10QSB 1 p17861_10qsb.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB (MARK ONE) [ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2003 ------------------ [ ] TRANSITION REPORT UNDER SECTION 13 OR A5(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (no fee required) Commission file number 0-23544 HUMAN PHEROMONE SCIENCES, INC. ------------------------------------------------------------- (Name of small business issuer in its charter) California 94-3107202 --------------------------------- ------------------------ (State or other jurisdiction (I.R.S. employee of incorporation or organization) Identification No.) 84 West Santa Clara Street, San Jose, California 95113 -------------------------------------------------- ------------------------ (Address of principal executive offices) (Zip code) Issuer's telephone number: (408) 938-3030 -------------- Not applicable ------------------------------------------------------------- (Former name or former address, if changed since last report) State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 4,027,616 shares of Common Stock as of October 31, 2003. 1 HUMAN PHEROMONE SCIENCES, INC. INDEX
Page ---- PART I FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of September 30, 2003 (Unaudited) and December 31, 2002...........................................................................3 Consolidated Statements of Operations and Comprehensive Income /Loss (Unaudited) for the For the Three and Nine Months Ended September 30, 2003 and 2002.................................4 Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2003 and 2002...............................................................5 Notes to Consolidated Financial Statements (Unaudited) .........................................6 Item 2. Management's Discussion and Analysis Management's Discussion and Analysis of Financial Conditions and Results of Operations .........9 Item 3. Controls and Procedures.........................................................................15 PART II OTHER INFORMATION Item 5. Other Information...............................................................................16 Item 6. Exhibits and Reports on Form 8-K ...............................................................16 SIGNATURES.......................................................................................................17
2 PART I FINANCIAL INFORMATION Item 1. Financial Statements Human Pheromone Sciences, Inc. Consolidated Balance Sheets
September 30, December 31, (in thousands except share data) 2003 2002 ---------------------------------------------------------------------------------- -------- -------- (unaudited) Assets Current assets: Cash and cash equivalents $ 1,860 $ 1,394 Accounts receivable, net of allowances of $12,000 and $70,000 in 2003 and 2002, respectively 250 249 Inventories, net 68 151 Assets to be sold -- 493 Other current assets 46 10 -------- -------- Total current assets 2,224 2,297 Property and equipment, net 9 5 Product licenses 50 50 -------- -------- $ 2,283 $ 2,352 ======== ======== Liabilities, Convertible Redeemable Preferred Stock and Shareholders' Equity (Deficiency) Current liabilities: Accounts payable $ 39 $ 186 Liabilities associated with assets to be sold -- 330 Deferred revenue 3 -- Accrued income tax 15 -- Accrued professional fees 52 57 Accrued vacation 45 34 Other accrued expenses 18 19 -------- -------- Total current liabilities 172 626 -------- -------- Commitments and Contingencies Convertible redeemable preferred stock: Preferred stock, issuable in series, no par value, 10,000,000 shares authorized, Series AA 100,000 and 1,433,333 convertible shares issued and outstanding in 2003 and 2002, respectively (total liquidation value $150 and $2,150, respectively) 150 2,146 Series BB 17,448 convertible shares issued and outstanding at December 31, 2002 (total liquidation value $1,745) -- 1,560 -------- -------- Total convertible redeemable preferred stock 150 3,706 -------- -------- Shareholders' equity (deficiency): Common stock, no par value, 13,333,333 shares authorized, 4,027,616 and 3,429,839 shares issued and outstanding at 2003 and 2002, respectively 20,717 17,667 Accumulated deficit (18,756) (19,581) Foreign currency translation -- (66) -------- -------- Total shareholders' equity (deficiency) 1,961 (1,980) -------- -------- $ 2,283 $ 2,352 ======== ========
See accompanying notes to consolidated financial statements 3 Human Pheromone Sciences, Inc. Consolidated Statements of Operations and Comprehensive Income (Loss) (unaudited)
(in thousands except per share data) Three months ended Nine months ended --------------------- --------------------- September 30, September 30, --------------------- --------------------- 2003 2002 2003 2002 ------- ------- ------- ------- Net revenues $ 227 $ 165 $ 506 $ 456 Cost of goods sold 73 54 157 135 ------- ------- ------- ------- Gross profit 154 111 349 321 Operating Expenses: Research and development 11 80 18 242 Selling, general and administrative 276 270 803 759 ------- ------- ------- ------- Total operating expenses 287 350 821 1,001 ------- ------- ------- ------- Income (Loss) from operations (133) (239) (472) (680) Other income and (expense) Interest income (expense) 4 6 12 16 Other income (expense) 20 11 20 11 ------- ------- ------- ------- Total other income and (expense) 24 17 32 27 Income tax benefit from on-going operations 1 -- 34 -- ------- ------- ------- ------- Income (loss) from on-going operations (108) (222) (406) (653) Net income from discontinued operations -- 134 79 481 Net gain from sale of assets (8) -- 1,218 -- ------- ------- ------- ------- Net income (loss) available to common shareholders (116) (88) 891 (172) Other comprehensive income - translation adjustment -- -- -- 2 ------- ------- ------- ------- Comprehensive income (loss) $ (116) $ (88) $ 891 $ (170) ======= ======= ======= ======= Net income (loss) per common share- basic From on-going operations $ (0.03) $ (0.07) $ (0.11) $ (0.19) From discontinued operations $ 0.00 $ 0.04 $ 0.02 $ 0.14 From assets sold $ 0.00 $ 0.00 $ 0.33 $ 0.00 Net income (loss) $ (0.03) $ (0.03) $ 0.24 $ (0.05) Net income (loss) per common share-fully diluted From on-going operations $ (0.03) $ (0.07) $ (0.09) $ (0.19) From discontinued operations $ 0.00 $ 0.04 $ 0.02 $ 0.14 From assets sold $ 0.00 $ 0.00 $ 0.26 $ 0.00 Net income (loss) $ (0.03) $ (0.03) $ 0.19 $ (0.05) Weighted average common shares outstanding - basic 4,028 3,430 3,717 3,430 ======= ======= ======= ======= Weighted average common shares outstanding - fully diluted 4,028 3,430 4,731 3,430 ======= ======= ======= =======
See accompanying notes to consolidated financial statements 4 Human Pheromone Sciences, Inc. Consolidated Statements of Cash Flows (unaudited) Nine months ended September 30, ------------------- (in thousands) 2003 2002 ------- ------- Cash flows from operating activities Net income (loss) $ 891 $ (172) Net income from discontinued operations 79 481 Net income from sale of assets 1,218 -- ------- ------- Net loss from on-going operations (406) (653) Adjustments to reconcile net income to net cash provided or used by operating activities: Depreciation and amortization 3 5 Changes in operating assets and liabilities: Accounts receivable (165) 4 Inventories 82 9 Other current assets (35) (20) Accounts payable and accrued liabilities (92) -- Deferred revenue 3 ------- ------- Net cash used by on-going operating activities (610) (655) ------- ------- Net cash provided by operations of assets sold 153 413 ------- ------- Cash flows provided (used) in investing activities Sale of Realm assets 1,435 -- Acquisition of fixed assets (7) (1) ------- ------- Net cash provided by investing activities 1,428 -- Cash flows used in financing activities Purchase of Series BB preferred stock (505) -- ------- ------- Net cash used in financing (505) -- Effect of exchange rate on cash -- 2 ------- ------- Net increase in cash and cash equivalents 466 (241) Cash and cash equivalents at beginning of period 1,394 1,355 ------- ------- Cash and cash equivalents at end of period $ 1,860 $ 1,114 ======= ======= See accompanying notes to consolidated financial statements. 5 Human Pheromone Sciences, Inc. Notes to Consolidated Financial Statements (unaudited) September 30, 2003 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Nature of Operations Human Pheromone Sciences, Inc. (the "Company") was incorporated in the State of California in 1989 under the name of EROX Corporation. The Company changed the name to Human Pheromone Sciences, Inc. in May 1998. The Company is engaged in the research, development, manufacturing and marketing of consumer products containing synthetic human pheromones as a component. The Company initiated commercial operations in late 1994 with a line of fine fragrances and toiletries. In April 2000, the Company licensed the sale of its REALM fragrance products through department and specialty stores across the United States and selected international markets to Niche Marketing, Inc. In April 2003 the Company sold the REALM(R) and innerREALM(R) brands and trademarks to Niche Marketing Group, Inc. The Company will continue to license and sell its human pheromones for inclusion in other companies products in exchange for supply revenues and/or royalties, and will continue to involved in brand and product development. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-QSB and Item 310(b) of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2003 are not necessarily indicative of the results that may be expected for the calendar year ending December 31, 2003. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-KSB for the year ended December 31, 2002. Certain prior period balances have been reclassified to conform to the current period presentation. Revenue Recognition Revenue is recorded at the time of merchandise shipment, net of provisions for returns. License fees are earned over the license period according to the terms of the license agreement and interpretative guidance provided by Staff Accounting Bulletin (SAB) No. 101. The majority of the Company's sales are to distributors and licensees, and these distributors and licensees have no right to return products. Inventories Inventories are stated at the lower of cost (first in - first out method) or market. The inventory at September 30, 2003 consists of finished goods inventory valued at $18,000 and raw materials of $50,000. At December 31, 2002, these balances were $14,000 and $137,000, respectively. Sale of Assets On April 14, 2003 the Company sold to Niche Marking Group, Inc. the assets and worldwide ownership rights to the REALM Women, REALM Men and innerREALM product lines. Assets consisting REALM and innerREALM trademarks, inventory and product licenses were sold resulting in a net gain of $1,218,000. All REALM and innerREALM operating results have been classified as discontinued operations, $79,000 for the nine months ending September 30, 2003 and $481,000 the comparable period in 2002. Reclassifications of certain 2002 financial statement information have been made to present the operating results from on-going operations on a comparable basis. 