CELLEGY PHARMACEUTICALS INC
10QSB, 1998-11-03
PHARMACEUTICAL PREPARATIONS
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                                   FORM 10-QSB


                       SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549


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


For the quarterly period ended September 30, 1998

                                       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 Number)


     1065 East Hillsdale Boulevard, Suite 418, Foster City, California 94404
          (Address of principal executive offices, including zip code)

                                 (650) 524-1600
              (Registrant's telephone number, including area code)


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

The number of shares outstanding of the registrant's common stock at November 2,
1998 was 10,165,315.


<PAGE>


                          CELLEGY PHARMACEUTICALS, INC.

                              INDEX TO FORM 10-QSB


                                                                            Page
                                                                            ----
PART   I      FINANCIAL INFORMATION

Item 1.       Financial Statements

              Unaudited Condensed Balance Sheets as of September 30,  1998
              and December 31, 1997 ........................................  3

              Unaudited  Condensed  Statements of Operations for the three
              months and nine months  ended  September  30, 1998 and 1997,
              and the  period  from  June  26,  1989  (inception)  through
              September 30, 1998 ...........................................  4

              Unaudited  Condensed  Statements of Cash Flows for the three
              months and nine months  ended  September  30, 1998 and 1997,
              and the  period  from  June  26,  1989  (inception)  through
              September 30, 1998 ...........................................  5

              Notes to Condensed Financial Statements ......................  7

Item 2.       Management's  Discussion and Analysis of Financial Condition
              and Results of Operations ....................................  9

PART   II     OTHER INFORMATION

Item 1.       Legal Proceedings ............................................ 12

Item 2.       Changes in Securities ........................................ 12

Item 3.       Defaults Upon Senior Securities .............................. 12

Item 4.       Submission of Matters to a Vote of Security Holders .......... 12

Item 5.       Other Information ............................................ 12

Item 6.       Exhibits and Reports on Form 8-K ............................. 12

Signature(s) ............................................................... 13


<PAGE>


<TABLE>
                                                   PART I - FINANCIAL INFORMATION


Item 1.  Financial Statements

                                                    Cellegy Pharmaceuticals, Inc.
                                                    (a development stage company)

                                                      Condensed Balance Sheets

                                            (Amounts in thousands, except share amounts)


<CAPTION>
                                                                                                        September 30,   December 31,
                                                                                                            1998             1997
                                                                                                          --------         --------
                                                                                                       (Unaudited)
<S>                                                                                                       <C>              <C>     
Assets
Current assets:
     Cash and cash equivalents ...................................................................        $    782         $  1,822
     Short-term investments ......................................................................           7,279            7,482
     Other current assets ........................................................................             755            1,011
                                                                                                          --------         --------
Total current assets .............................................................................           8,816           10,315
Property and equipment, net ......................................................................             251               14
Long-term investments ............................................................................           8,362           12,422
                                                                                                          --------         --------
Total assets .....................................................................................        $ 17,429         $ 22,751
                                                                                                          ========         ========


Liabilities and Shareholders' Equity 
Current liabilities:
     Accounts payable and accrued liabilities ....................................................        $    415         $    705
     Deferred revenue ............................................................................             250              500
     Accrued research fees .......................................................................             129              155
     Accrued compensation and related expenses ...................................................              58               37
     Note payable ................................................................................             421             --
                                                                                                          --------         --------
Total current liabilities ........................................................................           1,273            1,397
Shareholders' equity:
     Common stock, no par value;  20,000,000 shares  authorized:  10,165,315 shares
         issued and outstanding at September 30, 1998 and 10,123,751  shares issued
         and outstanding at December 31, 1997 ....................................................          44,353           44,192
     Accumulated other comprehensive income (loss) ...............................................              78              (12)
     Deficit accumulated during the development stage ............................................         (28,275)         (22,826)
                                                                                                          --------         --------
     Total shareholders' equity ..................................................................          16,156           21,354
                                                                                                          --------         --------
Total liabilities and shareholders' equity .......................................................        $ 17,429         $ 22,751
                                                                                                          ========         ========

<FN>
The accompanying notes are an integral part of these condensed financial statements.
</FN>
</TABLE>

