MEI Pharma, Inc. 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended September 30, 2011
For the transition period from to .
Commission File Number: 000-50484
Marshall Edwards, Inc.
(Exact name of registrant as specified in its charter)
11975 El Camino Real, Suite 101, San Diego, CA 92130
(Address of principal executive offices) (Zip Code)
(Registrants telephone number, including area code)
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of November 11, 2011 the number of shares outstanding of the issuers common stock, $0.00000002 par value, was 11,814,025.
Table of Contents
Item 1: Financial Statements
(A Development Stage Company)
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)
See accompanying notes to the unaudited consolidated financial statements.
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
See accompanying notes to the unaudited consolidated financial statements.
(A Development Stage Company)
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to the unaudited consolidated financial statements.
(A Development Stage Company)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Marshall Edwards, Inc., together with its wholly-owned subsidiary Marshall Edwards Pty Ltd (MEPL), collectively referred to as MEI (the Company), is a development stage oncology company focused on the clinical development of novel therapeutics targeting cancer metabolism. The Company was incorporated in December 2000 as a wholly-owned subsidiary of Novogen Limited (Novogen). Marshall Edwards Inc.s common stock is listed on the Nasdaq Capital Market under the symbol MSHL. As of September 30, 2011, Novogen owned approximately 55.6% of the outstanding shares of the Companys common stock.
The Companys drug development pipeline is derived from its isoflavone technology platform that has generated a number of compounds with anti-proliferative tumor activity. These small molecules have been shown to interact with specific enzyme targets resulting in inhibition of tumor cell metabolism, a function critical for cancer cell survival. As described in Note 5, in May 2011, the Company acquired from Novogen its entire isoflavone-based intellectual property portfolio, including assets which had previously been licensed.
Basis of Presentation
The accompanying unaudited consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto as of and for the year ended June 30, 2011, included in the Companys Annual Report on Form 10-K filed with the Securities and Exchange Commission on September 28, 2011. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, since these are interim statements, the accompanying consolidated financial statements do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the accompanying consolidated financial statements reflect all adjustments (consisting of normal recurring adjustments) that are necessary for a fair statement of the financial position, results of operations and cash flows for the interim periods presented. Interim results are not necessarily indicative of results for a full year. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. The Company has evaluated subsequent events through the date the financial statements were issued.
Since inception, the Companys operations have been financed primarily through the sale of equity securities. The Company has incurred losses from operations and negative cash flows since its inception due in large part to expenditures for its research and development activities, and the Company expects to continue to incur substantial losses for the foreseeable future as it continues development of its two lead drug candidates. As a result, the Company will need to obtain additional financing to fund its operations in the future. The Company intends to obtain any additional required funding through strategic relationships, public or private equity financings, debt financings, or other arrangements. Conditions in the financial markets and other factors could have a material adverse effect on the Companys ability to access sufficient funding on acceptable terms, or at all. If the Company cannot raise adequate additional capital, it will be required to delay, further reduce the scope of, or eliminate one or more of its research or development programs. In addition, the Company may be required to relinquish greater, or even all, rights to product candidates at earlier stages of development or on less favorable terms than it would otherwise choose.
Management believes that the Companys existing cash balances of $4.8 million as of September 30, 2011, and the expected proceeds of $2 million from future purchases of our common stock that Novogen has committed to make, will be sufficient to fund the Companys operations until late calendar year 2012. Changes in the Companys research and development plans or other changes affecting its operating expenses may affect actual future use of existing cash resources.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and disclosures made in the accompanying notes to the consolidated financial statements. The Company uses estimates for certain accruals including clinical and pre-clinical study fees and expenses, share-based compensation, and valuations of derivative liabilities, among others. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash and highly liquid investments with remaining maturities of three months or less when purchased.
Fair Value of Financial Instruments
The carrying amounts of financial instruments such as cash equivalents and current liabilities approximate the related fair values due to the short-term maturities of these instruments. The Company invests its excess cash into financial instruments which are readily convertible into cash, such as money market funds.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents. The Company maintains accounts in federally insured financial institutions in excess of federally insured limits. The Company also maintains investments in money market funds and similar short-term investments that are not federally insured. However, management believes that the Company is not exposed to significant credit risk due to the financial positions of the depository institutions in which these deposits are held and of the money market funds in which these investments are made.