6 License Fees The Company capitalizes license fees paid for the rights to use new pheromone discoveries. License agreements for pheromones and products that are not yet available for sale are not subject to amortization in accordance with Statement of Financial Accounting Standards No. 142: Goodwill and Other Intangible Assets. The Company continually evaluates whether events or circumstances have occurred that indicate the remaining estimated value of the license agreements may not be recoverable. When factors indicate that the value license may be impaired, the Company estimates the remaining value and reduces the license agreement to that amount. Income Taxes The Company has recorded a tax provision of $22,000 for 2003 and no income tax provision for 2002, due primarily to a valuation allowance on deferred tax assets being recorded, and the expected utilization of net operating losses carried forward from prior years to offset any significant tax liability. As of September 30, 2003, the Company's gross deferred tax asset, which relates primarily to net operating losses carried forward was $6,410,000. California has suspended for 2003 the utilization of operating loss carry forwards which will result in a tax liability for the year if the Company's taxes exceed the available Research & Development tax credit of $82,000. Earnings (Loss) Per Share The Company calculates earnings (loss) per share in accordance with SFAS No. 128, "Earnings Per Share." SFAS No. 128 replaced the presentation of primary and fully diluted earnings per share with the presentation of basic and diluted earnings per share. Basic earnings per share excludes dilution and is calculated by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share includes the potential dilutive effects that could occur if securities or other contracts to issue common stock were exercised or converted into common stock ("potential common stock") that would then share in the earnings of the Company. As of September 30, 2003 and 2002, the unaudited components of basic and diluted earnings per share are as follows (all amounts are in thousands): 2003 2002 ------ ------- Net income (loss) available to common shareholders $ 891 $ (172) ====== ======= Weighted-average common shares outstanding during the period 3,717 3,430 Incremental shares from assumed conversions of convertible preferred stock and stock options 1,014 -- ------ ------- Fully diluted weighted-average common shares and potential commons stock (unaudited) 4,731 3,430 ====== ======= Convertible Redeemable Preferred Stock On May 22, 2003 the Company purchased, from a fund of whom a board member was the general partner, all of the outstanding shares of its Series BB Preferred Stock for $505,000. In a related transaction 1,333,333 shares of Series AA Preferred Stock was converted into 597,777 shares of common stock. 7 Capital Stock and Stock Options Outstanding options to purchase shares of common stock and potential common shares issuable upon conversion of preferred stock are excluded from the computation of diluted earnings per share since when the average stock price for the period is less than the exercise price of outstanding options or when their effect would be antidilutive. On June 25, 2003 the Board of Directors adopted the 2003 Nonemployee Directors Stock Option Plan of Human Pheromone Sciences, Inc. A maximum of 300,000 shares of commons tock may be issued on exercise of the Options granted pursuant to this plan. The plan will expire June 24, 2010. This plan replaces the previous plan which expired June 13, 2003. During the three months ended September 30, 2003 no common or preferred stock was issued, and no stock options were issued. During the quarter 45,000 stock options expired. Recent Accounting Pronouncements In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 updates, clarifies, and simplifies existing accounting pronouncements. This statement rescinds SFAS No. 4, which required all gains and losses from extinguishments of debt to be aggregated and if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB No. 30 will now be used to classify those gains and losses. SFAS No. 64 amended SFAS No. 4 and is no longer necessary as SFAS No. 4 has been rescinded. SFAS No. 44 has been rescinded as it is no longer necessary. SFAS No. 145 amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-lease transactions. This statement also makes technical corrections to existing pronouncements. While those corrections are not substantive in nature, in some instances, they may change accounting practice. This statement is not applicable to the Company. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). This statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue 94-3, a liability for an exit cost, as defined, was recognized at the date of an entity's commitment to an exit plan. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002 with earlier application encouraged. The Company does not expect adoption of SFAS No. 146 to have a material impact, if any, on its financial position or results of operations. In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions. SFAS No. 147 removes the requirement in SFAS No. 72 and Interpretation 9 thereto, to recognize and amortize any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset. This statement requires that those transactions be accounted for in accordance with SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. In addition, this statement amends SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, to include certain financial institution-related intangible assets. This statement is not applicable to the Company. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. This statement is effective for financial statements for fiscal years ending after December 15, 2002. SFAS No. 148 will not have any impact on the Company's financial statements as management does not have any intention to change to the fair value method. In April 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies accounting and reporting for derivative instruments and hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for derivative instruments and hedging activities entered into or modified after June 30, 2003, except for certain forward purchase and sale securities. For these forward purchase and sale securities, SFAS No. 149 is effective for both new and existing securities after June 30, 2003. Management does not expect adoption of SFAS No. 149 to have a material impact on the Company's statements of earnings, financial position, or cash flows. 8 In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 will be effective for financial instruments entered into or modified after May 31, 2003 and otherwise will be effective at the beginning of the first interim period beginning after June 15, 2003. The Company has classified redeemable preferred stock as a separate liability. Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operations This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Except for the historical information contained in this discussion and analysis of financial condition and results of operations, the matters discussed herein are forward looking statements. These forward looking statements include but are not limited to the Company's plans for sales growth and expansion into new channels of trade, expectations of gross margin, expenses, new product introduction, and the Company's liquidity and capital needs. These matters involve risks and uncertainties that could cause actual results to differ materially from the statements made. In addition to the risks and uncertainties described in "Risk Factors", below, these risks and uncertainties may include consumer trends, business cycles, scientific developments, changes in governmental policy and regulation, currency fluctuations, economic trends in the United States and inflation. These and other factors may cause actual results to differ materially from those anticipated in forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Risk Factors The Company's future results may be affected to a greater or lesser degree by the following factors among others: The Company has not had sustained profitable operations since 1997. Since 1997, the Company has incurred losses from operations. The Company's business model is based on obtaining product-licensing agreements. While the Company anticipates that this business model will result in profitable operations, the Company's license based business model may not be successful. The Company's marketing strategy may not be successful. The Company or its distributors and licensees may not be able to establish and maintain the necessary sales and distribution channels. Retail outlets and catalogs may choose not to carry the Company's or its licensees' products. The Company, its licensees or its distributors may not have sufficient funds to successfully market its products if the current marketing strategy is not successful. The Company not be able to protect its technology or trade secrets. The Company's patents and patent applications may not protect the Company's technology or ensure that the Company's technology does not infringe another's valid patent. Others may independently develop substantially equivalent proprietary information. The Company may not be able to protect its technology, proprietary information or trade secrets. The Company's ongoing research and product development efforts may not be successful. While the Company plans to initiate several studies on human subjects, the products being tested may not be effective. The Company, its distributors and licensees may not be able to effectively compete with larger companies or with new products. The fragrance, toiletries and cosmetics markets are extremely competitive. Many competitive products are better known than the Company's products and compete for advertising and retail shelf space. Many competitors have significantly greater resources that will allow them to develop and introduce new competing products or increase the promotion of current products. The product life cycle of these products can be very short. Changing fashions and fads can dramatically shift consumer preferences and demands. Traditional fragrance, toiletries and cosmetics companies introduce a new products every year or so. Changing fashions and new products may reduce the chance of creating long term brand loyalty to human pheromone-based products. 