                                                                 3

<PAGE>


<TABLE>
                                                    Cellegy Pharmaceuticals, Inc.
                                                    (a development stage company)

                                                 Condensed Statements of Operations

                                                             (Unaudited)
                                          (Amounts in thousands, except per share amounts)


<CAPTION>
                                                                                                                       Period from
                                                                                                                       June 26, 1989
                                                                                                                       (inception)
                                                             Three Months Ended               Nine Months Ended          through
                                                                 September 30,                   September 30,         September 30,
                                                             1998            1997            1998            1997          1998
                                                           --------        --------        --------        --------      --------
<S>                                                        <C>             <C>             <C>             <C>           <C>     
Revenues:
     Licensing and contract revenue from
         affiliate .................................       $   --          $   --          $   --          $   --        $  1,145
     Licensing, milestone, and development
         funding ...................................             66             299             231             517         1,394
     Government grants .............................             16              26             102             126           400
     Product sales .................................            343            --               343            --             343
                                                           --------        --------        --------        --------      --------
Total revenue ......................................            425             325             676             643         3,282
     Cost of revenue ...............................            (91)           --               (91)           --             (91)
                                                           --------        --------        --------        --------      --------
Gross Profit .......................................            334             325             585             643         3,191
Operating expenses:
     Research and development ......................          1,886             852           4,819           2,389        17,729
     General and administrative ....................            690             330           2,044           1,066         9,833
     Acquired in process technology ................           --              --              --              --           3,843
                                                           --------        --------        --------        --------      --------
Total operating expenses ...........................          2,576           1,182           6,863           3,455        31,405
                                                           --------        --------        --------        --------      --------
Operating loss .....................................         (2,242)           (857)         (6,278)         (2,812)      (28,214)
     Interest income and other, net ................            258             170             831             354         2,254
     Interest expense ..............................             (3)           --                (3)           --            (867)
                                                           --------        --------        --------        --------      --------
Net loss ...........................................         (1,987)           (687)         (5,450)         (2,458)      (26,827)
Non-cash preferred dividends .......................           --                 2            --                35         1,448
                                                           --------        --------        --------        --------      --------
Net loss applicable to common shareholders .........       $ (1,987)       $   (689)       $ (5,450)       $ (2,493)     $(28,275)
                                                           ========        ========        ========        ========      ========
Basic and diluted net loss per common share ........       $  (0.20)       $  (0.10)       $  (0.54)       $  (0.41)
                                                           ========        ========        ========        ========
Weighted average common shares outstanding .........         10,165           7,112          10,158           6,076
                                                           ========        ========        ========        ========

<FN>
The accompanying notes are an integral part of these condensed financial statements.
</FN>
</TABLE>

                                                                 4

<PAGE>


<TABLE>
                                                    Cellegy Pharmaceuticals, Inc.
                                                    (a development stage company)

                                                 Condensed Statements of Cash Flows

                                                             (Unaudited)
                                                       (Amounts in thousands)


<CAPTION>
                                                                                                                        Period from
                                                                                                                       June 26, 1989
                                                                                                                        (inception)
                                                                                     Nine Months Ended September 30,      through
                                                                                     -------------------------------   September 30,
                                                                                         1998              1997             1998
                                                                                       --------          --------          --------
<S>                                                                                    <C>               <C>               <C>      
Operating activities
Net loss .....................................................................         $ (5,450)         $ (2,458)         $(26,827)
Adjustment to reconcile net loss to net cash used in operating
   activities:
   Acquired in process technology ............................................             --                --               3,843
   Depreciation and amortization .............................................               10                15               274
   Compensation expense related to the extension of option
     exercise periods ........................................................             --                  70               338
   Loss on sale of property and equipment ....................................             --                --                   4
   Amortization of discount on notes payable and deferred
     financing costs .........................................................             --                --                 568
   Issuance of common shares for services ....................................             --                --                  24
   Issuance of Series A convertible preferred stock for services
     rendered ................................................................             --                --                  73
   Issuance of Series A convertible preferred stock for interest .............             --                --                  68
   Issuance of Series A convertible preferred stock for license
     agreement ...............................................................             --                --                 100
Changes in operating assets and liabilities:
   Other current assets ......................................................              256               (97)             (755)
   Accounts payable and accrued liabilities ..................................             (290)              (88)              415
   Accrued research fees .....................................................              (26)             --                 129
   Accrued compensation and related expenses .................................               21                 6                58
   Deferred revenue ..........................................................             (250)              500               250
                                                                                       --------          --------          --------
Net cash used in operating activities ........................................           (5,729)           (2,052)          (21,438)

