. Klar, M.D. 43 Director
Alan A. Steigrod (1) 60 Director
Larry J. Wells (2) 55 Director
<FN>
- ------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
</FN>
</TABLE>
K. Michael Forrest. Mr. Forrest became President, CEO, and a director in
December 1996. From January 1996 to November 1996, he served as a biotechnology
consultant. From November 1994 to December 1995, he served as President and CEO
of Mercator Genetics, a public biotechnology company. From March 1991 to June
1994, he served as President and CEO of Transkaryotic Therapies, Inc., a public
biotechnology company. From 1968 to 1991, Mr. Forrest held a series of positions
with Pfizer, Inc. and senior management positions with American Cyanamid,
including Vice President of Lederle U.S. and Lederle International. He is a
director of AlphaGene Inc., a private functional genomics company.
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<PAGE>
Carl R. Thornfeldt, M.D. Dr. Thornfeldt is the Chairman of the Board of
Directors and a co-founder of the Company, as well as a physician, board
certified in dermatology. He has been Medical Director of the Company since its
inception. Dr. Thornfeldt served as acting CEO from July 1996 to December 1996.
In addition, Dr. Thornfeldt served as Vice President, Research and Development
from October 1994 until May 1996. Since 1983, Dr. Thornfeldt has maintained a
private dermatology practice and is an Assistant Clinical Professor in
Dermatology at the University of Oregon Health Sciences Center. Dr. Thornfeldt
received his M.D. from the University of Oregon.
Daniel L. Azarnoff, M.D. Dr. Azarnoff became Vice President, Clinical and
Regulatory Affairs in October 1997. Since January 1986, Dr. Azarnoff has been
President of D.L. Azarnoff Associates and will continue consulting to the
industry on a part-time basis. From August 1978 to December 1985, he served as
President of Research and Development at G.D. Searle and Co. From July 1967 to
August 1978, he was KUMC Distinguished Professor of Medicine and Pharmacology,
as well as the Director of the Clinical Pharmacology-Toxicology Center at the
University of Kansas Medical Center. Dr. Azarnoff has also served as a member of
advisory and expert committees within the Food and Drug Administration, World
Health Organization, American Medical Association, National Academy of Sciences
and National Institutes of Health. He received his M.D. from the University of
Kansas Medical School.
Michael L. Francoeur, Ph.D. Dr. Francoeur became Vice President, Research
and Development in June 1996. From March 1994 to May 1996, he was founder,
Chairman and Chief Technical Officer of De Novo, Inc., a dermal therapeutics
company. From September 1992 to March 1994, Dr. Francoeur held senior executive
positions with Pharmetrix, Inc., a drug delivery company, where he led research
and development. From February 1983 to August 1992, he was employed by Pfizer,
Inc., where he held various research and management positions in product
development, drug delivery, and drug discovery. Dr. Francoeur holds a Ph.D. in
pharmaceutical chemistry and a B.S. in pharmacy from the University of Kansas.
A. Richard Juelis. Mr. Juelis became Vice President, Finance and Chief
Financial Officer in March 1996. From November 1994 until March 1996, he worked
as a financial consultant to the Company, as well as to other companies. From
January 1993 to September 1994 he served as Vice President, Finance and Chief
Financial Officer for VIVUS, Inc., a publicly traded drug delivery company. From
October 1990 to December 1992, he served as Vice President, Finance and Chief
Financial Officer at XOMA Corporation, a public biotechnology company. Mr.
Juelis has also held domestic and international financial and general management
positions with Hoffmann-LaRoche from 1976 to 1982, and Schering-Plough from 1983
to 1990.
Jack L. Bowman. Mr. Bowman became a director in December 1996. He is
currently a consultant to various pharmaceutical and biotechnology industry
groups. From August 1987 to January 1994, he was Company Group Chairman at
Johnson & Johnson, where he managed much of its global diagnostic and
pharmaceutical businesses. Before then, Mr. Bowman held executive positions with
CIBA-Geigy and American Cyanamid, where he had responsibility for worldwide
pharmaceutical, medical device, and consumer product divisions. He is currently
a director of NeoRx Corp., CytRx Corp., Cell Therapeutics, Inc., Targeted
Genetics, Inc. and Osiris Therapeutics.
Denis R. Burger, Ph.D. Dr. Burger became a director in October 1995.
Currently, he serves as Chief Executive Officer of AVI BioPharma, a
biotechnology company, and acts as an industry consultant for Paulson Investment
Company. He is a director of SuperGen, Inc. and Trinity Biotech, plc. He was a
co-founder of Epitope, Inc. and served as Chairman from 1981 to 1990. Dr. Burger
has also served as a research scientist and professor of microbiology and
immunology at the Oregon Health Sciences University. He holds M.S. and Ph.D.
degrees in microbiology and immunology.
Tobi B. Klar, M.D. Dr. Klar became a director of the Company in June 1995.
She is a physician, board certified in dermatology. Since 1986, Dr. Klar has
maintained a private dermatology practice and has served as Co-Chairperson of
the Department of Dermatology at New Rochelle Hospital Medical Center, New
Rochelle, New York, and Associate Clinical Professor in dermatology at Albert
Einstein Medical Center in New York City. Dr. Klar holds a M.D. from the State
University of New York.
Alan A. Steigrod. Mr. Steigrod became a director in July 1996. Since
January 1996 he has been President and Chief Executive Officer of Newport
HealthCare Ventures, which invests in and advises biopharmaceutical companies.
From March 1993 to November 1995, he served as President and CEO of Cortex
Pharmaceuticals, Inc. From February 1991 to February 1993, he worked as a
biotechnology consultant. From March 1981 through February 1991, Mr. Steigrod
held a series of executive positions with Glaxo, Inc., serving as Chairman of
Glaxo's operating committee, as well as on its board of directors. As Executive
Vice President, he managed five divisions, including Glaxo Pharmaceuticals and
Glaxo Dermatology Products. Prior to Glaxo, Mr. Steigrod held a number of
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<PAGE>
senior management positions with Boehringer Ingelheim, Ltd. and Eli Lilly & Co.
He is a director of Sepracor Inc.
Larry J. Wells. Mr. Wells became a director of the Company in 1989. For the
past five years, he has been a venture capitalist. He is the President of Wells
Investment Group and the founder of Sundance Venture Partners, L.P., a venture
capital fund. Mr. Wells is a director of Identix, Inc., Gateway Data Sciences,
Telegen Corp., Isonics Corp., Virtual Mortgage Network and Legacy Brands.
Directors hold office until the next annual meeting of shareholders and
until their respective successors have been elected and qualified. Executive
officers are chosen by and serve at the discretion of the Board of Directors,
subject to any written employment agreements with the Company.
Standing committees of the Board include an Audit Committee and a
Compensation Committee. Dr. Burger and Mr. Wells are the current members of the
Audit Committee. The Audit Committee reviews the Company's accounting practices,
internal control systems and meets with the Company's outside auditors
concerning the scope and terms of their engagement and the results of their
audits. Messrs. Bowman and Steigrod are the current members of the Compensation
Committee. The Compensation Committee recommends compensation for officers and
employees of the Company, and grants options and stock awards under the
Company's employee benefit plans.
Scientific Advisory Board
The Company has established relationships with a group of scientific
advisors with expertise in the fields of dermatology, drug delivery and skin
care. The Company's scientific advisors consult with management and key
scientific employees of the Company to assist the Company in identifying
scientific and product development opportunities, to review the progress of the
Company's specific projects, and to recruit and evaluate the Company's
scientific staff. The nature, scope and frequency of consultations between the
Company and each scientific advisor vary depending upon the Company's current
activities, the need for specific assistance and the individual scientific
advisor.
The Company's scientific advisors and consultants include:
Carl R. Thornfeldt, M.D. Dr. Thornfeldt is Co-Chairman of the Scientific
Advisory Board. See "Executive Officers and Directors."
Peter M. Elias, M.D. Dr. Elias is Co-Chairman of the Scientific Advisory
Board. Dr. Elias is a board certified dermatologist and served as a director of
the Company from April 1995 until October 1997. He is an expert in the stratum
corneum barrier, as well as epidermal structure, function and lipid metabolism.
Dr. Elias is currently Professor, Department of Dermatology, University of
California, San Francisco School of Medicine. He received his M.D. from
University of California, San Francisco, and performed his dermatology residency
at Harvard University Medical Center.
Bruce A. Beutler, M.D. Dr. Beutler is a Professor of Internal Medicine and
an Associate Investigator at the Howard Hughes Medical Institute at the
University of Texas Southwestern Medical Center in Dallas. He is best known for
his work related to tumor necrosis factor alpha (TNF) which he originally
isolated and demonstrated to be an essential mediator in shock and other
inflammatory diseases. Dr. Beutler has published numerous articles related to
these subjects, and has lectured extensively on TNF and the role of cytokines in
inflammation. He is an elected member of the American Society for Clinical
Research and the American Society for Hematology. He is also a member of the New
York Academy of Sciences and the American Federation for Clinical Research. He
has received numerous awards and honors including the Young Investigator Award
(American Society for Clinical Research) and the Alexander von Humboldt -
Stiftung Award. Dr. Beutler is also a Consulting and Advisory Editor for the
Journal of Experimental Medicine and the Journal of Clinical Investigation.
Kenneth R. Feingold, M.D. Dr. Feingold is a physician at the VAMC, San
Francisco and is also a professor of Medicine and Dermatology at the University
of California, San Francisco, School of Medicine. Dr. Feingold has performed
extensive research in metabolism, endocrinology and dermatology.
Ho-Leung Fung, Ph.D. Dr. Fung is Professor and Chairman, Department of
Pharmaceutics, School of Pharmacy, State University of New York, Buffalo. He is
also Member of the Executive Council and Management Committee of the American
Association of Pharmaceutical Scientists and was appointed Chair,
Pharmacological Sciences Review Committee, National Institutes of General
Medical Sciences, NIH. Dr. Fung is an elected fellow of the Academy of
Pharmaceutical Sciences, the American Association of Pharmaceutical Scientists,
and the
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<PAGE>
American Association for the Advancement of Science. In 1995, he was awarded the
Higuchi Award, Academy of Pharmaceutical Sciences and Technology Japan. He is
the author of more than 200 publications.
Richard H. Guy, Ph.D. Dr. Guy is the Directeur Scientifique of the Centre
Interuniversitaire de Recherche et d'enseignement (Pharmapeptides), and
Professeur Associe in the Faculte des Sciences at the Universite de Geneve. Dr.
Guy was formerly Professor of Biopharmaceutical Sciences and Pharmaceutical
Chemistry at the University of California, San Francisco, where he continues to
hold a position as Adjunct Professor. Dr. Guy is an elected fellow of the Royal
Society of Chemistry, the American Association of Pharmaceutical Scientists and
the American Association for the Advancement of Science, and serves on the
editorial advisory boards of Advanced Drug Delivery Reviews, the Journal of
Controlled Release, the Journal of Pharmacy & Pharmacology and the European
Journal of Pharmaceutics and Biopharmaceutics.
Jean-Paul L. Marty, Ph.D. Dr. Marty is Professor of Dermopharmacology at
the University of Paris Sud, School of Pharmacy, in Chatenay-Malabry, France. In
1994 he founded and is still chairing the Diploma of Superior Studies
Specialized in Cosmetology DESS) of the Faculty of Pharmacy of Paris. Since
1985, Dr. Marty has been Reviewer for the French Health Ministerial
Pharmaceutical group for the approval of drug products. In 1994 he was nominated
Expert for the Pharmaceutical group of the French Agency for the registration of
drug products (generics, OTC and dermatological products) and Vice President of
the group for the approval of veterinary drug products. Laureate of the Faculty
of Pharmacy of Paris, of the Paul Neuman Foundation and of the French Medical
Academy. He has, since 1974, authored or co-authored nearly 200 papers and
abstracts in Pharmaceutics, Biopharmacy, Cosmetology and Dermopharmacology.
Kenneth L. Melmon, M.D. Dr. Melmon serves as the Professor of Medicine and
Pharmacology and Associate Dean for Postgraduate Medical Education at Stanford
University School of Medicine. He joined Stanford Medical School in 1978 where
he served as Chairman of the Department of Medicine. Dr. Melmon's work in
Clinical Pharmacology has resulted in the training of numerous fellows at the
University of California, San Francisco and Stanford University School of
Medicine. Dr. Melmon's area of research is directed at the pharmacology of the
immune response, and in particular he has focused on the molecular and cellular
mechanisms by which mediators of inflammation modulate and suppress the immune
response.
Lester Mitscher, Ph.D. Dr. Mitscher is the University Distinguished
Professor, Department Medicinal Chemistry, University of Kansas, where he
previously served as Chairman. He also currently holds the positions of Adjunct
Professor of Medicinal Chemistry, University of Missouri (Kansas City) and
Adjunct Professor of Microbiology, University of Kansas. Dr. Mitscher is a
member of numerous organizations including the American Chemical Society, where
he served as Chairman of the Medical Chemistry Division, and the American
Society for Pharmacognosy, where he served as Chairman. Dr. Mitscher has
received several awards and honors, such as the Edward E. Smissman Award in the
Biomedical Sciences and is an Elected Fellow for the American Association for
the Advancement of Science. He has published or presented numerous research
papers, authored several books on drug synthesis, and holds twelve U.S. patents
and several foreign patents. His current research interests relate to the
chemistry and mechanisms of medicinals, including anti-oxidants, antibiotics and
anti-inflammatory drugs.