9 The current retail environment may cause pricing and promotional pressures. Less than ten companies control the majority of the sales in the U. S. in the fragrance, toiletries and cosmetics arena. Because of their market share, each company will have significant power to determine the price and promotional terms that the Company and its licensees or distributors must meet in order to introduce and sell its products to the consumer. Seasonality in sales may cause significant variation in quarterly results. Sales in the fragrance industry are generally seasonal with sales higher in the second half of the year because of Christmas. This seasonality could cause a significant variation in the Company's quarterly operating results. The Company may not be able to recruit and retain key personnel. The Company's success substantially depends upon recruiting and retaining key employees and consultants with research, product development and marketing experience. The Company may not be successful in recruiting and retaining these key people. The Company relies upon other companies to manufacture its products. The Company relies upon other companies to manufacture its pheromones, supply components, and to blend, fill and package its fragrance products. The Company may not be able to obtain or retain pheromone manufacturers, fragrance suppliers, or component manufacturers on acceptable terms. If the Company is unable to obtain commercial quantities of its products the operating results would be adversely effected. Results of Operations On April 24, 2000, the Company signed a multi-year licensing agreement for its REALM and innerREALM fragrance and toiletry products with Niche Marketing, Inc. ("Niche"), a newly formed affiliate of Northern Brands, Inc. Under the agreement, Niche will be responsible for the manufacture, marketing, selling and distribution of the REALM and innerREALM products in the United States and internationally, excluding the Far East. On April 14, 2003, the Company sold to Niche Marking Group, Inc. the assets and worldwide ownership rights to the REALM Women, REALM Men and innerREALM product lines. The Company will continue to focus operations on the marketing of its patented technology to companies with established consumer product franchises while directly managing the on-going development of identified compounds for potential new products. All REALM(R) and innerREALM(R) financial activities have been classified as assets to be sold as a result of the April 14, 2003 sale. Therefore reclassifications of certain 2002 financial statement information have been made to present the operating results from on-going operations on a comparable basis. Three Months ended September 30, 2003 compared to the Three Months ended September 30, 2002 Net sales and revenues for the third quarter of 2003 were $227,000, representing an increase of 38% from sales of $165,000 for the prior year's quarter. The $40,000, or 26%, increase in license and supply revenues, from customers utilizing the Company's technology as a components in their consumer products, was due to deferred purchases from the second quarter of the current year. Sales of the Natural Attraction(R) products specifically manufactured for international distributors commenced during the 2003 quarter resulting in sales of $23,000. Net sales for the quarters ended September 30, 2003 and 2002 were as follows (in thousands): 2003 2002 ------------------------------------------------------------------------------- Markets: License and Supply Revenues $195 $155 Direct Marketing 8 10 U.S. Retail & Distributor Markets 1 -- International Markets 23 -- ---- ---- Net Sales $227 $165 ==== ==== Gross profit for the quarter ended September 30, 2003 of $154,000 is 39% more than last years $111,000. As a percentage of sales, gross profit of 68% is slightly better than last years of 67% due to reductions in cost of goods sold. 10 Research and Development expenses for the third quarter of 2003 were $11,000 compared to $80,000 in 2002. The Company desires to directly control all future research and development work; as such the Company terminated its relationships with its primary consultants in October 2002. The Company incurred very minimal expenses in the third quarter of 2003 since its independent research and development efforts had not commenced. Selling, general and administrative expenses of $276,000 were comparable to last year's third quarter expenses of $270,000. Selling, and marketing and distribution expenses were $9,000 more than the prior year as we begin to fund product and marketing development activities for Natural Attraction. General, administrative and facility costs were $3,000 less in the current year with employee related costs slightly more than last year off set by reducing other expenses. The Company earned $4,000 and $6,000 in net interest income in 2003 and 2002, respectively. The increase in cash balances was offset by lower interest rates earned. The Company has recorded a tax provision of $22,000, due primarily to a valuation allowance on deferred tax assets being recorded, and the expected utilization of net operating losses carried forward from prior years to offset any significant tax liability. As of September 30, 2003, the Company's gross deferred tax asset, which relates primarily to net operating losses carried forward was $6,410,000. However, California has suspended for 2003 the utilization of operating losses carried forward which will result in a tax liability for the year if the Company's taxes exceed the available Research & Development tax credit of $82,000. On April 14, 2003 the Company sold to Niche Marking Group, Inc. the assets and worldwide ownership rights to the REALM Women, REALM Men and innerREALM product lines. Assets consisting REALM and innerREALM trademarks, inventory and product licenses were sold resulting in a year to date net gain of $1,218,000, with $8,000 of expense recorded this quarter for legal fees for the transfer of trademarks. All REALM and innerREALM operating results have been classified as discontinued operations; for the quarter