Investing activities
Purchase of property and equipment ...........................................             (247)             --                (420)
Purchases of investments .....................................................           (3,000)           (6,990)          (38,538)
Sales and maturities of investments ..........................................            7,354             6,255            22,975
                                                                                       --------          --------          --------
Net cash provided by (used in) investing activities ..........................            4,107              (735)          (15,983)


                                                      (continued on next page)

<FN>
The accompanying notes are an integral part of these condensed financial statements.
</FN>
</TABLE>

                                                                 5

<PAGE>


<TABLE>
                                                    Cellegy Pharmaceuticals, Inc.
                                                    (a development stage company)

                                          Condensed Statements of Cash Flows - (Continued)

                                                             (Unaudited)
                                                       (Amounts in thousands)


<CAPTION>
                                                                                                                        Period from
                                                                                                                       June 26, 1989
                                                                                                                        (inception)
                                                                                     Nine Months Ended September 30,      through
                                                                                     -------------------------------   September 30,
                                                                                         1998              1997             1998
                                                                                       ----------         --------         --------
<S>                                                                                    <C>                <C>              <C>     
Financing activities
Proceeds from notes payable ..................................................         $     --           $   --           $  3,547
Repayment of notes payable ...................................................               --               --             (2,111)
Proceeds from bank note payable ..............................................                421                               421
Net proceeds from issuance of common stock ...................................                161            4,089           24,668
Issuance of convertible preferred stock, net of issuance costs ...............               --               --             11,758
Deferred financing costs .....................................................               --               --                (80)
                                                                                       ----------         --------         --------
Net cash provided by financing activities ....................................                582            4,089           38,203
                                                                                       ----------         --------         --------
Net increase (decrease) in cash and cash equivalents .........................             (1,040)           1,302              782
Cash and cash equivalents, beginning of period ...............................              1,822               36             --
                                                                                       ----------         --------         --------
Cash and cash equivalents, end of period .....................................         $      782         $  1,338         $    782
                                                                                       ==========         ========         ========

Supplemental disclosure of non-cash transactions:
Issuance of common stock in connection with acquired in process
   technology ................................................................         $     --           $   --           $  3,843
                                                                                       ==========         ========         ========
Conversion of preferred stock to common stock ................................         $     --           $  2,196         $ 14,715
                                                                                       ==========         ========         ========
Issuance of common stock for notes payable ...................................         $     --           $   --           $    269
                                                                                       ==========         ========         ========
Issuance of warrants in connection with notes payable financing
                                                                                       $     --           $   --           $    487
                                                                                       ==========         ========         ========
Issuance of Series A convertible preferred stock for notes
   payable ...................................................................         $     --           $   --           $  1,153
                                                                                       ==========         ========         ========
Issuance of Series B convertible preferred stock for notes
   payable ...................................................................         $     --           $   --           $    115
                                                                                       ==========         ========         ========
Issuance of common stock for Pacific Pharmaceuticals, Inc. ...................         $     --           $   --           $      9
                                                                                       ==========         ========         ========

<FN>
The accompanying notes are an integral part of these condensed financial statements.
</FN>
</TABLE>

                                                                 6

<PAGE>


                          Cellegy Pharmaceuticals, Inc.
                          (a development stage company)

                     Notes to Condensed Financial Statements


Note 1.   -   Basis of Presentation


     The accompanying  interim condensed financial statements have been prepared
by the Company in accordance with generally accepted  accounting  principles for
interim financial  information and with the instructions to Form 10-QSB and Item
310(b)  of  Regulation  S-B.  Accordingly,  they  do  not  include  all  of  the
information and footnote  disclosures  required by generally accepted accounting
principles  for  complete  financial   statements.   These  condensed  financial
statements should be read in conjunction with the Company's financial statements
and notes thereto  contained in the  Company's  Annual Report on Form 10-KSB for
the year ended December 31, 1997. In the opinion of management, the accompanying
condensed  financial  statements  include all  adjustments  (consisting  of only
normal recurring  adjustments)  considered  necessary for a fair presentation of
financial position and results of operations for the periods presented.