Jim E. Riviere, D.V.M., Ph.D. Dr. Riviere is the Burroughs Wellcome Fund
Distinguished Professor of Pharmacology and Director, Cutaneous Pharmacology and
Toxicology Center, College of Veterinary Medicine, North Carolina State
University. Dr. Riviere is a member of numerous organizations including the U.S.
Pharmacopeia General Committee of Revision, Society of Toxicology, American
Board of Forensic Examiners and the American Veterinary Medical Association. Dr.
Riviere has received the American Pharmaceutical Association's Ebert Prize, the
Harvey W. Wiley Medal and FDA Commissioner's Special Citation in 1997. He has
published or presented numerous research papers and is the holder of four U.S.
patents. His current research interests relate to pharmacokinetics, transdermal
drug delivery and pesticide dermal absorption and metabolism.
19
<PAGE>
PART II
ITEM 5: MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Price Range of Common Stock
Cellegy's Common Stock currently trades on The Nasdaq Stock Market under
the symbol "CLGY." The following table sets forth the range of high and low
sales prices for the Common Stock as reported on The Nasdaq Stock Market for the
periods indicated below.
1996 High Low
- ---- ---- ---
First Quarter........................................ $ 7.13 $ 5.00
Second Quarter....................................... 10.13 5.50
Third Quarter........................................ 9.38 4.75
Fourth Quarter....................................... 6.00 4.38
1997
- ----
First Quarter........................................ 5.13 4.13
Second Quarter....................................... 4.50 2.38
Third Quarter........................................ 6.56 2.44
Fourth Quarter....................................... 9.50 6.25
Holders
As of March 23, 1998, there were approximately 83 shareholders of record.
However, many of these shareholders hold shares in nominee or street name. The
Company estimates it has at least 1,500 beneficial owners of its shares.
Dividend Policy
The Company has never paid cash or declared dividends on its Common Stock.
Cellegy does not anticipate that it will declare or pay cash dividends on its
Common Stock in the foreseeable future.
ITEM 6: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This Report contains forward-looking statements which involve risks and
uncertainties, including, but not limited to, statements concerning the
commencement and completion of clinical trials, the timing of planned regulatory
filings, the applicability of drug and cosmetic laws and regulations to the
Company's products, planned activities of collaborative partners, the Company's
strategic plans, the scope of the Company's patent coverage, anticipated
expenditures and the need for additional funds. Discussions containing such
forward-looking statements may be found in the material set forth under
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Factors That May Affect Operating Results" and "Business" as well as
in the Report generally. Actual events or results may differ materially from
those discussed in this Report.
20
<PAGE>
Cellegy Pharmaceuticals, Inc. is a biopharmaceutical company engaged in the
development of prescription drugs and cosmeceuticals to address a variety of
diseases and conditions utilizing its patented transdermal and topical delivery
technologies. The Company was incorporated in California in 1989. Cellegy is
developing several prescription drugs, including Anogesic, a nitroglycerin-based
product for the treatment of anal fissures and hemorrhoids, and a transdermal
testosterone gel for the treatment of hypogonadism, a condition that frequently
results in lethargy and reduced libido in men above the age of 40. Cellegy's
Glylorin is a novel treatment for certain forms of ichthyosis, a debilitating
skin disease, as well as for other severe dry skin conditions. Glylorin has been
licensed by Cellegy to Glaxo Wellcome Inc., which is currently conducting
clinical trials in the United States. In addition to its prescription drugs,
Cellegy is testing and developing a line of anti-wrinkling cosmeceutical
products which the Company believes will address the skin care needs of an
affluent and aging population.
General
In July 1997, the Company reacquired rights to skin repair technology that
had originally been licensed to Neutrogena, a subsidiary of Johnson & Johnson,
in April 1992. As part of the technology reacquisition, two institutional
investors purchased from Neutrogena the remaining shares of Cellegy's Common
Stock (approximately 425,000 shares) acquired by Neutrogena as part of the
original licensing arrangement. The Company simultaneously completed a $3.8
million private placement of approximately 1.5 million shares with the same
institutional investors and Cellegy's CEO.
In November 1997, the Company completed a $15.1 million public offering of
approximately 2.0 million shares of Common Stock. CIBC Oppenheimer Corp. acted
as underwriter in connection with the offering. Simultaneously, the Company's
stock was approved for listing on the Nasdaq National Market.
In December 1997, the Company completed an asset purchase agreement with
Neptune Pharmaceutical Corporation ("Neptune") to acquire all patent and other
intellectual property rights relating to Anogesic, a topical product candidate
for the treatment of anal fissures and hemorrhoids. The Company's expenses
relating to product development and clinical trials are expected to increase
during 1998 and thereafter as a result of clinical trial expenses relating to
Anogesic. Although the purchase price for Anogesic is payable in Cellegy Common
Stock, the Company recorded a non-cash charge to operations for in process
technology of $3,843,000 upon completion of the Anogesic acquisition in 1997.
Results of Operations
Revenues. The Company had revenues of $828,000 and $648,000 in 1997 and
1996, respectively. In 1997, revenues consisted of $529,000 for development
funding associated with the Glaxo license agreement, $224,000 related to an
Orphan Drug grant from the FDA to cover certain of the Company's clinical trial
costs for Glylorin, and $75,000 from Neutrogena for the reimbursement of patent
expenses incurred by Cellegy related to a license agreement with Neutrogena. In
1996, revenues consisted of $559,000 associated with the Glaxo license
agreement, $74,000 from FDA Orphan Drug grant payments and $15,000 associated
with the Neutrogena licensing agreement. The Company expects to receive lower
levels of development funding and milestones from Glaxo over the next several
quarters, but is pursuing other licensing and product supply agreements which,
if entered into, may result in additional contract revenues or product sales.
There can be no assurances regarding when, or if, such revenues will occur.
Through the end of the Orphan Drug grant period on September 30, 1998, the
Company expects to receive approximately $50,000 in FDA Orphan Drug grant
funding.
Research and Development Expenses. Research and development expenses were
$3,786,000 in 1997, compared with $2,712,000 in 1996. The increase of $1,074,000
was primarily due to salary costs associated with the addition of scientific
personnel, as well as increased contract research expenses. Cellegy's research
expenses are expected to increase during 1998 as preclinical and clinical trial
activity associated with its Anogesic, transdermal testosterone gel and
anti-wrinkling programs increases and as it continues to focus on the
identification and testing of compounds using the Company's drug delivery
technologies, including PERMEATE and CELLEDIRM. The Company plans to accelerate
hiring in research and development in order to accomplish its goals.
Although the Company's expenses related to Glylorin are expected to
decrease significantly, Cellegy's total research expenses are expected to
increase in the future as preclinical and clinical trial activity associated
with its research programs increases. The Company has increased its research
spending in 1997 and expects to increase its
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<PAGE>
research spending again during 1998 as a result of its efforts to identify,
develop and test compounds using the Company's PERMEATE and CELLEDIRM
technologies.
General and Administrative Expenses. General and administrative expenses
remained comparable at $1,608,000 in 1997, and $1,634,000 in 1996. The Company's
general and administrative expenses are expected to increase in the future in
support of its research and product commercialization efforts and the planned
expansion and consolidation of its office and laboratory facilities.
Acquired in Process Technology. Acquired in process technology expenses
were $3,843,000 in 1997. No such charges were recorded in 1996. This non-cash
charge to operations resulted from Common Stock issued pursuant to the Anogesic
purchase agreement the Company signed with Neptune. The Company expects to have
additional non-cash charges in connection with future stock issuances if and
when certain milestones are achieved. However, no such charges are expected
during 1998. Although the dollar amount of future milestone payments is fixed by
the agreement, the amount of the non-cash accounting charge will vary as a
function of the share price of Cellegy's Common Stock at the time the milestone
is achieved. Such payments could result in issuance of a significant number of
shares of Common Stock.
Interest Income and Expense. The Company earned $556,000 in interest income
for 1997, compared with $330,000 for 1996. The additional interest income earned
during 1997 was due to higher average investment balances during that period
resulting from proceeds associated with a private placement in July 1997 and a
public offering of Common Stock in November 1997. No interest expense was
incurred during 1997 or 1996. However, the Company may incur such expenses in
future periods for a planned tenant improvement loan associated with its
facility expansion.
Net Loss. The net loss applicable to common shareholders was $7,889,000 or
$1.18 per share in 1997, compared with a net loss of $4,782,000 or $1.11 per
share in 1996. The net loss applicable to common shareholders in 1997 was
impacted by the significant non-cash acquired in process technology charge of
$3,843,000 and a non-cash preferred dividend of $35,000. The net loss, excluding
these charges, was $4,011,000.
Liquidity and Capital Resources
The Company has experienced net losses and negative cash flow from
operations each year since its inception. Through December 31, 1997, the Company
had incurred an accumulated deficit of $22.8 million and had consumed cash from
operations of $15.7 million. The Company's public financings included
approximately $6.4 million in net proceeds from its initial public offering in
August 1995, approximately $6.8 million in net proceeds from a preferred stock
financing in April 1996, approximately $3.8 million in net proceeds from a
private placement of Common Stock in July 1997, and approximately $13.8 million
in net proceeds for a secondary public offering in November 1997.
The Company's cash and investments were $21.7 million at December 31, 1997,
compared to $7.3 million at December 31, 1996. The increase of $14.4 million
during 1997 was principally due to additional funds received in the private
placement completed in July 1997 and the secondary public offering in November
1997, offset by net cash used in operating activities.
The Company's operations have and will continue to use substantial amounts
of cash. The Company has no current source of significant ongoing revenues or
capital beyond existing cash and investments. In order to complete the research
and development and other activities necessary to commercialize its products,
additional financing may be required. The Company's future expenditures and
capital requirements depend on numerous factors including, without limitation,
the progress and focus of its research and development programs, the progress
and results of preclinical and clinical testing, the time and costs involved in
obtaining regulatory approvals and complying with pre- and post-approval
regulatory requirements, the costs of filing, prosecuting, defending and
enforcing any patent claims and other intellectual property rights, competing
technological and market developments, changes in the Company's existing
research relationships, the ability of the Company to establish collaborative
arrangements, the initiation of commercialization activities, the purchase of
capital equipment and the availability of other financing.
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<PAGE>
In the course of its development activities, the Company has incurred
significant losses and expects to incur substantial additional development
costs. As a result, the Company will require additional funds to finance
operations and may seek private or public equity investments and future
collaborative arrangements with third parties to meet such needs. There is no
assurance that such funding will be available for the Company to finance its
operations on acceptable terms, if at all. Insufficient funding may require the
Company to delay, reduce or eliminate some or all of its research and
development activities, planned clinical trials and administrative programs. The
Company believes that available cash resources and the interest thereon will be
adequate to satisfy its capital needs through at least December 31, 1999.
As of December 31, 1997, the Company had federal and state income tax net
operating loss carryforwards of approximately $16,576,000 and $5,413,000,
respectively, which expire between 2004 and 2012, and 1997 and 2002,
respectively. The Company also had federal and state research tax credit
carryforwards of approximately $354,000 and $187,000, respectively. The federal
credits expire between 2006 and 2012; the state credits have no expiration date.
Impact of Year 2000. Certain older computer programs were written using two
digits rather than four to define the applicable year. As a result, those
computer programs have time-sensitive software that recognize a date using "00"
as the year 1900 rather than the year 2000. This could cause a system failure or
miscalculations causing disruptions of operations. The Company intends to
complete an assessment by June 1998, and plans to modify or replace portions of
its software, if necessary, so that its computer systems will function properly
with respect to dates in the year 2000 and thereafter. The total Year 2000
project cost has not been estimated; however, the Company believes that the
potential expenditures will not have a material impact on the Company. To date,
the Company has not incurred any expenses related to the assessment of the Year
2000 issue or the purchase of new software. The project is estimated to be
completed no later than December 31, 1998, which is prior to any anticipated
impact on its operating systems. The Company believes that with modifications to
existing software and conversions to new software, the Year 2000 issue will not
pose significant operational problems for its computer systems. However, if such
modifications and conversions are not made, or are not completed timely, the
Year 2000 issue may have a material impact on the operations of the Company.
Factors That May Affect Future Operating Results
History of Losses; Future Profitability Uncertain. The Company has a
history of operating losses and expects to incur substantial additional expenses
with resulting quarterly losses over at least the next several years as it
continues to develop its potential products and to devote significant resources
to preclinical studies, clinical trials and manufacturing. As of December 31,
1997, the Company had an accumulated deficit of approximately $22.9 million. To
date, the Company has not sought regulatory approval to distribute any products.
The time and resource commitment required to achieve market success for any
individual product is extensive and uncertain. No assurance can be given that
the Company's product development efforts will be successful, that required
regulatory approvals can be obtained, that potential products can be
manufactured at an acceptable cost and with appropriate quality or that any
approved products can be successfully marketed.
The Company has not generated any significant revenues from product sales
or royalties from licenses of the Company's technology, and most of the
potential products that may be marketed by the Company, if any, are not expected
to be marketed or approved for marketing for at least the next several years.
Moreover, the Company anticipates that its operating expenses will continue to
increase significantly as the Company increases its research and development,
preclinical, clinical, administrative and patent activities. Accordingly, in the
absence of substantial revenues from new corporate collaborations, royalties on
product sales or other sources, the Company expects to incur substantial and
increased operating losses in the foreseeable future as certain of its earlier
stage potential products move into clinical development, as additional potential
products are selected as clinical candidates for further development, as the
Company invests in additional facilities or capacity, and as the
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Company invests in research or acquires additional technologies, product
candidates or businesses. The amount of net losses and the time required to
reach sustained profitability are highly uncertain. To achieve sustained
profitable operations, the Company, alone or with its collaborative partners,
must successfully discover, develop, obtain regulatory approvals for and market
its potential pharmaceutical products. No assurances can be given that the
Company will be able to achieve or sustain profitability, and results are
expected to fluctuate from quarter to quarter.