ending September 30, 2003 no income or loss was incurred from these operations. For the three months ended September 30, 2002 these operations produced $134,000 of income. Nine Months ended September 30, 2003 as compared to the Nine Months ended September 30, 2002 Net revenues for the nine months ended September 30, 2003 were $506,000. This was an 11% increase from net revenues of $456,000 for the first nine months of 2002. License and supply revenues increased by $66,000 for the first nine months of 2003 to $442,000 as a result of increased licensing and supply activities to Avon Products in 2003. Sales in International markets decreased by $12,000 due to the delayed receipt of new bottles for the Natural Attraction product line, and reduced promotional efforts. Net sales for the nine months ended September 30, 2003 and 2002 were as follows: -------------------------------------------------------------------------------- Markets 2003 2002 -------------------------------------------------------------------------------- License and Supply Revenues $442 $376 Direct Marketing 28 41 U.S. Retail & Distributor Markets 12 3 International Markets 24 36 ---- ---- Net Sales $506 $456 Gross profit for the nine months of 2003 increased 9% to $349,000 from $321,000 in 2002. The increase is the result of increased license revenue. Gross profit as a percentage of revenues, 69% for 2003 and 70% for 2002, has remained consistent. Research and Development expenses for the first nine months of 2003 and 2002 were $18,000 and expense of $242,000, respectively. The Company has ended its relationship with Pherin Pharmaceuticals and plans to conduct its own independent research and development operations, which have not commenced as of September 30, 2003. 11 Selling, general and administrative expenses for the first none months of 2003 were $803,000 and $759,000 for the comparable period of 2002. Sales, marketing and distribution expenses were equal to the prior year as Natural Attraction sales activity was limited. Administrative and facilities were $46,000 more than last year. In 2002 a $32,000 bad debt recovery was made and no similar recovery was made in 2003. Additional professional fees were incurred this year due to the sale of assets in April 2003, the redemption and conversion of the Company's Series AA and BB preferred stock in May 2003. The Company's cash balances generated $12,000 in net interest income during the first nine months of 2003, as compared to $16,000 in 2002. The decrease is due to reduced interest rates. LIQUIDITY AND CAPITAL RESOURCES At September 30, 2003, the Company had cash of $1,860,000 with no outstanding bank borrowings and working capital of $2,052,000; at December 31, 2002, it had cash of $1,394,000 with no outstanding bank borrowings and working capital of $1,671,000. For the first nine months of 2003, net cash provided from all activities was $466,000. For the first nine months of 2002, net cash used from all activities was $241,000. On May 2, 2003, the Company renewed a its Business Loan Agreement with Mid-Peninsula Bank of Palo Alto, California (the "Bank") providing for a revolving line of credit. The Company may borrow up to $500,000 at an interest rate equal to the Bank's prime rate plus 0.75% with borrowings secured primarily by the Company's trade receivables and inventory. The agreement, which expires on May 3, 2004, contains certain debt-to-equity and working capital covenants. At September 30, 2003 the Company was in compliance with such covenants. On May 22, 2003 the Company purchased, from a fund of whom a board member was a general partner, all of the outstanding shares of its Series BB Preferred Stock for $505,000. In a related transaction, with the same fund, 1,333,333 shares of Series AA Preferred Stock was converted into 597,777 shares of common stock. Assuming the Company's activities proceed substantially as planned, the Company's current cash position and projected results of operations for the next twelve months are not expected to require additional outside financing. RECENT ACCOUNTING PRONOUNCEMENTS In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS No. 145 updates, clarifies, and simplifies existing accounting pronouncements. This statement rescinds SFAS No. 4, which required all gains and losses from extinguishments of debt to be aggregated and if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in APB No. 30 will now be used to classify those gains and losses. SFAS No. 64 amended SFAS No. 4 and is no longer necessary as SFAS No. 4 has been rescinded. SFAS No. 44 has been rescinded as it is no longer necessary. SFAS No. 145 amends SFAS No. 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-lease transactions. This statement also makes technical corrections to existing pronouncements. While those corrections are not substantive in nature, in some instances, they may change accounting practice. This statement is not applicable to the Company. In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). This statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF Issue 94-3, a liability for an exit cost, as defined, was recognized at the date of an entity's commitment to an exit plan. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002 with earlier application encouraged. The Company does not expect adoption of SFAS No. 146 to have a material impact, if any, on its financial position or results of operations. In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions. SFAS No. 147 removes the requirement in SFAS No. 72 and Interpretation 9 thereto, to recognize and amortize any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable intangible assets acquired as an unidentifiable intangible asset. This statement requires that those transactions be accounted for in accordance with SFAS No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. In addition, this statement 12 amends SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, to include certain financial institution-related intangible assets. This statement is not applicable to the Company. In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of SFAS No. 123. SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation. This statement is effective for financial statements for fiscal years ending after December 15, 2002. SFAS No. 148 will not have any impact on the Company's financial statements as management does not have any intention to change to the fair value method. In April 2003, the Financial Accounting Standards Board ("FASB") issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and clarifies accounting and reporting for derivative instruments and hedging activities under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 149 is effective for derivative instruments and hedging activities entered into or modified after June 30, 2003, except for certain forward purchase and sale securities. For these forward purchase and sale securities, SFAS No. 149 is effective for both new and existing securities after June 30, 2003. Management does not expect adoption of SFAS No. 149 to have a material impact on the Company's statements of earnings, financial position, or cash flows. In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity. In accordance with the standard, financial instruments that embody obligations for the issuer are required to be classified as liabilities. SFAS No. 150 will be effective for financial instruments entered into or modified after May 31, 2003 and otherwise will be effective at the beginning of the first interim period beginning after June 15, 2003. The Company has classified redeemable preferred stock as a separate liability. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial conditions and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of financial statements require managers to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses and disclosures on the date of the financial statements. On an on-going basis, we evaluate our estimates, including, but not limited to, those related to revenue recognition and license fees. We use authoritative pronouncements, historical experience and other assumptions as the basis for making judgments. Actual results could differ from those estimates. We believe that the following critical accounting policies affect our more significant judgments and estimates in the preparation of our consolidated financial statements. Revenue Recognition Revenue is recorded at the time of merchandise shipment, net of provisions for returns. License fees are earned over the license period according to the terms of the license agreement and interpretative guidance provided by Staff Accounting Bulletin (SAB) No. 101. The majority of the Company's sales are to distributors and licensees, and these distributors and licensees have no right to return products. License Fees The Company capitalizes license fees paid for the rights to use new pheromone discoveries, and rights for additional REALM and innerREALM sales territories. License agreements that have a finite useful life are amortized using the straight-line method over the life of the agreement. License agreements for pheromones and products that are not yet for available for sale are not subject to amortization in accordance with Statement of Financial Accounting Standards No. 142: Goodwill and Other Intangible Assets. 13 The Company continually evaluates whether events or circumstances have occurred that indicate the remaining estimated value of the license agreements may not be recoverable. When factors indicate that the value license may be impaired, the Company estimates the remaining value and reduces the license agreement to that amount. 14 Item 3. Controls and Procedures Evaluation of Disclosure Controls and Procedures. Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Changes in Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with our evaluation that occurred during our first fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 15 PART II OTHER INFORMATION Item 5. Other Events On July 1, 2003 Michael D. Kaufman, a director since August 1997, resigned from the Board of Directors. Mr. Kaufman determined that his other business commitments would consume significantly more of his time, and prevent him from devoting the amount of time necessary to fulfill his duties and responsibilities as a Board member. Item 6. Exhibits and Reports on Form 8-K a. Exhibits Exhibit 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act Exhibit 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act Exhibit 32 Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. 1350 b. Reports on Form 8-K None 16 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant had duly caused this Report to be signed on behalf by the undersigned thereunto duly authorized. HUMAN PHEROMONE SCIENCES, INC. Registrant Date: November 11, 2003 /s/ William P. Horgan ------------------------------------ William P. Horgan Chairman and Chief Executive Officer Date: November 11, 2003 /s/ Gregory S. Fredrick ------------------------------------- Gregory S. Fredrick Vice President Finance 17