     Operating  results for the three months and nine months ended September 30,
1998 may not  necessarily  be  indicative  of the results to be expected for any
other interim period or for the full year.


Note 2.   -   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 are anti-dilutive.


Note 3.   -   Comprehensive Income (Loss)

     The  Company  has  adopted  Statement  of  Financial  Accounting  Standards
("SFAS") No. 130, "Reporting  Comprehensive  Income," as of the first quarter of
1998.  SFAS No.  130  establishes  new rules for the  reporting  and  display of
comprehensive  income  and  its  components.  It has no  impact  on net  loss or
stockholders' equity.

     The components of comprehensive income (loss) are as follows:

      (in thousands)                    Three Months Ended    Nine Months Ended
                                           September 30,        September 30,
                                        1998        1997       1998       1997
                                       -------    -------    -------    -------
Net loss applicable to common
     shareholders ..................   $(1,987)   $  (689)   $(5,450)   $(2,493)
Change in unrealized gain (loss) on
     available-for-sale investments         14         43         90         26
                                       -------    -------    -------    -------
Comprehensive net loss .............   $(1,973)   $  (646)   $(5,360)   $(2,467)
                                       =======    =======    =======    =======

     Accumulated other comprehensive income (loss) presented on the accompanying
balance  sheet  consists  of the  accumulated  net  unrealized  gain  (loss)  on
available-for-sale investments.

                                       7

<PAGE>


Note 4.   -   Bank Note Payable

     In June 1998, the Company  entered into an agreement with a bank to provide
for borrowings of up to $4.5 million through  December 1999 with interest at the
bank's  prime  rate plus one  percentage  point or a rate  equal to four and one
quarter  percentage  points  above  the  yield  of the 48 month  treasury  bill.
Interest only payments are due during the first twelve months of the  agreement.
After the initial  12-month period of the agreement,  the Company is required to
repay the amount then borrowed in 48 equal monthly installments. As of September
30, 1998, a total of $421,000 has been borrowed.


Note 5.   -   Lease Agreement

     In April 1998,  the Company  signed an agreement  to lease a new  facility,
currently under construction,  in the proximity of its current  facilities.  The
lease term is for ten years.  The facility size is  approximately  65,000 square
feet,  of which a  significant  portion  will 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 1998.

         The lease commitments are the following as of September 30, 1998:

                  1999                      $  989,625
                  2000                      $1,164,936
                  2001                      $1,199,880
                  2002                      $1,235,880
                  2003                      $1,272,948
                  Thereafter                $6,961,020

     The  Company   expects   that,   at  current  real  estate   market  rates,
approximately  one half of the lease  commitment  above in 1999 and 2000 will be
offset by sublease of the facility. A letter of intent to sublease approximately
15,000 square feet in the new facility has been completed.


Note 6.   -   Product Revenues

     Revenues  related  to  cosmeceutical  product  sales  are  recognized  upon
shipment.

                                       8

<PAGE>


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


     This Quarterly Report on Form 10-QSB 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  that could cause actual
results  to differ  materially  from  those in the  forward-looking  statements.
Further,  the Company  undertakes no  obligation  to revise any  forward-looking
statements in order to reflect events or circumstances  that may arise after the
date of this report.  Actual events or results may differ  materially from those
discussed  in this  Quarterly  Report.  See  "Factors  That  May  Affect  Future
Operating Results."

     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(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. 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 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 the  remainder of 1998 and  thereafter  as a result of the  initiation of
Phase III clinical trials in July 1998. 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.