Uncertainty of Clinical Trial Results. Before obtaining regulatory approval
for the commercial sale of many of its potential drug products, the Company must
demonstrate through preclinical studies and clinical trials that the product is
safe and efficacious for use in the clinical indication for which approval is
sought. There can be no assurance that the Company will be permitted to
undertake or continue clinical trials for any of its potential products or, if
such trials are permitted, that such products will be demonstrated to be safe
and efficacious. Moreover, the results from preclinical studies and early
clinical trials may not be predictive of results that will be obtained in
later-stage clinical trials, as was the case with the Phase III trial results
announced by Cellegy in March 1998 regarding Glylorin. Thus, there can be no
assurance that the Company's present or future clinical trials, for example, the
planned Phase III clinical trials relating to Anogesic or testosterone, will
demonstrate the safety and efficacy of any potential products or will result in
approval to market products.
The Company's topical prescription candidate, Glylorin, has been licensed
by Cellegy to Glaxo and recently completed Phase III clinical trials in the
United States. See "Business - Products Under Development Prescription Topical
Products - Glylorin." There can be no assurance that the outcome of the current
Phase II clinical trials on ichthyosis vulgaris will be favorable, that further
clinical studies will not be needed for Glylorin, that the FDA will approve
Glylorin for marketing or that current or future clinical trials of any of the
Company's other product candidates, including Anogesic and testosterone, will be
successfully completed or lead to FDA approval. The failure of Glylorin to
successfully complete its current Phase II or any future clinical testing,
including toxicology studies, could have a material adverse effect on the
Company.
The evaluation of animal and human clinical test results involves making
judgments about data and other information that often are not conclusive. Later
testing may show those judgments to have been erroneous. For example, the
Company's beliefs regarding the potential comparative therapeutic benefits of
its products compared to currently marketed products may be erroneous, or the
FDA may not agree with the Company's conclusions regarding such matters.
Furthermore, due to the independent and blind nature of certain human clinical
testing, there will be extended periods during the testing process when the
Company will have only limited, or no, access to information about the status or
results of the tests. Other pharmaceutical companies have believed that their
products performed satisfactorily in early tests, only to find their performance
in later tests, including Phase III clinical trials, to be inadequate or
unsatisfactory, or that FDA Advisory Committees have declined to recommend
approval of the drugs, or that the FDA itself refused approval, with the result
that such companies' stock prices have fallen precipitously.
Early Stage of Product Development. With the exception of certain skin care
cosmeceutical products, Cellegy has not yet completed the development of its
proposed products or sought regulatory approval for the marketing of drug
products and has not begun to market or generate revenues from the
commercialization of products. Development of most of the Company's products
will require significant additional research and development. All of the
Company's product development efforts are based upon technologies and
therapeutic approaches that have not been widely tested or used. Moreover, the
Company's beliefs regarding the therapeutic and commercial potential for its
products are based on studies conducted to date, and later studies may not
support the Company's current beliefs. In addition, results of the Company's
studies have not been published in medical journals or reviewed by independent
third parties, and as a result have not been subjected to the same degree of
scrutiny as results that have been published or subjected to review by
independent parties.
The Company's potential products are subject to the risks of failure
inherent in the development of products based on new technologies. These risks
include the possibilities that the Company's therapeutic approaches will not be
successful; that the results from future clinical trials may not correlate with
any safety or effectiveness results from prior clinical studies conducted by the
Company or others; that some or all of the Company's potential products will not
be successfully developed or will not be found to be safe and effective by the
FDA, or otherwise will fail to meet applicable regulatory standards or receive
necessary regulatory clearances; that the products, if safe and effective, will
be difficult to manufacture in commercial quantities at reasonable costs or will
be
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uneconomical to market; that proprietary rights of third parties will preclude
the Company from commercializing such products; or that third parties will
market superior or equivalent products. There can be no assurance the Company's
research and development activities will result in any commercially viable
products.
Possible FDA Regulation of Cosmeceutical Products as Drugs. The Company
intends to introduce products that will compete in the cosmeceutical market.
"Cosmeceuticals" are not defined in the FD&C Act. The FDA has not defined the
term by regulation and may consider use of the term to imply drug-like
qualities. Cosmeceuticals (a hybrid of the words "cosmetics" and
"pharmaceuticals") are products that contain active ingredients which, when
applied to the skin, will enhance appearance. Cosmeceuticals which satisfy the
definition of a cosmetic under the FD&C Act and which are not also drugs under
that statute are not subject to the same FDA requirements as drug products. For
example, cosmeceutical products that constitute cosmetics (but not drugs as
well) as defined by applicable federal laws may be marketed to consumers without
prior approval by the FDA, and without requiring a prescription from a
physician. The Company intends to develop a number of cosmeceutical products,
including a product that will compete in what is generally referred to as the
"anti-wrinkling" market.
The FDA has at times in the past contended, and may in the future contend,
that one or more cosmeceutical products, including the Company's or competitors'
anti-wrinkling products that are currently marketed or may in the future be
marketed, are not cosmetics but instead are subject to regulation as drugs. Even
if the FDA were not ultimately to prevail with regard to such a contention, such
a claim by the FDA could have a material adverse effect on the Company's ability
to market its proposed cosmeceutical products and could significantly delay or
prohibit marketing of such products. The extent to which different kinds of
current or future cosmeceutical products of the Company or its competitors are
subject to FDA regulation as drugs, and the extent to which the FDA will seek to
become more active in regulating cosmeceutical products, such as products that
compete in the "anti-wrinkling" market, is uncertain, but will depend in part on
the claims made for the cosmeceuticals by their manufacturers and marketers. See
"Business -- Government Regulation." The inability of the Company to market its
proposed cosmeceutical products as cosmetics without prior FDA approval could
have a material adverse effect on the Company's business and financial
condition.
Competition and Technological Change. The pharmaceutical industry is
subject to rapid and significant technological change. In the development and
marketing of topical prescription drugs, skin care and other cosmeceutical
products and drug delivery systems, Cellegy faces intense competition.
Competitors of the Company in the United States and abroad are numerous and
include, among others, major pharmaceutical, chemical, cosmetic, consumer
product, and biotechnology companies, specialized firms, universities and other
research institutions. There can be no assurance that the Company's competitors
will not succeed in developing technologies and products that are more effective
than any which are being developed by the Company or that would render the
Company's technology and potential products obsolete and noncompetitive. Many of
these competitors have substantially greater financial and technical resources,
production and marketing capabilities and regulatory experience than the
Company. In addition, many of the Company's competitors have significantly
greater experience than the Company in preclinical testing and human clinical
trials of pharmaceutical products and in obtaining FDA and other regulatory
approvals of products for use in health care. There can be no assurance that the
Company's products under development will be able to compete successfully with
existing products or products under development by other companies, universities
and other institutions or that they will obtain regulatory approval in the
United States or elsewhere. The Company also competes with universities
developing drug delivery technologies and with several companies which have been
formed to develop unique delivery systems. In addition, these companies and
academic and research institutions compete with Cellegy in recruiting and
retaining highly qualified scientific and management personnel.
Patents and Proprietary Technology. The Company's success depends, in part,
on its ability to obtain patent protection for its products and methods, both in
the United States and in other countries. Several of the Company's products are
based on existing compounds with a history of use in humans but which are being
developed by the Company for new therapeutic use in skin diseases unrelated to
the systemic diseases for which the compounds were previously approved. The
Company cannot obtain composition patent claims on the compound itself, and will
instead need to rely on patent claims, if any, directed to use of the compound
to treat certain conditions or to specific formulations. The Company may not be
able to prevent a competitor from using that formulation or compound for a
different purpose. No assurance can be given that any additional patents will be
issued to the Company, that the protection of any patents issued in the future
will be significant or that current or future patents will be held valid if
subsequently challenged.
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The patent position of companies engaged in businesses such as the
Company's business generally is uncertain and involves complex legal and factual
questions. There is a substantial backlog of patent applications at the United
States Patent and Trademark Office ("USPTO"). Further, issued patents can later
be held invalid by the patent office issuing the patent or by a court. There can
be no assurance that any patent applications relating to the Company's products
or methods will issue as patents, or, if issued, that the patents will not be
challenged, invalidated or circumvented or that the rights granted thereunder
will provide a competitive advantage to the Company. In addition, many other
entities are engaged in research and product development efforts in drug
delivery, skin biology and cosmeceutical fields that may overlap with the
Company's currently anticipated and future products, and such other entities may
currently have, or may obtain in the future, legally blocking proprietary
rights, including patent rights, in one or more products or methods under
development or consideration by the Company. These rights may prevent the
Company from commercializing technology, or may require the Company to obtain a
license from the entity to practice the technology. There can be no assurance
that the Company will be able to obtain any such licenses that may be required
on commercially reasonable terms, if at all, or that the patents underlying any
such licenses will be valid or enforceable. Moreover, the laws of certain
foreign countries do not protect intellectual property rights relating to United
States patents as extensively as those rights are protected in the United
States. As with other companies in the pharmaceutical industry, the Company is
subject to the risk that persons located in such countries will engage in
development, marketing or sales activities of products that would infringe the
Company's patent rights if such activities were in the United States.
The agreements with the University of California pursuant to which the
Company has exclusive license rights to certain drug delivery and other
technology contain certain development and performance milestones which the
Company must satisfy in order to retain such rights. While the Company currently
believes it will be able to satisfy the revised milestone dates, a loss of
rights to these technologies could have a material adverse effect on the
Company.
Dependence on Collaborative Partners. In view of the early stage of the
Company and its research and development programs, the Company has restricted
hiring to research and development scientists and a small administrative staff
and has made limited or no investment in marketing, product sales and regulatory
compliance resources. The Company has granted to Glaxo certain exclusive rights
to commercialize Glylorin for the indications covered by the Company's agreement
with Glaxo, and may in the future enter into agreements with certain of its
collaborative partners granting similar rights with respect to other products.
The Company has other collaborative agreements with certain third party
companies or academic institutions, and intends to enter into other
collaborative agreements in the future, relating to the research, development,
manufacture and marketing of certain potential products. In some cases, the
Company is relying, and in the future will rely, on its collaborative partners
to conduct clinical trials, to compile and analyze the data received from such
trials, to obtain regulatory approvals and, if approved, to manufacture and
market these products. As a result, the Company may have little or no control
over the development of these potential products and little or no opportunity to
review clinical data before or after public announcement. There can be no
assurance that the Company will be able to establish any such collaborative
arrangements or that they will be successful. Failure to enter into any such
arrangements that in the future might be necessary could have a material adverse
effect on the Company's business and financial condition.
Government Regulation and Drug Product Approvals. The research,
development, testing, manufacture, labeling, distribution, marketing and
advertising of products such as the Company's products and its ongoing research
and development activities are subject to extensive regulation by governmental
regulatory authorities in the United States and other countries. The extensive
preclinical and clinical testing requirements and regulatory approval process of
the FDA in the United States and of certain foreign regulatory authorities
require a number of years and the expenditure of substantial resources. There
can be no assurance that the Company will be able to obtain the necessary
approvals for clinical testing or for the marketing of products on a timely
basis or at all. Moreover, additional government regulations may be established
that could prevent or delay regulatory approval of the Company's products.
Delays in obtaining regulatory approvals could have a material adverse effect on
the Company's business and results of operations. Even if regulatory approval of
a product is granted, such approval may include significant limitations on the
indicated uses of the product or the manner in which or conditions under which
the product may be marketed. For example, even if the Company seeks FDA approval
of a product for non-prescription consumer sales, the FDA could instead require
that the product be distributed by means of a prescription before considering
approval for distribution as a non-prescription product. Prescription only
approval, which the Company believes is common where a company seeks approval
for a product involving a new compound
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or a compound previously approved for other uses, could delay for several years,
or indefinitely, distribution through the non-prescription channel of the
Company's products which are subject to premarket review and approval by the
FDA. Moreover, failure to comply with regulatory requirements for marketing
drugs, or if the Company's cosmeceutical products are deemed to be drugs by the
FDA, could subject the Company to regulatory or judicial enforcement actions,
including, but not limited to, product recalls or seizures, injunctions against
production, distribution, sales and marketing, civil penalties, criminal
prosecution of the Company, its officers or employees, refusals to approve new
products and suspensions and withdrawals of existing approvals, as well as
potentially increased product liability exposure. Sales of the Company's
products outside the United States will be subject to regulatory requirements
governing clinical trials and marketing approval. These requirements vary widely
from country to country and could delay introduction of the Company's products
in those countries. See "Business -- Government Regulation."
Limited Experience with Clinical Trials. The Company has conducted only a
limited number of clinical trials to date. There can be no assurance that the
Company will be able to successfully commence and complete all of its planned
clinical trials without significant additional resources and expertise. In
addition, there can be no assurance that the Company will meet its contemplated
development schedule for any of its potential products. The inability of the
Company or its existing or any future collaborative partners to commence or
continue clinical trials as currently planned, to complete the clinical trials
on a timely basis or to demonstrate the safety and efficacy or its potential
products, would have a material adverse effect on the business and the financial
condition of the Company.