Property and Equipment
Property and equipment are stated at cost and depreciated over the estimated useful lives of the assets (generally three to seven years) using the straight-line method. Leasehold improvements are stated at cost and are amortized over the shorter of the estimated useful lives of the assets or the lease term. Capital improvements are stated at cost and amortized over the estimated useful lives of the underlying assets.
The Company accounts for its warrants and other derivative financial instruments as either equity or liabilities based upon the characteristics and provisions of each instrument. Warrants classified as equity are recorded as additional paid-in capital on our consolidated balance sheet and no further adjustments to their valuation are made. Some of the Companys warrants were determined to be ineligible for equity classification because of anti-dilution provisions that may result in an adjustment to their exercise price. Warrants classified as derivative liabilities and other derivative financial instruments that require separate accounting as liabilities are recorded on the Companys consolidated balance sheet at their fair value on the date of issuance and will be revalued on each subsequent balance sheet date until such instruments are exercised or expire, with any changes in the fair value between reporting periods recorded as other income or expense. Management estimates the fair value of these liabilities using option pricing models and assumptions that are based on the individual characteristics of the warrants or instruments on the valuation date, as well as assumptions for expected volatility, expected life, yield, and risk-free interest rate.
Research and Development Costs
Research and development costs are expensed as incurred and include costs paid to third-party contractors to perform research, conduct clinical trials and develop and manufacture drug materials. Clinical trial costs, including costs associated with third-party contractors, are a significant component of research and development expenses. The Company accrues research and development costs based on work performed. In determining the amount to accrue, management relies on estimates of total costs based on contract components completed, the enrollment of subjects, the completion of trials, and other events.
Costs incurred related to the acquisition or licensing of products that have not yet received regulatory approval to be marketed, or that are not commercially viable and ready for use, or have no alternative future use, are charged to expense in the period incurred.
The fair value of each stock option granted is estimated on the grant date under the fair value method using a binomial valuation model. The estimated fair values of the stock options, including the effect of estimated forfeitures, are expensed over the vesting period. The Company recognized share-based compensation expenses of $118,000 and $120,000 during the three months ended September 30, 2011 and 2010, respectively.
Interest and Dividend Income
Interest on cash balances is recognized when earned. Dividend revenue is recognized when the right to receive the payment is established.
The Companys income tax expense consists of current and deferred income tax expense or benefit. Current income tax expense or benefit is the amount of income taxes expected to be payable or refundable for the current year. A deferred income tax asset or liability is recognized for the future tax consequences attributable to tax credits and loss carryforwards and to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of September 30, 2011, the Company has established a valuation allowance to fully reserve its net deferred tax assets. Tax rate changes are reflected in income during the period such changes are enacted. Changes in ownership may limit the amount of net operating loss carry-forwards that can be utilized in the future to offset taxable income.
The Financial Accounting Standards Board Topic on Income Taxes prescribes a recognition threshold and measurement attribute criteria for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. There were no unrecognized tax benefits as of September 30, 2011.
Foreign Currency Translation
The functional currency of the Companys wholly owned subsidiary in Australia, MEPL, is the U.S. dollar. Monetary assets and liabilities are translated from Australian dollars into U.S. dollars using the exchange rates in effect at the balance sheet date. Nonmonetary assets and liabilities and equity accounts are translated using historical exchange rates. Income statement amounts are translated using the average exchange rate for the periods. Realized gains and losses from foreign currency transactions are reflected in the consolidated statements of operations as a component of general and administrative expenses and, to date, have not been material.
Certain prior year amounts have been reclassified to conform with the current year presentation.
Net Loss Per Share
Basic and diluted net loss per share is computed using the weighted-average number of shares of common stock outstanding during the period, less any shares subject to repurchase or forfeiture. There were no shares of common stock subject to repurchase or forfeiture for the three months ended September 30, 2011 and 2010. Because the Company is in a net loss position, it has excluded stock options and warrants from the calculation of diluted net loss per share because these securities are antidilutive for all years presented.