     In  June  1998,  Cellegy  and 3M Drug  Delivery  Systems  announced  that a
research  agreement had been signed to evaluate  combining  Cellegy's  CELLEDIRM
anti-inflammatory technology with 3M's Latitude(TM) Transdermal Delivery System.
3M Drug  Delivery  Systems  is a world  leader in  transdermal  technology.  The
Latitude  Transdermal  System and 3M's  transdermal  components are technologies
used for products in various therapeutic areas.

     In September 1998, Cellegy completed initial shipments and product sales of
its C79 skin formulation to Gryphon  Development  Inc., the product  development
arm of Bath & Body Works.  C79 is a key ingredient in a new line of healing hand
creams launched for the 1998 holiday season at selected Bath & Body Works stores
in the United States.

                                       9

<PAGE>


Results of Operations

     Revenues.  The Company had  revenues of $676,000  and $643,000 for the nine
months ended September 30, 1998 and 1997,  respectively.  During the nine months
ended September 30, 1998, revenues consisted of $231,000 for development funding
associated with the Glaxo license agreement,  $102,000 related to an Orphan Drug
grant from the FDA to cover  certain of the Company's  clinical  trial costs for
Glylorin,  and  $343,000  in product  sales  associated  with a  purchase  order
received  from Gryphon  Development  Inc.  During the first nine months of 1997,
revenues  consisted of $517,000  associated with the Glaxo license agreement and
$126,000 from FDA Orphan Drug grant payments.

     For the three  months  ended  September  30,  1998,  the  Company  recorded
revenues of $425,000,  compared with $325,000 for the same period last year. The
Company will receive  significantly  lower  levels of  development  funding from
Glaxo, 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
received the full grant funding of $400,000 from the FDA.

     Research and Development  Expenses.  Research and development expenses were
$4,819,000 for the nine months ended September 30, 1998,  compared with expenses
of $2,389,000 for the same period last year. The Company  incurred  research and
development  expenses of  $1,886,000  and  $852,000  for the three  months ended
September 30, 1998 and 1997, respectively. These increases were primarily due to
salary  costs  in  connection  with  increased   scientific  personnel  and  the
associated  recruiting and relocation  expenses,  as well as increased  contract
research  and patent  expenses.  The  increase  during the last three months was
principally  due to expenses  related to the Anogesic Phase III clinical  trial.
Cellegy's  research expenses are expected to continue to increase during 1998 as
preclinical and clinical trial activity  associated  with its Anogesic  clinical
program   increases  and  as  it  continues   development  of  its   transdermal
testosterone gel.

     General and Administrative  Expenses.  General and administrative  expenses
increased to $2,044,000 for the nine months ended  September 30, 1998,  compared
with $1,066,000 for the same period last year. The Company  incurred general and
administrative  expenses of $690,000  and  $330,000  for the three  months ended
September 30, 1998 and 1997, respectively. These increases were primarily due to
salary costs in connection with the addition of administrative personnel and the
associated  recruiting and relocation  expenses,  increased  external  reporting
expenses and marketing  expenses  related to the Company's  cosmeceuticals.  The
Company's  general  and  administrative  expenses  are  expected  to continue 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.

     Interest Income and Expense. The Company earned $831,000 in interest income
for the nine months ended  September  30, 1998,  compared  with $354,000 for the
same period last year.  For the three months ended  September 30, 1998 and 1997,
the interest income earned was $258,000 and $170,000, respectively. Increases in
interest income were due to higher average investment balances during the period
resulting from proceeds principally  associated with a public offering of Common
Stock in November 1997. Interest expense of $3,000 was incurred during the three
months ended September 30, 1998 in connection with a bank loan agreement.

     Net Loss. The net loss applicable to common  shareholders was $5,450,000 or
$0.54 per share for the nine months ended September 30, 1998 based on 10,158,000
weighted average shares  outstanding,  compared with a net loss of $2,493,000 or
$0.41 per share for the same period in the prior year,  when 6,076,000  weighted
average shares were outstanding.  For the three months ended September 30, 1998,
the net loss applicable to common shareholders was $1,987,000 or $0.20 per share
based on 10,165,000 weighted average shares outstanding,  compared with $689,000
or $0.10 per share based on 7,112,000  weighted  average shares  outstanding for
the same period last year.