Future Capital Needs; Uncertainty of Additional Funding. The Company's
operations to date have consumed substantial amounts of cash. The Company's cash
needs are expected to continue to increase significantly over at least the next
several years in order to fund the additional expenses the Company will incur as
it expands its current research and development programs, particularly in the
drug delivery, prescription pharmaceutical and cosmeceutical product areas. The
Company has no current source of significant ongoing revenues or capital beyond
existing cash and payments, if any, that may be received pursuant to the
existing licensing agreements with Glaxo. In order to complete the research and
development and other activities necessary to commercialize its products,
additional financing may be required. The Company's future expenditures and
capital requirements depend on numerous factors, including, without limitation,
the progress of its research and development programs, the progress of
preclinical and clinical testing, the time and costs involved in obtaining
regulatory approvals and complying with pre- and post-regulatory approval
requirements, the costs of filing, prosecuting, defending and enforcing any
patent claims and other intellectual property rights, competing technological
and market developments, changes in the Company's existing research
relationships, the ability of the Company to establish collaborative
arrangements, the development of commercialization activities and arrangements,
the purchase of capital equipment and any funding that may be received from
third parties pursuant to license, development or other agreements that the
Company may enter into in the future and the level of royalties or revenues, if
any, from commercial product sales.
As a result, the Company may seek private or public equity investments and
future collaborative arrangements with third parties to help fund its future
cash needs. There is no assurance that such funding will be available on
acceptable terms, if at all. Insufficient funding may require the Company to
delay, reduce or eliminate some or all of its research and development
activities, planned clinical trials and administrative programs. The Company
believes that available cash resources and the interest thereon will be adequate
to satisfy its capital needs through at least December 31, 1999.
Limited Sales and Marketing Experience. The Company may market certain of
its products, if successfully developed and approved, through a direct sales
force in the United States and through sales and marketing partnership
arrangements or distribution arrangements outside the United States. The Company
has no history or experience in sales, marketing or distribution. To market its
products directly, the Company must either establish a marketing group and
direct sales force or obtain the assistance of one or more third parties. There
can be no assurance that the Company will be able to establish sales and
distribution capabilities or succeed in gaining market acceptance for its
products. If the Company enters into marketing or licensing arrangements with
established pharmaceutical companies, the Company's revenues will be subject to
the payment provisions of such arrangements and will be dependent on the efforts
of third parties. There can be no assurance that the Company will be able to
successfully establish a direct sales force or that its collaborators will
effectively market any of the
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Company's potential products, and the inability of the Company or its
collaborators to do so could have a material adverse effect on the business and
financial condition of the Company.
Manufacturing Limitations; Suppliers. The Company has no experience in
manufacturing commercial quantities of its potential products and currently does
not have any capacity to manufacture potential products on a commercial scale
itself. The Company currently relies on a third party to manufacture unprocessed
compounds into therapeutic products. Although the Company believes that there
will be adequate third party manufacturers, there can be no assurance that the
Company will be able to enter into acceptable agreements with third party
manufacturers, and the Company is and will be dependent upon third party
contract manufacturers for such production. There can be no assurance that the
Company will continue to be able to obtain contract manufacturing on
commercially acceptable terms for compounds or products and quantities currently
obtainable. There can be no assurance that manufacturing or quality control
problems will not arise at the manufacturing plants of the Company's contract
manufacturers or that such manufacturers will be able to maintain the compliance
with the FDA's current good manufacturing practice requirements necessary to
continue manufacturing the Company's products.
Uncertainty Related to Health Care Industry. The health care industry is
subject to changing political, economic and regulatory influences that may
significantly affect the purchasing practices and pricing of human therapeutics.
Cost containment measures, whether instituted by health care providers or
enacted as a result of government health administration regulators or new
regulations, such as pricing limitations or formulating eligibility for
dispensation by medical providers, could result in greater selectivity in the
availability of treatments. Such selectivity could have an adverse effect on the
Company's ability to sell its prescription products and there can be no
assurance that adequate third party coverage will be available for the Company
to maintain price levels sufficient to generate an appropriate return on its
investment in product development. Third-party payors are increasingly focusing
on the cost-benefit profile of alternative therapies and prescription drugs and
challenging the prices charged for such products and services. Also, the trend
towards managed health care in the United States and the concurrent growth of
organizations such as health maintenance organizations which could control or
significantly influence the purchase of health care services and products, as
well as legislative proposals to reform health care or reduce government
insurance programs, may all result in lower prices or proposals to reform health
care or reduce government insurance programs or result in lower prices or
reduced markets for the Company's products. The cost containment measures and
reforms that government institutions and third party payors are considering
instituting could result in significant and unpredictable changes to the
marketing, pricing and reimbursement practices of prescription drugs marketed by
bio-pharmaceutical companies such as the Company. The adoption of any such
measures or reforms could have a material adverse effect on the business and
financial condition of the Company. However, cosmeceutical products generally
are not reimbursed by third party payors.
Dependence Upon Key Employees. The success of the Company is dependent upon
the efforts of its senior management team, including Dr. Carl R. Thornfeldt,
Chairman of the Board of Directors and Medical Director of the Company, and K.
Michael Forrest, Chief Executive Officer of the Company. A change in the
association of these individuals or other officers and directors of the Company
could adversely affect the Company if suitable replacement personnel could not
be employed. The success of the Company also depends upon its ability to
continue to attract and retain qualified scientific and technical personnel.
There is intense competition for qualified personnel in the areas of the
Company's activities, and there can be no assurance that the Company will be
able to continue to attract and retain the qualified personnel necessary for the
development or expansion of its business.
Environmental Regulation. The Company is subject to federal, state and
local laws and regulations governing the use, generation, manufacture, storage,
discharge, handling and disposal of certain materials and wastes used in its
operations, some of which are classified as "hazardous." There can be no
assurance that the Company will not be required to incur significant costs to
comply with environmental laws, the Occupational Safety and Health Act, and
state, local and foreign counterparts to such laws, rules and regulations as its
activities are increased or that the operations, business and future
profitability of the Company will not be adversely affected by current or future
laws, rules and regulations. The risk of accidental contamination or injury from
hazardous materials cannot be eliminated. In the event of such an accident, the
Company could be held liable for any damages that result and any such liability
could exceed the resources of the Company. In any event, the cost of defending
claims arising from such contamination or injury could be substantial. In
addition, the Company cannot predict the extent of the
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adverse effect on its business or the financial and other costs that might
result from any new government requirements arising out of future legislative,
administrative or judicial actions.
Risk of Product Liability; Limited Product Liability Insurance. The
testing, marketing and sale of human health care products entails an inherent
risk of allegations of product liability. There can be no assurance that
substantial product liability claims will not be asserted against the Company.
The Company has obtained limited amounts of insurance relating to its clinical
trials. There can be no assurance that the Company will be able to obtain or
maintain insurance on acceptable terms for its clinical and commercial
activities or that any insurance obtained will provide adequate protection
against potential liabilities.
Anti-Takeover Provisions. Certain provisions of the Company's Amended and
Restated Articles of Incorporation, as well as the California General
Corporation Law, could discourage a third party from attempting to acquire, or
make it more difficult for a third party to acquire, control of the Company
without approval of the Company's Board of Directors. Such provisions could also
limit the price that certain investors might be willing to pay in the future for
shares of the Common Stock. Certain of such provisions allow the Board of
Directors to authorize the issuance of preferred stock with rights superior to
those of the Common Stock. The rights of the holders of Common Stock will be
subject to, and may be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The issuance of preferred
stock could adversely affect the voting power of holders of Common Stock and the
likelihood that such holders will receive dividend payments and payments upon
liquidation. The Company has no current plans to issue shares of preferred
stock. The Company is also subject to the provisions of Section 1203 of the
California General Corporation Law which requires that a fairness opinion be
provided to the Company's shareholders in connection with their consideration of
any proposed "interested party" reorganization transaction.
Volatility of Stock Price. The stock market has from time to time
experienced significant price and volume fluctuations that may be unrelated to
the operating performance of particular companies. In addition, the market price
of the Common Stock, like the stock prices of many publicly-traded
pharmaceutical, chemical, consumer, and biotechnology companies, may prove to be
highly volatile. Announcements of technological innovations or new commercial
products by the Company or its competitors, developments or disputes concerning
patent or proprietary rights, publicity regarding actual or potential medical
results relating to products under development by the Company or its
competitors, regulatory developments in both the United States and foreign
countries, public concern as to the safety of pharmaceutical products, sales of
a large number of shares of Common Stock in the market and economic and other
external factors, as well as period-to-period fluctuations in financial results,
among other factors, may have a significant impact on the market price of the
Common Stock.
ITEM 7: FINANCIAL STATEMENTS
The financial statements and supplementary data required by item 7 are set
forth below on pages F-1 through F-20 of this report.
ITEM 8: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not Applicable.
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PART III
ITEM 9: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this Item with respect to directors and compliance
with Section 16(a) of the Securities Exchange Act of 1934 may be found in the
sections captioned "Election of Cellegy Directors" and "Compliance under Section
16(a) of the Securities Exchange Act of 1934" appearing in the definitive Proxy
Statement to be delivered to shareholders in connection with the Annual Meeting
of Shareholders expected to be held on May 28, 1998. Such information is
incorporated herein by reference. Information required by this Item with respect
to executive officers may be found in Part I hereof in the section captioned
"Executive Officers of the Registrant."
ITEM 10: EXECUTIVE COMPENSATION
Information with respect to this Item may be found in the section captioned
"Executive Compensation" appearing in the definitive Proxy Statement to be
delivered to shareholders in connection with the Annual Meeting of Shareholders
expected to be held on May 28, 1998. Such information is incorporated herein by
reference.
ITEM 11: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information with respect to this Item may be found in the section captioned
"Security Ownership of Certain Beneficial Owners and Management" appearing in
the definitive Proxy Statement to be delivered to Shareholders in connection
with the Annual Meeting of Shareholders expected to be held on May 28, 1998.
Such information is incorporated herein by reference.
ITEM 12: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information with respect to this Item may be found in the section captioned
"Executive Compensation --Certain Transactions" appearing in the definitive
Proxy Statement to be delivered to Shareholders in connection with the Annual
Meeting of Shareholders expected to be held May 28, 1998. Such information is
incorporated herein by reference.
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PART IV
ITEM 13: EXHIBITS AND REPORTS ON FORM 8-K
Exhibits
(a) The following exhibits are attached hereto or incorporated herein by
reference:
Exhibit
Number Exhibit Title
------ -------------
2.1 Asset Purchase Agreement dated December 31, 1997 between the Company
and Neptune Pharmaceutical Corporation. (Confidential treatment has
been granted with respect to portions of this agreement.)
(Incorporated by reference to Exhibit 4.4 of the Company's
Registration Statement on Form S-3 declared effective on February
19, 1998.)
3.1 Amended and Restated Articles of Incorporation of the Company.
(Incorporated by reference to Exhibit 3.2 to the Company's
Registration Statement on Form SB-2 (Registration No. 33-93288 LA)
declared effective on August 11, 1995 (the "SB-2").)
3.2 Bylaws of the Company. (Incorporated by reference to Exhibit 3.3 to
the SB-2.)
4.1 Specimen Common Stock Certificate. (Incorporated by reference to
Exhibit 4.1 to the SB-2.)
4.2 Specimen Warrant Certificate. (Incorporated by reference to Exhibit
4.2 to the SB-2.)
4.3 Form of Warrant Agreement Between the Company and First Interstate
Bank of California. (Incorporated by reference to Exhibit 4.3 to the
SB-2.)
4.4 Form of Representatives' Warrant Agreement. (Incorporated by
reference to Exhibit 27.2 to the SB-2.)
4.5 Certificate of Determination, as amended, relating to the Series A
Preferred Stock. (Incorporated by reference to Exhibit 4.1 to the
Company's Quarterly Report on Form 10-QSB for the three months ended
March 31, 1996 (the "Q1 1996 Form 10-QSB").)
4.6 Securities Subscription Agreement dated April 1996 relating to the
Series A Preferred Stock. (Incorporated by reference to Exhibit 4.2
to the Q1 1996 Form 10-QSB.)
4.7 Registration Rights Agreement dated April 18, 1996 relating to the
Series A Preferred Stock. (Incorporated by reference to Exhibit 4.3
to the Q1 1996 Form 10-QSB.)
10.1 License Option Agreement, dated April 16, 1992, between the Company
and Neutrogena. (Incorporated by reference to Exhibit 10.1 to the
SB-2.)
10.2 Azelaic Acid Agreement, dated April 16, 1992, between the Company
and Neutrogena. (Incorporated by reference to Exhibit 10.2 to the
SB-2.)
10.3 Metabolic Moisturizer OTC License Agreement, dated April 16, 1992,
between the Company and Neutrogena. (Incorporated by reference to
Exhibit 10.3 to the SB-2.)
10.4 Patent License Agreement, effective June 1, 1994, between the
Company and Neutrogena. (Incorporated by reference to Exhibit 10.4
to the SB-2.)
10.5 Barrier Repair Formulations License Agreement, dated October 26,
1993 between the Company and the University of California.
(Incorporated by reference to Exhibit 10.5 to the SB-2.)
10.6 License Agreement, dated March 4, 1994, regarding Drug Delivery by
Skin Barrier Disruption, between the Company and University of
California. (Incorporated by reference to Exhibit 10.6 to the SB-2.)
31
<PAGE>
Exhibit
Number Exhibit Title
------ -------------
*10.7 Employment Agreement, dated as of January 21, 1996, between the
Company and Dr. Carl Thornfeldt. (Incorporated by reference to
Exhibit 10.7 to the Company's Form 10-KSB for fiscal year ended
December 31, 1995 (the "1995 Form 10-KSB".)
10.8 Amended and Restated Registration Rights Agreement dated April 10,
1992. (Incorporated by reference to Exhibit 10.11 to the SB-2.)