                                       10

<PAGE>


Liquidity and Capital Resources

     The  Company  has  experienced  net  losses  and  negative  cash  flow from
operations  each year since its  inception.  Through  September  30,  1998,  the
Company had incurred an  accumulated  deficit of $28.3  million and had consumed
cash from operations of $21.4 million.  The Company's public financings included
$6.4 million in net proceeds  from its initial  public  offering in August 1995,
$6.8 million in net  proceeds  from a preferred  stock  financing in April 1996,
$3.8  million in net proceeds  from a private  placement of Common Stock in July
1997,  and $13.8  million in net  proceeds from a secondary  public  offering in
November 1997.

     The  Company's  cash and  investments  were $16.4  million at September 30,
1998, compared with $21.7 million at December 31, 1997. The decrease in cash and
investments was principally  due to net cash used in operating  activities.  The
Company's  operations have and will continue to use substantial amounts of cash.
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,  the
costs of filing,  prosecuting,  defending  and  enforcing  any patent claims and
other intellectual  property rights, the ability of the Company to establish new
collaborative  arrangements,  its ability to maintain  existing  collaborations,
particularly  with Glaxo, the initiation of  commercialization  activities,  the
purchase of capital equipment, and the availability of other financing.

     In order to complete  the  research and  development  and other  activities
necessary to commercialize its products,  additional financing will be required.
As a result,  the Company will seek  private or public  equity  investments  and
future  collaborative  arrangements with third parties to meet such needs. There
is no assurance that such financing,  including further development funding from
Glaxo,  will be available  for the Company to fund 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.

     Impact of Year 2000.  The Company has  established a project team to review
and  make  necessary  modifications  to  its  computer  systems  for  Year  2000
compliance.  The Company completed an initial assessment of its Year 2000 status
in September  1998. The majority of the hardware can be made Year 2000 compliant
through BIOS upgrades or software patches. The expected completion date for this
is December  1998.  The Company  currently  does not expect the cost of its Year
2000  compliance  program  will  be  material  to its  financial  condition.  In
addition,  the  Company is  developing  a  contingency  plan in the event that a
business interruption caused by Year 2000 problems should occur. The contingency
plans also include  plans to address  third  parties'  Year 2000 issues that may
arise. Nevertheless, Year 2000 compliance is a complex project and it depends on
many factors,  some of which are not  completely  within the Company's  control.
Should either the Company's  internal  systems or the internal systems of one or
more significant vendors or suppliers fail to achieve Year 2000 compliance,  the
Company's business and its results of operations could be adversely affected.


Factors That May Affect Future Operating Results

     This Quarterly  Report on Form 10-QSB 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,  independent  decisions  made  by its
collaborative   partners,   the  Company's   strategic   plans,  the  scope  and
defensibility of the Company's patent coverage, anticipated expenditures and the
need for additional  funds. The factors discussed in the Company's reports filed
with the  Securities  and Exchange  Commission,  including the Company's  Annual
Report on Form 10-KSB for the year ended December 31, 1997, in particular  under
the  caption  "Factors  That May Affect  Future  Operating  Results,"  should be
carefully considered when evaluating the Company's business and prospects.

                                       11

<PAGE>


                           PART II - OTHER INFORMATION


Item 1.           Legal Proceedings

         None


Item 2.           Changes in Securities

         None


Item 3.           Defaults Upon Senior Securities

         None


Item 4.           Submission of Matters to a Vote of Security Holders

         None


Item 5.           Other Information

         None


Item 6.           Exhibits and Reports on Form 8-K

         (a)      Exhibits

         None

         (b)      Reports on Form 8-K

         None

                                       12

<PAGE>


                                   SIGNATURES

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


                                             CELLEGY PHARMACEUTICALS, INC.


Date:  November 3, 1998              /s/   K. Michael Forrest
                                     -------------------------------------------
                                           K. Michael Forrest
                                           President and Chief Executive Officer


Date:  November 3, 1998              /s/   A. Richard Juelis
                                     -------------------------------------------
                                           A. Richard Juelis
                                           Vice President, Finance and
                                           Chief Financial Officer



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