*10.9 1992 Stock Option Plan. (Incorporated by reference to Exhibit 10.12
to the SB-2.)
10.10 Secured Debenture and Warrant Purchase Agreement dated as of
February 10, 1995. (Incorporated by reference to Exhibit 10.13 to
the SB-2.)
10.11 Amended and Restated Registration Rights Agreement dated as of
February 10, 1995. (Incorporated by reference to Exhibit 10.14 to
the SB-2.)
10.12 Warrant Agreement dated as of February 10, 1995. (Incorporated by
reference to Exhibit 10.15 to the SB-2.)
10.13 Agency Agreement dated as of February 10, 1995. (Incorporated by
reference to Exhibit 10.16 to the SB-2.)
*10.14 1995 Equity Incentive Plan (Incorporated by reference to Exhibit
10.17 to the 1995 Form 10-KSB.)
*10.15 1995 Directors' Stock Option Plan (Incorporated by reference to
Exhibit 10.18 to the 1995 Form 10-KSB.)
10.16 Standard Industrial Lease dated April 6, 1992, between the Company
and H&H Management. (Incorporated by reference to Exhibit 10.20 to
the 1995 Form 10-KSB.)
*10.17 Employment Agreement dated November 20, 1996, between the Company
and K. Michael Forrest. (Incorporated by reference to Exhibit 10.19
to the Company's Form 10-KSB for fiscal year ended December 31, 1996
(the "1996 Form 10-KSB".)
10.18 Exclusive Licensing Agreement for Glylorin between the Company and
Glaxo Wellcome Inc. dated November 11, 1996. (Confidential treatment
has been granted with respect to portions of this agreement.)
(Incorporated by reference to Exhibit 10.20 to the 1996 Form
10-KSB.)
*10.19 Consulting Agreement between the Company and Dr. Peter M. Elias
dated May 1, 1996. (Incorporated by reference to Exhibit 10.21 to
the 1996 Form 10-KSB.)
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (See signature page.)
27.1 Financial Data Schedule.
- ----------------
* Represents a management contract or compensatory plan or arrangement.
(b)Reports on Form 8-K
On November 3, 1997, the Company signed a letter of intent with Neptune
Pharmaceutical Corporation to acquire all patent and intellectual property
rights relating to "Anogesic", a topical product candidate for the treatment of
anal fissures and hemorrhoids. This event was reported on a Form 8-K filed on
November 12, 1997. The final purchase agreement for this product was signed on
December 31, 1997. This product acquisition was reported on a Form 8-K on
January 14, 1998.
32
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Foster City, State of California, on the 31st day of March, 1998.
CELLEGY PHARMACEUTICALS, INC.
By: /s/ K. MICHAEL FORREST
---------------------------------------
K. Michael Forrest
President and Chief Executive Officer
Each person whose signature appears below constitutes and appoints K.
Michael Forrest and A. Richard Juelis, jointly and severally, his true and
lawful attorneys-in-fact, each with the power of substitution, for him in any
and all capacities, to sign amendments to this Report on Form 10-KSB, and to
file the same, with all exhibits thereto and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
conforming all that said attorneys-in-fact, or his substitute or substitutes,
may do or cause to be done by virtue thereof.
<TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed by the following persons in the capacities
and on the dates indicated.
<CAPTION>
Name Title Date
<S> <C> <C>
Principal Executive Officer:
/s/ K. MICHAEL FORREST President, Chief Executive Officer and March 31, 1998
- -------------------------------------------- Director
K. Michael Forrest
Principal Financial Officer
and Principal Accounting Officer:
/s/ A. RICHARD JUELIS Vice President, Finance, Chief Financial March 31, 1998
- ------------------------------------------- Officer and Secretary
A. Richard Juelis
Directors:
/s/ CARL R. THORNFELDT, M.D. Chairman of the Board of Directors March 31, 1998
- -------------------------------------------
Carl R. Thornfeldt, M.D.
/s/ JACK L. BOWMAN Director March 31, 1998
- -------------------------------------------
Jack L. Bowman
/s/ DENIS R. BURGER, PH.D. Director March 31, 1998
- -------------------------------------------
Denis R. Burger, Ph.D.
/s/ TOBI B. KLAR, M.D. Director March 31, 1998
- -------------------------------------------
Tobi B. Klar, M.D.
/s/ ALAN A. STEIGROD Director March 31, 1998
- -------------------------------------------
Alan A. Steigrod
/s/ LARRY J. WELLS Director March 31, 1998
- -------------------------------------------
Larry J. Wells
</TABLE>
33
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
EXHIBITS
to
Form 10-KSB
Under
THE SECURITIES EXCHANGE ACT OF 1934
----------
CELLEGY PHARMACEUTICALS, INC.
34
<PAGE>
INDEX TO EXHIBITS
Exhibit Page
Number Description No.
------ ----------- ---
2.1 Asset Purchase Agreement dated December 31, 1997 between
the Company and Neptune Pharmaceutical Corporation.
(Confidential treatment has been granted with respect to
portions of this agreement.) (Incorporated by reference to
Exhibit 4.4 of the Company's Registration Statement on
Form S-3 declared effective on February 19, 1998.)
3.1 Amended and Restated Articles of Incorporation of the
Company. (Incorporated by reference to Exhibit 3.2 to the
Company's Registration Statement on Form SB-2
(Registration No. 33-93288 LA) declared effective on
August 11, 1995 (the "SB-2").)
3.2 Bylaws of the Company. (Incorporated by reference to
Exhibit 3.3 to the SB-2.)
4.1 Specimen Common Stock Certificate. (Incorporated by
reference to Exhibit 4.1 to the SB-2.)
4.2 Specimen Warrant Certificate. (Incorporated by reference
to Exhibit 4.2 to the SB-2.)
4.3 Form of Warrant Agreement Between the Company and First
Interstate Bank of California. (Incorporated by reference
to Exhibit 4.3 to the SB-2.)
4.4 Form of Representatives' Warrant Agreement. (Incorporated
by reference to Exhibit 27.2 to the SB-2.)
4.5 Certificate of Determination, as amended, relating to the
Series A Preferred Stock. (Incorporated by reference to
Exhibit 4.1 to the Company's Quarterly Report on Form
10-QSB for the three months ended March 31, 1996 (the "Q1
1996 Form 10-QSB").)
4.6 Securities Subscription Agreement dated April 1996
relating to the Series A Preferred Stock. (Incorporated by
reference to Exhibit 4.2 to the Q1 1996 Form 10-QSB.)
4.7 Registration Rights Agreement dated April 18, 1996
relating to the Series A Preferred Stock. (Incorporated by
reference to Exhibit 4.3 to the Q1 1996 Form 10-QSB.)
10.1 License Option Agreement, dated April 16, 1992, between
the Company and Neutrogena. (Incorporated by reference to
Exhibit 10.1 to the SB-2.)
10.2 Azelaic Acid Agreement, dated April 16, 1992, between the
Company and Neutrogena. (Incorporated by reference to
Exhibit 10.2 to the SB-2.)
10.3 Metabolic Moisturizer OTC License Agreement, dated April
16, 1992, between the Company and Neutrogena.
(Incorporated by reference to Exhibit 10.3 to the SB-2.)
10.4 Patent License Agreement, effective June 1, 1994, between
the Company and Neutrogena. (Incorporated by reference to
Exhibit 10.4 to the SB-2.)
10.5 Barrier Repair Formulations License Agreement, dated
October 26, 1993 between the Company and the University of
California. (Incorporated by reference to Exhibit 10.5 to
the SB-2.)
10.6 License Agreement, dated March 4, 1994, regarding Drug
Delivery by Skin Barrier Disruption, between the Company
and University of California. (Incorporated by reference
to Exhibit 10.6 to the SB-2.)
35
<PAGE>
Exhibit Page
Number Description No.
------ ----------- ---
*10.7 Employment Agreement, dated as of January 21, 1996,
between the Company and Dr. Carl Thornfeldt. (Incorporated
by reference to Exhibit 10.7 to the Company's Form 10-KSB
for fiscal year ended December 31, 1995 (the "1995 Form
10-KSB".)
10.8 Amended and Restated Registration Rights Agreement dated
April 10, 1992. (Incorporated by reference to Exhibit
10.11 to the SB-2.)
*10.9 1992 Stock Option Plan. (Incorporated by reference to
Exhibit 10.12 to the SB-2.)
10.10 Secured Debenture and Warrant Purchase Agreement dated as
of February 10, 1995. (Incorporated by reference to
Exhibit 10.13 to the SB-2.)
10.11 Amended and Restated Registration Rights Agreement dated
as of February 10, 1995. (Incorporated by reference to
Exhibit 10.14 to the SB-2.)
10.12 Warrant Agreement dated as of February 10, 1995.
(Incorporated by reference to Exhibit 10.15 to the SB-2.)
10.13 Agency Agreement dated as of February 10, 1995.
(Incorporated by reference to Exhibit 10.16 to the SB-2.)
*10.14 1995 Equity Incentive Plan (Incorporated by reference to
Exhibit 10.17 to the 1995 Form 10-KSB.)
*10.15 1995 Directors' Stock Option Plan (Incorporated by
reference to Exhibit 10.18 to the 1995 Form 10-KSB.)
10.16 Standard Industrial Lease dated April 6, 1992, between the
Company and H&H Management. (Incorporated by reference to
Exhibit 10.20 to the 1995 Form 10-KSB.)
*10.17 Employment Agreement dated November 20, 1996, between the
Company and K. Michael Forrest. (Incorporated by reference
to Exhibit 10.19 to the Company's Form 10-KSB for fiscal
year ended December 31, 1996 (the "1996 Form 10-KSB".)
10.18 Exclusive Licensing Agreement for Glylorin between the
Company and Glaxo Wellcome Inc. dated November 11, 1996.
(Confidential treatment has been granted with respect to
portions of this agreement.) (Incorporated by reference to
Exhibit 10.20 to the 1996 Form 10-KSB.)
*10.19 Consulting Agreement between the Company and Dr. Peter M.
Elias dated May 1, 1996. (Incorporated by reference to
Exhibit 10.21 to the 1996 Form 10-KSB.)
23.1 Consent of Ernst & Young LLP, Independent Auditors.
24.1 Power of Attorney (See signature page.)
27.1 Financial Data Schedule.
- ----------------
* Represents a management contract or compensatory plan or arrangement.
36
<PAGE>
Index to Financial Statements
Page
-------
Report of Ernst & Young LLP, Independent Auditors ....................... F-2
Balance Sheets .......................................................... F-3
Statements of Operations ................................................ F-4
Statements of Shareholders' Equity ..................................... F-5
Statements of Cash Flows ............................................... F-8
Notes to Financial Statements ......................................... F-10
F-1
<PAGE>
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Shareholders
Cellegy Pharmaceuticals, Inc.
We have audited the accompanying balance sheets of Cellegy
Pharmaceuticals, Inc. (a development stage company) as of December 31, 1997 and
1996, and the related statements of operations, shareholders' equity and cash
flows for the years then ended, and for the period from June 26, 1989
(inception) through December 31, 1997. 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 in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Cellegy
Pharmaceuticals, Inc. at December 31, 1997 and 1996, and the results of its
operations and its cash flows for the years then ended, and for the period from
June 26, 1989 (inception) through December 31, 1997, in conformity with
generally accepted accounting principles.
ERNST & YOUNG LLP
San Jose, California
February 3, 1998
F-2
<PAGE>
<TABLE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Balance Sheets
<CAPTION>
December 31,
----------------------------
1997 1996
------------ ------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents ................................................. $ 1,821,791 $ 36,453
Short-term investments .................................................... 7,481,870 5,255,668
Other current assets ...................................................... 1,011,913 350,561
------------ ------------
Total current assets ........................................................... 10,315,574 5,642,682
Property and equipment, net .................................................... 13,663 31,281
Long-term investments .......................................................... 12,422,230 2,022,499
------------ ------------
Total assets ................................................................... $ 22,751,467 $ 7,696,462
============ ============
Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable and accrued liabilities .................................. $ 705,153 $ 270,013
Deferred revenue .......................................................... 500,000 --
Accrued research fees ..................................................... 154,665 21,000
Accrued compensation and related expenses ................................. 37,220 17,958
------------ ------------
Total current liabilities ...................................................... 1,397,038 308,971
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares authorized: Series A
convertible preferred stock; 1,100 shares designated; no shares issued
or outstanding at December 31, 1997 and 195 shares issued and
outstanding at December 31, 1996 ...................................... -- 2,161,271
Common stock, no par value; 20,000,000 shares authorized: 10,123,751 shares
issued and outstanding at December 31, 1997 and 5,152,752 shares issued
and outstanding at December 31, 1996 .................................. 44,192,387 20,141,370
Unrealized gain (loss) on investments ..................................... (11,833) 22,167
Deficit accumulated during the development stage .......................... (22,826,125) (14,937,317)
------------ ------------
Total shareholders' equity ................................................ 21,354,429 7,387,491
------------ ------------
Total liabilities and shareholders' equity ..................................... $ 22,751,467 $ 7,696,462
============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
F-3
<PAGE>
<TABLE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Statements of Operations
<CAPTION>
Period from
June 26, 1989
(inception)
Years ended December 31, through
---------------------------- December 31,
1997 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Revenues:
Licensing and contract revenue from affiliate $ -- $ 15,000 $ 1,145,373
Licensing, milestone, and development funding 603,700 559,157 1,162,857
Government grants 223,995 73,503 297,498
------------ ------------ ------------
Total revenues ................................... 827,695 647,660 2,605,728
Operating expenses:
Research and development .................... 3,786,411 2,712,008 12,908,640
General and administrative .................. 1,608,319 1,633,917 7,790,549
Acquired in process technology .............. 3,842,968 -- 3,842,968
------------ ------------ ------------
Total operating expenses ......................... 9,237,698 4,345,925 24,542,157
------------ ------------ ------------
Operating loss ................................... (8,410,003) (3,698,265) (21,936,429)
Interest expense ............................ -- -- (863,740)
Interest income and other, net .............. 555,935 330,169 1,422,549
------------ ------------ ------------
Net loss ......................................... (7,854,068) (3,368,096) (21,377,620)
Non-cash preferred dividends ..................... 34,740 1,413,765 1,448,505
------------ ------------ ------------
Net loss applicable to common shareholders ....... $ (7,888,808) $ (4,781,861) $(22,826,125)
============ ============ ============
Basic and diluted net loss per common share ...... $ (1.18) $ (1.11)
============ ============
Weighted average common shares outstanding ....... 6,670,192 4,306,550
============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
F-4
<PAGE>
<TABLE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Statements of Shareholders' Equity
<CAPTION>
Series A Convertible Series B Convertible Series C Convertible
Preferred Stock Preferred Stock Preferred Stock
--------------- --------------- ---------------
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Issuance of common stock for
cash through December 31, 1995 . -- $ -- -- $ -- -- $ --
Issuance of common stock for
services rendered through
December 31, 1995 .............. -- -- -- -- -- --
Issuance of common stock in
connection with merger
with Pacific
Pharmaceuticals, Inc. in
April 1992 ..................... -- -- -- -- -- --
Repurchase of common shares
in 1992 ........................ -- -- -- -- -- --
Issuance of Series A
convertible preferred
stock for cash through
December 31, 1995 .............. 26,899 48,500 -- -- -- --
Issuance of Series A convertible
preferred stock and warrants to
purchase 14,191 shares of Series
A convertible preferred stock
in exchange for convertible
promissory notes and
accrued interest through
December 31, 1995 .............. 625,845 1,199,536 -- -- -- --
Issuance of Series A
convertible preferred
stock for services
rendered through December
31, 1995 ....................... 40,597 73,198 -- -- -- --
Issuance of Series A
convertible preferred
stock in exchange for
license agreement .............. 9,513 100,000 -- -- -- --
Issuance of Series B
convertible preferred
stock in exchange for
convertible promissory
notes in 1992 .................. -- -- 12,750 114,000 -- --
</TABLE>
<TABLE>
<CAPTION>
Deficit
Unrealized Accumulated
Common Stock Gain (Loss) During the Total
------------ On Development Shareholders'
Shares Amount Investments Stage Equity
------ ------ ----------- ----- ------
<S> <C> <C> <C> <C> <C>
Issuance of common stock for
cash through December 31, 1995 . 856,338 $ 117,749 $ -- $ -- $ 117,749
Issuance of common stock for
services rendered through
December 31, 1995 .............. 269,116 24,261 -- -- 24,261
Issuance of common stock in
connection with merger
with Pacific
Pharmaceuticals, Inc. in
April 1992 ..................... 97,062 8,750 -- -- 8,750
Repurchase of common shares
in 1992 ........................ (3,586) (324) -- -- (324)
Issuance of Series A
convertible preferred
stock for cash through
December 31, 1995............... -- -- -- -- 48,500
Issuance of Series A convertible
preferred stock and warrants to
purchase 14,191 shares of Series
A convertible preferred stock
in exchange for convertible
promissory notes and
accrued interest through
December 31, 1995 .............. -- -- -- -- 1,199,536
Issuance of Series A
convertible preferred
stock for services
rendered through December
31, 1995 ....................... -- -- -- -- 73,198
Issuance of Series A
convertible preferred
stock in exchange for
license agreement............... -- -- -- -- 100,000
Issuance of Series B
convertible preferred
stock in exchange for
convertible promissory
notes in 1992 .................. -- -- -- -- 114,000
<FN>
See accompanying notes.
</FN>
</TABLE>
F-5
<PAGE>
<TABLE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Statements of Shareholders' Equity - (Continued)
<CAPTION>
Series A Convertible Series B Convertible Series C Convertible
Preferred Stock Preferred Stock Preferred Stock
------------------- ------------------- -------------------
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Issuance of Series C
convertible preferred
stock for cash, net of
issuance cost, through
December 31, 1995 .......... -- -- -- -- 477,081 4,978,505
Issuance of common stock in
exchange for notes payable.. -- -- -- -- -- --
Issuance of warrants in
connection with notes
payable financing .......... -- -- -- -- -- --
Conversion of preferred
stock to common stock in
connection with IPO in
August 1995 ................ (702,854) (1,421,234) (12,750) (114,000) (477,081) (4,978,505)
Issuance of common stock in
connection with IPO in
August 1995 ................ -- -- -- -- -- --
Net loss for the period June
26, 1989 (inception)
through December 31, 1995 .. -- -- -- -- -- --
-------- ---------- ------- -------- -------- ----------
Balances at December 31, 1995 . -- -- -- -- -- --
Issuance of Series A
convertible preferred
stock, net of issuance costs 750 6,753,230 -- -- -- --
Conversion of preferred
stock, including
dividends, to common stock . (555) (6,005,724) -- -- -- --
Exercise of warrants to
purchase common stock ...... -- -- -- -- -- --
Exercise of options to
purchase common stock ...... -- -- -- -- -- --
Compensation expense related
to the extension of
option exercise periods .... -- -- -- -- -- --
Unrealized gain on investments -- -- -- -- -- --
Non-cash preferred dividends .. -- 1,413,765 -- -- -- --
Net loss - 1996 ............... -- -- -- -- -- --
-------- ---------- ------- -------- -------- ----------
Balances at December 31, 1996 . 195 2,161,271 -- -- -- --
</TABLE>
<TABLE>
<CAPTION>
Deficit
Unrealized Accumulated
Common Stock Gain (Loss) During the Total
------------ On Development Shareholders'
Shares Amount Investments Stage Equity
------ ------ ----------- ----- ------
<S> <C> <C> <C> <C> <C>
Issuance of Series C
convertible preferred
stock for cash, net of
issuance cost, through
December 31, 1995 .......... -- -- -- -- 4,978,505
Issuance of common stock in
exchange for notes payable.. 42,960 268,500 -- -- 268,500
Issuance of warrants in
connection with notes
payable financing .......... -- 487,333 -- -- 487,333
Conversion of preferred
stock to common stock in
connection with IPO in
August 1995 ................ 1,192,685 6,513,739 -- -- --
Issuance of common stock in
connection with IPO in
August 1995 ................ 1,322,500 6,383,785 -- -- 6,383,785
Net loss for the period June
26, 1989 (inception)
through December 31, 1995 .. -- -- -- (10,155,456) (10,155,456)
--------- ---------- ------ ----------- ---------
Balances at December 31, 1995 . 3,777,075 13,803,793 -- (10,155,456) 3,648,337
Issuance of Series A
convertible preferred
stock, net of issuance costs -- -- -- -- 6,753,230
Conversion of preferred
stock, including
dividends, to common stock . 1,234,077 6,005,724 -- -- --
Exercise of warrants to
purchase common stock ...... 135,256 51,814 -- -- 51,814
Exercise of options to
purchase common stock ...... 6,344 11,553 -- -- 11,553
Compensation expense related
to the extension of
option exercise periods .... -- 268,486 -- -- 268,486
Unrealized gain on investments -- -- 22,167 -- 22,167
Non-cash preferred dividends .. -- -- -- (1,413,765) --
Net loss - 1996 ............... -- -- -- (3,368,096) (3,368,096)
--------- ---------- ------ ----------- ---------
Balances at December 31, 1996 . 5,152,752 20,141,370 22,167 (14,937,317) 7,387,491
<FN>
See accompanying notes.
</FN>
</TABLE>
F-6
<PAGE>
<TABLE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Statements of Shareholders' Equity - (Continued)
<CAPTION>
Series A Convertible Series B Convertible Series C Convertible
Preferred Stock Preferred Stock Preferred Stock
------------------ ------------- ---------------
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Exercise of warrants to
purchase common stock ..... -- -- -- -- -- --
Non-cash preferred dividends . -- 34,740 -- -- -- --
Conversion of preferred
stock, including
dividends, to common stock (195) (2,196,011) -- -- -- --
Exercise of options to
purchase common stock ..... -- -- -- -- -- --
Compensation expense related
to the extension of
option exercise periods ... -- -- -- -- -- --
Issuance of common stock in
connection with the
private placement in July
1997, net of issuance costs -- -- -- -- -- --
Issuance of common stock in
connection with the
public offering of common
stock in November 1997,
net of issuance costs ..... -- -- -- -- -- --
Issuance of common stock in
connection with the
acquisition of product
rights from Neptune
Pharmaceutical Corp. ...... -- -- -- -- -- --
Unrealized gain on
investments ............... -- -- -- -- -- --
Net loss - 1997 .............. -- -- -- -- -- --
------------ ------------ --- ----- --- ------
Balances at December 31, 1997 -- $ -- -- $-- -- $ --
============ ============ === ===== === ======
</TABLE>
<TABLE>
<CAPTION>
Deficit
Unrealized Accumulated
Common Stock Gain (Loss) During the Total
------------ On Development Shareholders'
Shares Amount Investments Stage Equity
------ ------ ----------- ----- ------
<S> <C> <C> <C> <C> <C>
Exercise of warrants to
purchase common stock ..... 227,847 930 -- -- 930
Non-cash preferred dividends . -- -- -- (34,740) --
Conversion of preferred
stock, including
dividends, to common stock 587,879 2,196,011 -- -- --
Exercise of options to
purchase common stock ..... 132,137 362,303 -- -- 362,303
Compensation expense related
to the extension of
option exercise periods ... -- 69,995 -- -- 69,995
Issuance of common stock in
connection with the
private placement in July
1997, net of issuance costs 1,547,827 3,814,741 -- -- 3,814,741
Issuance of common stock in
connection with the
public offering of common
stock in November 1997,
net of issuance costs ..... 2,012,500 13,764,069 -- -- 13,764,069
Issuance of common stock in
connection with the
acquisition of product
rights from Neptune
Pharmaceutical Corp. ...... 462,809 3,842,968 -- -- 3,842,968
Unrealized gain on
investments ............... -- -- (34,000) -- (34,000)
Net loss - 1997 .............. -- -- -- (7,854,068) (7,854,068)
------------ ------------ ------------ ------------ ------------
Balances at December 31, 1997 10,123,751 $ 44,192,387 $ (11,833) $(22,826,125) $ 21,354,429
============ ============ ============ ============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
F-7
<PAGE>
<TABLE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Statements of Cash Flows
<CAPTION>
Period from
June 26, 1989
(inception)
Years ended December 31, through
---------------------------- December 31,
1997 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Operating activities
Net loss ................................................................ $ (7,854,068) $ (3,368,096) $(21,377,620)
Adjustment to reconcile net loss to net cash used in
operating activities:
Acquired in process technology ....................................... 3,842,968 -- 3,842,968
Depreciation and amortization ........................................ 17,618 35,384 264,256
Compensation expense related to the extension of option
exercise periods ................................................... 69,995 268,486 338,481
Loss on sale of property and equipment ............................... -- -- 3,724
Amortization of discount on notes payable and deferred
financing costs .................................................... -- -- 567,503
Issuance of common shares for services ............................... -- -- 24,261
Issuance of Series A convertible preferred stock for
services rendered .................................................. -- -- 73,198
Issuance of Series A convertible preferred stock for interest ........ -- -- 67,720
Issuance of Series A convertible preferred stock for license agreement -- -- 100,000
Changes in operating assets and liabilities:
Other current assets ................................................. (661,352) (201,521) (1,011,913)
Accounts payable and accrued liabilities ............................. 435,140 77,781 705,153
Accrued research fees ................................................ 133,665 21,000 154,665
Accrued compensation and related expenses ............................ 19,262 (169,308) 37,220
Deferred revenue ..................................................... 500,000 -- 500,000
------------ ------------ ------------
Net cash used in operating activities ................................... (3,496,772) (3,336,274) (15,710,384)
Investing activities
Purchase of property and equipment ...................................... -- (8,000) (172,893)
Purchases of investments ................................................ (18,915,933) (9,576,000) (35,538,453)
Sales and maturities of investments ..................................... 6,256,000 3,820,000 15,622,520
------------ ------------ ------------
Net cash used in investing activities ................................... (12,659,933) (5,764,000) (20,088,826)
<FN>
See accompanying notes.
</FN>
</TABLE>
F-8
<PAGE>
<TABLE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Statements of Cash Flows - (Continued)
<CAPTION>
Period from
June 26, 1989
(inception)
Years ended December 31, through
--------------------------- December 31,
1997 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Financing activities
Proceeds from notes payable ................................... $ -- $ -- $ 3,547,424
Repayment of notes payable .................................... -- -- (2,110,608)
Net proceeds from issuance of common stock .................... 17,942,043 63,367 24,506,944
Repurchase of common stock .................................... -- -- (324)
Issuance of convertible preferred stock, net of issuance costs -- 6,753,230 11,757,735
Deferred financing costs ...................................... -- -- (80,170)
------------ ------------ ------------
Net cash provided by financing activities ..................... 17,942,043 6,816,597 37,621,001
------------ ------------ ------------
Net increase (decrease) in cash ............................... 1,785,338 (2,283,677) 1,821,791
Cash and cash equivalents, beginning of period ................ 36,453 2,320,130 --
------------ ------------ ------------
Cash and cash equivalents, end of period ...................... $ 1,821,791 $ 36,453 $ 1,821,791
============ ============ ============
Supplemental disclosure of non-cash transactions:
Issuance of common stock in connection with acquired
in process technology ........................................ $ 3,842,968 $ -- $ 3,842,968
============ ============ ============
Conversion of preferred stock to common stock ................. $ 2,196,011 $ 6,005,724 $ 14,715,474
============ ============ ============
Issuance of common stock for notes payable .................... $ -- $ -- $ 268,500
============ ============ ============
Issuance of warrants in connection with notes payable financing $ -- $ -- $ 487,333
============ ============ ============
Issuance of Series A convertible preferred stock
for notes payable ............................................ $ -- $ -- $ 1,153,316
============ ============ ============
Issuance of Series B convertible preferred stock
for notes payable ........................................... $ -- $ -- $ 115,000
============ ============ ============
Issuance of common stock for Pacific Pharmaceuticals, Inc. .... $ -- $ -- $ 8,750
============ ============ ============
<FN>
See accompanying notes.
</FN>
</TABLE>
F-9
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements
1. Accounting Policies
Description of Business
The Company is engaged in the development of prescription drugs and
cosmeceutical products based upon its patented transdermal and topical drug
delivery technologies and its expertise in skin biology. The Company is in the
development stage.
Basis of Presentation
In the course of its development, the Company has incurred significant
losses and will continue to incur additional losses during its development
phase. As a result, the Company will require substantial additional funds for
its operational activities and may seek private or public equity financings and
future collaborative arrangements with third parties to meet its cash needs.
There is no assurance that such additional funds will be available on acceptable
terms or available at all. Insufficient funding may require the Company to
delay, reduce, or eliminate some or all of its research and development, planned
clinical trials, and administrative programs.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Revenues and Research and Development Expenses
Revenues related to cost reimbursement provisions under development
contracts are recognized as the costs associated with the projects are incurred.
Revenues related to milestones specified under development contracts are
recognized as the milestones are achieved. Research and development costs are
expensed as incurred.
The Company receives certain United States government grants that
support the Company's research effort in defined research projects. These grants
generally provide for reimbursement of approved costs incurred as defined in the
various grants. Revenues associated with these grants are recognized as costs
under each grant are incurred.
Cash, Cash Equivalents and Investments
Cash equivalents consist of highly liquid financial instruments with
original maturities of three months or less.
The Company accounts for its investments in accordance with Statement
of Financial Accounting Standards No. 115, "Accounting for Certain Investments
in Debt and Equity Securities" ("FAS 115"). Under FAS 115, management classifies
investments as available-for-sale or held-to-maturity at the time of purchase
and periodically reevaluates such designations. Investments in marketable equity
securities and debt securities are classified as held-to-maturity when the
Company has the positive intent and ability to hold the securities to maturity.
Held-to-maturity securities are stated at amortized cost with corresponding
premiums or discounts amortized to interest income over the life of the
investment. Debt securities, not classified as held-to-maturity, are classified
as available-for-sale and are reported at fair market value. Unrealized gains or
losses on available-for-sale securities are included in shareholders' equity
until their disposition. Realized gains or losses and declines in value judged
to be other than temporary on available-for-sale securities are included in
other income or expense.
F-10
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements - (Continued)
While the Company's intent is to hold debt securities to maturity, they are
classified as available-for-sale as the sale of such securities may be required
prior to maturity.
Property and Equipment
Property and equipment are stated at cost less accumulated
depreciation. Depreciation is provided over the estimated useful life of five
years using the straight-line method.
Stock-Based Compensation
The Company accounts for its stock option grants in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB Opinion No. 25") and has elected to follow the disclosure-only
alternative prescribed by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("FAS 123").
Recent Accounting Pronouncements
The Company intends to adopt Statement of Accounting Standards No. 130,
"Reporting Comprehensive Income," ("FAS130") and Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information," ("FAS131") in 1998. Both will require additional
disclosure but will not have a material effect on the Company's financial
position or results of operations. FAS130 will first be reflected in the
Company's first quarter of 1998 interim financial statements. Components of
comprehensive income include items such as net income and changes in the value
of available-for-sale securities. FAS131 requires segments to be determined
based on how management measures performance and makes decisions about
allocating resources. FAS131 will first be reflected in the Company's 1998
Annual Report.
Basic and Diluted Net Loss per Share
The financial statements are presented in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings per Share." Basic net loss per
common share is computed using the weighted average number of common shares
outstanding during the period. Diluted earnings per share incorporates the
incremental shares issued upon the assumed exercise of stock options and
warrants, when dilutive. There is no difference between basic and diluted net
loss per share, as presented in the statement of operations, because all options
and warrants (see note 5) are anti-dilutive.
F-11
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements - (Continued)
2. Investments
<TABLE>
At December 31, 1997, available-for-sale securities consist of the
following:
<CAPTION>
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Corporate Notes .......... $10,406,917 $ 3,327 $ (23,987) $10,386,257
U.S. Government Notes .... 5,030,259 5,589 (197) 5,035,651
Time Deposits ............ 1,999,948 1,202 (122) 2,001,028
Money Market ............. 1,788,853 -- -- 1,788,853
Variable Rate Securities . 1,500,000 -- -- 1,500,000
Commercial Paper ......... 978,809 2,355 -- 981,164
----------- ----------- ----------- -----------
Total available-for-sale
securities ............ 21,704,786 12,473 (24,306) 21,692,953
Less amounts classified as
cash equivalents ...... 1,788,853 -- -- 1,788,853
----------- ----------- ----------- -----------
Total investments ........ $19,915,933 $ 12,473 $ (24,306) $19,904,100
=========== =========== =========== ===========
</TABLE>
At December 31, 1996, available-for-sale securities consist of the
following:
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---------- ---------- ---------- ----------
U.S. Government Notes .... $4,400,000 $ 22,809 $ (1,886) $4,420,923
Corporate Notes .......... 2,000,000 8,280 -- 2,008,280
Time Deposits ............ 500,000 -- -- 500,000
Commercial Paper ......... 356,000 -- (7,036) 348,964
Money Market ............. 6,691 -- -- 6,691
---------- ---------- ---------- ----------
Total available-for-sale
securities ............ 7,262,691 31,089 (8,922) 7,284,858
Less amounts classified as
cash equivalents ...... 6,691 -- -- 6,691
---------- ---------- ---------- ----------
Total investments ........ $7,256,000 $ 31,089 $ (8,922) $7,278,167
========== ========== ========== ==========
F-12
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements - (Continued)
The amortized cost and estimated fair value of available-for-sale
securities in debt securities at December 31, 1997, by contractual maturity,
were as follows:
Estimated
Cost Fair Value
----------- -----------
Due in 1 year or less ..................... $ 9,266,547 $ 9,270,723
Due in 1 - 3 years ........................ 12,438,239 12,422,230
----------- -----------
Total available-for-sale securities ....... 21,704,786 21,692,953
Less amounts classified as cash equivalents 1,788,853 1,788,853
----------- -----------
Total investments ......................... $19,915,933 $19,904,100
=========== ===========
There have been no realized gains or losses on the sale of securities
for the years ended December 31, 1997 and 1996.
3. Property and Equipment
Property and equipment consist of the following:
December 31,
----------------------
1997 1996
--------- ---------
Furniture and fixtures ...... $ 49,702 $ 49,702
Office equipment ............ 39,142 39,142
Laboratory equipment ........ 65,310 65,310
Leasehold improvements ...... 3,610 3,610
--------- ---------
157,764 157,764
Less accumulated depreciation (144,101) (126,483)
--------- ---------
$ 13,663 $ 31,281
========= =========
4. Lease Commitments
The Company leases its facilities and equipment under non-cancelable
operating leases. Future minimum lease payments at December 31, 1997 are as
follows:
1998 ...................... $361,070
1999 ...................... 272,120
2000 ...................... 227,830
2001 ..................... 82,617
-------
$943,637
=======
Lease expense was $362,532 and $209,715 for the years ended December
31, 1997 and 1996, respectively. For the year ended December 31, 1997, such
lease expense included $207,299 of office rent expense and $155,233 of equipment
lease expense, compared with office rent and equipment lease expense of $145,879
and $63,836, respectively, for the year ended December 31, 1996.
F-13
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements - (Continued)
5. Shareholders' Equity
Convertible Series A Preferred Stock Offering
On April 19, 1996, the Company completed a $7,500,000 private placement
of 750 shares of convertible Series A preferred stock ("Series A Preferred") or
("Preferred Stock Financing"). Net proceeds were $6,753,230. The shares were
convertible, at the option of the holder, into common stock. The number of
shares of common stock issuable on conversion of a share of Series A Preferred
was calculated based on the lower of $6.6275 or a variable conversion price of
85% of the average market price of the common stock on the five trading days
proceeding the conversion date. At August 31, 1997, all Series A Preferred was
converted into a total of 1,821,956 shares of common stock.
For the year ended December 31, 1997, the Company had non-cash
preferred dividends of $34,740 reflecting the 8% per annum mandatory preferred
dividends of the Series A preferred stock. For the year ended December 31, 1996,
the Company had non-cash preferred dividends of $1,125,000 reflecting the 15%
discount in conjunction with the common stock variable conversion price of the
Series A preferred stock, and non-cash preferred dividends of $288,765
reflecting the 8% per annum mandatory preferred dividends of the Series A
preferred stock.
Common Stock Private Placement
On July 23, 1997, the Company completed a $3,850,000 private placement
of 1,547,827 shares of common stock. Net proceeds were $3,814,741. The purchase
price for all investors, except the Company's chief executive officer, was
$2.375 per share. The purchase price for the shares purchased by the Company's
chief executive officer in the private placement was $2.875 per share, which is
equal to the closing price of the common stock on the Nasdaq SmallCap Market on
the date immediately preceding the closing date of the private placement.
Secondary Public Offering
On November 24, 1997, the Company completed a public offering of
2,012,500 shares of common stock at $7.50 per share. Net proceeds were
$13,764,069.
Preferred Stock
The Company's Articles of Incorporation provide that the Company may
issue up to 5,000,000 shares of preferred stock in one or more series. The Board
of Directors is authorized to establish from time to time the numbers of shares
to be included in, and the designation of, any such shares to determine or alter
the rights, preferences, privileges, and restrictions granted to or imposed upon
any wholly unissued series of preferred stock and to increase or decrease the
number of shares of any such series without any further vote or action by the
shareholders.
F-14
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements - (Continued)
Warrants
The Company has the following warrants outstanding to purchase common
stock at December 31, 1997:
Number of Exercise Price Date Expiration
Shares per Share Issued Date
- --------------- ---------------- ------------------ ---------------------
35,496 4.51 October 1994 December 31, 1999
30,368 0.01 February 1995 December 31, 1999
365,728 7.81 February 1995 December 31, 1999
44,604 9.02 March 1995 December 31, 1999
42,960 5.19 August 1995 December 31, 1999
115,000 10.31 August 1995 August 11, 2000
57,500 15.47 August 1995 August 11, 2000
661,250 9.38 August 1995 August 11, 2000
86,005 7.23 April 1996 April 18, 2001
7,000 6.25 April 1996 April 24, 1998
25,000 4.00 July 1997 July 22, 1998
24,000 10.50 October 1997 October 1, 2002
24,000 10.50 October 1997 October 1, 2002
94,063 9.75 November 1997 November 24, 2002
-----------
1,612,974
===========
Included in the table above are warrants to acquire 661,250 shares of
common stock at a price of $9.375 per share that were issued in connection with
the Company's initial public offering. The warrants are exercisable at any time
unless previously redeemed until August 11, 2000. The Company may redeem the
warrants, in whole or in part, at any time upon at least thirty days prior
written notice to the warrant holders at a price of $0.05 per warrant provided
that the closing price of the common stock has been at least $12.50 for at least
ten consecutive trading days ending on a date within 30 days before the date of
the notice of redemption. No warrants have been redeemed through December 31,
1997.
Also included in the table above are warrants issued in October 1997 to
two vendors to acquire up to 24,000 shares of common stock each which become
exercisable at the rate of 2,000 shares per month for one year commencing
October 1, 1997. The exercise price for the first six month period will be at a
price of $10.50 per share. The exercise price for the remaining six month period
varies with the actual common stock price on the dates the warrants become
exercisable. However, the exercise price will be not greater than $15 per share
or less than $8.75 per share. The warrants are exercisable for a period of five
years commencing October 1, 1997, but subject to earlier termination under
certain circumstances.
Stock Option Plans
In 1995, the Company adopted the Equity Incentive Plan (the "Plan") to
provide for the issuance of incentive stock options and non-statutory stock
options. When the Plan was established, the Company reserved 700,000 shares for
issuance. In 1996, additional 300,000 shares were reserved for issuance under
the Plan. In 1997, an additional 450,000 shares were reserved for issuance under
the Plan. Under the Plan, incentive stock options may be granted at a price per
share of not less than the fair market value of common stock on the date of
grant. Nonqualified options may be granted at a price per share of not less than
85% of fair market value on the date of grant. Options are exercisable to the
extent vested. The Compensation Committee establishes the vesting schedules.
F-15
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements - (Continued)
Activity under the Plan is summarized as follows:
Shares Price Weighted
Under Range Average
Option Per Share Exercise Price
---------- ------------- ----------
Balance at December 31, 1995 ..... 650,685 $0.45 - $6.66 $ 3.35
Granted ................. 605,447 $4.56 - $8.25 $ 5.43
Canceled ................ (253,443) $1.39 - $6.38 $ 4.49
Exercised ............... (6,344) $1.81 - $2.09 $ 1.82
---------
Balance at December 31, 1996 ..... 996,345 $0.45 - $8.25 $ 4.34
Granted ................. 430,500 $3.00 - $8.81 $ 5.17
Canceled ................ (213,371) $3.07 - $8.25 $ 5.58
Exercised ............... (132,138) $0.45 - $5.69 $ 2.74
---------
Balance at December 31, 1997 ..... 1,081,336 $0.46 - $8.81 $ 4.62
=========
At December 31, 1997, options to purchase 375,034 shares of common
stock were vested and exercisable at exercise prices ranging from $0.46 to $8.25
per share. At December 31, 1997, options to purchase 49,875 shares of common
stock at exercise prices ranging from $4.56 to $5.50 per share vest in the year
of 2001 but are subject to earlier vesting if certain performance criteria are
met. At December 31, 1997, options to purchase 36,750 shares of common stock at
an exercise price of $3.75 per share vest in the year of 2002 but are subject to
earlier vesting if certain performance criteria are met. At December 31, 1997,
208,737 options to purchase shares of common stock were available for future
option grants under the Plan.
<TABLE>
The following table summarizes information about stock options
outstanding and exercisable related to the Plan at December 31, 1997:
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------- -----------------------------
Weighted Weighted Weighted
Average Average Average
Outstanding at Remaining Exercise Exercisable at Exercise
Range of Exercise Price December 31, 1997 Contractual Life Price December 31, 1997 Price
- ----------------------- ----------------- ---------------- ----- ----------------- -----
<S> <C> <C> <C> <C> <C>
$0.46-$3.75 ........ 421,706 8.5 years $ 3.03 129,933 $ 2.23
$4.38-$6.66 ........ 551,030 8.6 years $ 5.07 225,501 $ 4.93
$7.25-$8.81 ........ 108,600 9.7 years $ 8.51 19,600 $ 7.28
--------- -------
Total ................. 1,081,336 8.7 years $ 4.62 375,034 $ 4.12
========= =======
</TABLE>
In February 1995, the Company adopted the Directors' Stock Option Plan
(the "Directors' Plan"). The Company reserved 100,000 shares of common stock for
issuance under the Directors' Plan. In June 1997, additional 50,000 shares were
reserved for issuance under the Directors' Plan. The Directors' Plan provides
for the automatic annual grant ("Annual Grant") of an option to acquire 1,000
shares of common stock to each non-employee then serving as a director at an
exercise price equal to the fair value of the common stock on the date of grant.
The Directors' Plan also provides for an initial option grant ("Initial Option")
to acquire 20,000 shares of common stock to each future non-employee director of
the Company at an exercise price equal to the fair value of the common stock on
the date of grant. Vesting generally occurs over four years from the date of
grant except that 25% of the shares subject to the Initial Option generally
become exercisable on the grant date.
F-16
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements - (Continued)
In December 1997, the Board of Directors approved, subject to
shareholder approval, an amendment to the Directors' Plan to increase the Annual
Grant to 8,000 shares of common stock, with vesting in increments of one third
per year at the end of each consecutive three year period following the grant
date, and to increase the Initial Option to 30,000 shares of common stock.
Activity under the Directors' Plan is summarized as follows:
Shares Price Weighted
Under Range Average
Option Per Share Exercise Price
--------- ------------- ---------
Balance at December 31, 1995 ....... 20,000 $5.00 $5.00
Granted ................... 50,000 $4.50 - $8.50 $5.31
------
Balance at December 31, 1996 ....... 70,000 $4.50 - $8.50 $5.22
Granted ................... 6,000 $3.25 $3.25
------
Balance at December 31, 1997 ....... 76,000 $3.25 - $8.50 $5.07
======
At December 31, 1997, options to purchase 32,500 shares of common stock
were vested and exercisable at exercise prices ranging from $4.50 to $8.50 per
share. At December 31, 1997, options to purchase 74,000 shares of common stock
were available for future option grants under the Directors' Plan.
<TABLE>
The following table summarizes information about stock options
outstanding and exercisable related to the Directors' Plan at December 31, 1997:
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------------- -------------------------------
Weighted Weighted Weighted
Average Average Average
Outstanding at Remaining Exercise Exercisable at Exercise
Range of Exercise Price December 31, 1997 Contractual Life Price December 31, 1997 Price
- ----------------------- ----------------- ---------------- ----- ----------------- -----
<S> <C> <C> <C> <C> <C>
$3.25 ........... 6,000 9.4 years $3.25 -- $---
$4.50-$5.50 ..... 65,000 8.5 years $4.97 31,250 $4.98
$8.50 ........... 5,000 8.4 years $8.50 1,250 $8.50
------ ------
Total ........... 76,000 8.6 years $5.06 32,500 $5.12
====== ======
</TABLE>
The Company has elected to follow APB Opinion No. 25 and related
interpretations in accounting for its stock options since, as discussed below,
the alternative fair market value accounting provided for under FAS 123 requires
use of option valuation models that were not developed for use in valuing stock
options. Under APB Opinion No. 25, if the exercise price of the Company's stock
options is equal to the market price of the underlying stock on the date of
grant, no compensation expense is recognized.
Pro forma information regarding net loss and net loss per share is
required by FAS 123, which requires that the information be determined as if the
Company has accounted for its stock options granted subsequent to December 31,
1994 under the fair market value method. The fair market value for options
granted in 1997 and 1996 was estimated at the date of the grant using a
Black-Scholes option pricing model.
F-17
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements - (Continued)
The Company valued its options using the following weighted average
assumptions for the years ended December 31, 1997 and 1996:
1997 1996
---- ----
Risk-free interest rate ..................... 6.20% 6.23%
Dividend yield .............................. 0% 0%
Volatility .................................. 0.487 0.517
Expected life of options in years ........... 4.9 4.8
The Black-Scholes option valuation model was developed for use in
estimating the fair market value of traded options that have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions, including the expected stock
price volatility. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair market value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair market value of its stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:
1997 1996
----------- ----------
Pro forma net loss applicable to common shareholders $(8,221,875) $(5,494,675)
Pro forma basic and diluted net loss per
share applicable to common shareholders ......... $ (1.23) $ (1.29)
The weighted average grant date fair value of options granted during
the years ended December 31, 1997 and 1996 was $2.57 and $2.79, respectively.
As a result of FAS 123 only being applicable to options granted
subsequent to December 31, 1994, its pro forma effect will not be fully
reflected until the year ending December 31, 1999.
6. Product Acquisitions
In December 1997, the Company acquired patent and related intellectual
property rights relating to "Anogesic" (the "Anogesic Acquisition"), a topical
product candidate for the treatment of anal fissures and hemorrhoids from
Neptune Pharmaceutical Corporation. Under the terms of the Agreement, the
Company issued 429,752 shares of common stock to Neptune on December 31, 1997.
Upon the signing of a letter of intent on November 3, 1997, 33,057 shares of
common stock had been issued to Neptune. The Agreement calls for a series of
additional payments, payable in shares of common stock, upon successful
completion of various milestones which, if achieved, would occur over the next
several years. Depending on several factors, including the market price of the
common stock, such payments could result in issuance of a significant number of
shares of common stock. The Agreement does not provide for the payment by the
Company of any future product royalties in connection with sales of Anogesic.
F-18
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements - (Continued)
7. License Agreements
In November 1996, the Company entered into an agreement with Glaxo
Wellcome Inc. ("Glaxo") for licensing rights to Glylorin, Cellegy's compound for
the treatment of ichthyoses. Under the terms of the agreement, Cellegy provided
Glaxo with an exclusive license of patent rights and know-how covering Glylorin
in most of the world's major markets. In exchange for this license, the Company
received from Glaxo an initial license fee payment and could potentially receive
future milestone payments (upon achievement of the specified milestones), as
well as a royalty on net sales assuming successful completion of product
development and market launch. The agreement provides that Glaxo will assume
responsibility for and the associated costs of all future development and
commercialization, including certain development costs incurred prior to the
date of the agreement. There can be no assurances, however, that the Company
will receive any additional payments from Glaxo.
In October 1993, the Company entered into a license agreement with the
University of California (the "Licensor") providing for an exclusive, worldwide,
royalty-bearing license, subject to customary government rights, for patent
rights relating to barrier repair formulations, jointly held by the Licensor and
the Company, in consideration of the issuance to the Licensor of certain shares
of preferred stock (which subsequently converted into shares of common stock)
and the payment by the Company of a licensing fee. In March 1994, the Company
entered into a second exclusive, worldwide, royalty-bearing license agreement
with the Licensor for patent rights jointly held by the Licensor and the
Company, relating to drug delivery technologies, in consideration of the payment
by the Company of a licensing fee, and an annual maintenance fee payable each
year until the Company is commercially selling a licensed product. Both
agreements require the Company to pay the Licensor royalties based on net sales
of consumer and prescription products (with minimum annual royalty payments).
The Company has the right to grant sublicenses to third parties under both
agreements. In May and October 1997, the Licensor and the Company amended these
agreements. The amendments modified and extended certain development and
commercialization milestones contained in the original agreements. The revised
milestones are tied to the achievement of certain clinical, regulatory, or
product commercialization goals over the next several years. Although there can
be no assurance that such goals will be achieved, the Company believes its
development programs in place will result in the satisfaction of such
milestones.
In April 1992, the Company entered into the License Option Agreement
(the "License Option Agreement"), the Azelaic Acid OTC License Agreement (the
"Azelaic Acid Agreement") and the Metabolic Moisturizer OTC License Agreement
(the "Metabolic Moisturizer Agreement"), with Neutrogena Corporation. The
Azelaic Acid Agreement was terminated and replaced by the Patent License
Agreement effective June 1, 1994 (the "Patent License Agreement"). Pursuant to
the Patent License Agreement, Neutrogena paid the Company $1 million for an
exclusive, royalty-free license for certain azelaic acid uses for both
prescription and consumer products in most major markets of the world. In July
1997, Neutrogena and the Company terminated the Metabolic Moisturizer Agreement
and the License Option Agreement (except as it relates to azelaic acid), and the
metabolic moisturizer technology that had been licensed to Neutrogena was
returned to the Company. The Company agreed to continue prosecution of patents
related to azelaic acid on behalf of Neutrogena and will be reimbursed by
Neutrogena for legal costs, up to a certain limit.
8. Related Party Transactions
The Company has entered into consulting agreements with certain
shareholders of the Company. The total consulting fees paid to these
shareholders was $35,000 and $52,250 for the years ended December 31, 1997 and
1996, respectively. One of these consulting agreements requires a shareholder to
provide consulting services through May 1999 in exchange for monthly payments of
approximately $3,500.
F-19
<PAGE>
Cellegy Pharmaceuticals, Inc.
(a development stage company)
Notes to Financial Statements - (Continued)
9. Income Taxes
At December 31, 1997, the Company has net operating loss carryforwards
of approximately $16,576,000 and $5,413,000 for federal and state purposes,
respectively. The federal net operating loss carryforwards expire between the
years 2004 and 2012. The state net operating loss carryforwards expire between
the years 1997 and 2002. At December 31, 1997, the Company also has research and
development credit carryforwards of approximately $354,000 and $187,000 for
federal and state purposes, respectively.
The federal credits expire between the years 2006 and 2012. The state credits
have no expiration date.
Pursuant to the "change in ownership" provisions of the Tax Reform Act
of 1986, utilization of the Company's net operating loss and research and
development tax credit carryforwards may be limited if a cumulative change of
ownership of more than 50% occurs within any three-year period.
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax liabilities and assets are as follows:
December 31,
--------------------------
1997 1996
----------- -----------
Deferred tax assets:
Net operating loss carryforwards ......... $ 5,986,000 $ 4,634,000
Credit carryforwards ..................... 477,000 357,000
Capitalized research and development costs 510,000 251,000
Deferred compensation of stock options ... 136,000 --
Capital loss carryforwards ............... 39,000 39,000
Capitalized license fee .................. 43,000 50,000
Other .................................... -- 17,000
----------- -----------
Total deferred tax assets ................... 7,191,000 5,348,000
Valuation allowance ......................... (7,142,000) (5,315,000)
----------- -----------
Net deferred tax assets ..................... 49,000 33,000
Deferred tax liabilities .................... (49,000) (33,000)
----------- -----------
Net deferred tax assets ..................... $ -- $ --
=========== ===========
The net valuation allowance increased by $1,827,000 and $1,335,000
during the years ended December 31, 1997 and 1996, respectively.
Approximately $110,000 of the valuation allowance for deferred tax
assets relates to benefits of stock option deductions which, when recognized,
will be allocated directly to contributed capital.
F-20
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration
Statement (Form S-8 No. 333-06065) pertaining to the 1992 Stock Option Plan,
1995 Equity Incentive Plan, and 1995 Directors' Stock Option Plan, and in the
Registration Statement (Form SB-2 No. 33-03401), the Registration Statement
(Form S-3 No. 33-11457), the Registration Statement (Form S-8 No. 333-32301),
the Registration Statement (Form S-3 No. 333-36057), the Registration Statement
(Form S-1 No. 333-38179), and the Registration Statement (Form S-3 No.
333-46087) of Cellegy Pharmaceuticals, Inc. of our report dated February 3,
1998, with respect to the financial statements of Cellegy Pharmaceuticals, Inc.
included in the Annual Report (Form 10-KSB) for the year ended December 31,
1997.
ERNST & YOUNG LLP
San Jose, California
March 31, 1998
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