The Company has contracted with various consultants and third parties to assist it in pre-clinical research and development and clinical trials work for its leading drug compounds. The contracts are terminable at any time, but obligate the Company to reimburse the providers for any time or costs incurred through the date of termination. The Company also has employment agreements with certain of its current employees that provide for severance payments and accelerated vesting for share-based awards if their employment is terminated under specified circumstances. Additionally, the Company leases office space for monthly rental rates ranging from $10,403 to $10,734, plus other pass-through charges, under the lease term expiring in April 2013.
The Companys restated certificate of incorporation provides that it will indemnify Novogen in connection with certain actions brought against Novogen by any of the Companys stockholders or any other person.
The Company is not currently a party to any significant legal proceedings.
4. Segment Information
The Company has one operating segment, the discovery and development of pharmaceutical compounds. The Companys business contains two geographic segments. The following segment information is net of intercompany transactions.
5. Related Party Transactions
On December 21, 2010, the Company entered into an Asset Purchase Agreement (the Isoflavone Asset Purchase Agreement) with Novogen and Novogen Research Pty Limited, a wholly-owned subsidiary of Novogen, pursuant to which the Company agreed to purchase certain assets used in or generated under, or in connection with, the discovery, development, manufacture and marketing of intellectual property and products based on the field of isoflavonoid technology and on compounds known as isoflavones, including those related to the drug candidates Phenoxodiol, Triphendiol, NV-143 and NV-128, Isoflavone-related Assets, in exchange for 1,000 shares of the Companys Series A Convertible Preferred Stock. Each share of Series A Convertible Preferred Stock is convertible at any time and from time to time and without the payment of additional consideration by the holder thereof into 4,827 shares of our common stock. In addition, if a Phase II clinical trial involving any of the Isoflavone-related Assets has achieved a statistically significant result (p=0.05 or less) or a first patient is enrolled in a Phase III clinical trial involving such technology, whichever is earlier, each share of the Series A Convertible Preferred Stock not already converted may thereafter be converted into 9,654 shares of our common stock. The transaction closed on May 9, 2011. Under the terms of the Isoflavone Asset Purchase Agreement, the Company also assumed certain liabilities that are related to the Isoflavone-related Assets.
The Company did not record a value for the Isoflavone-related Assets acquired, since there were no historical carrying amounts recorded by Novogen and the transaction was between entities under common control.
In conjunction with signing the Isoflavone Asset Purchase Agreement, the Company and Novogen agreed to terminate, effective upon consummation of the Isoflavone Transaction, each of the following agreements, along with any other agreements relating thereto, with respect to the Isoflavone-related Assets:
Amended and Restated Services Agreement
In September 2003, the Company, Novogen and MEPL entered into the Services Agreement. The Company and Novogen terminated the Services Agreement effective December 31, 2010. Under the terms of the Services Agreement, Novogen or its subsidiaries agreed to provide services reasonably required by the Company relating to the development and commercialization of Phenoxodiol and other licensed products, including Triphendiol and ME-143. Novogen agreed to provide these services at cost plus a 10% mark-up.
Transactions giving rise to expenditures amounting to $503,000 were made under the Services Agreement with Novogen during the three month period ended September 30, 2010. Of this amount, $358,000 related to service fees paid to Novogen for research and development services provided in the three month period ended September 30, 2010, reflecting the time spent by Novogen research staff on the development of Phenoxodiol, Triphendiol, NV-143 and NV-128. Additionally, $145,000 related to costs incurred for administration and accounting services provided by Novogen. As the Services Agreement was terminated effective December 31, 2010, there were no transactions under the Services Agreement during the three month period ended September 30, 2011, and no amounts were due to Novogen under the agreement as of September 30, 2011.
Private Placement of Common Stock with Novogen
On September 27, 2011, the Company entered into a Securities Subscription Agreement with Novogen, pursuant to which the Company agreed to sell to Novogen 1,333,333 shares of the Companys common stock, at a purchase price of $1.50 per share, for proceeds of $2,000,000. The offering closed on September 30, 2011. In a letter dated September 28, 2011, Novogen also committed to make an additional equity investment in the Company of $2,000,000 on or before June 30, 2012.
May 2011 Private Placement
On May 2, 2011, the Company entered into a Securities Purchase Agreement (Original Purchase Agreement) with certain accredited investors pursuant to which the Company agreed to issue and sell to the investors certain shares of the Companys common stock, and warrants to purchase additional shares of common stock. On May 16, 2011, the Company entered into an Amended and Restated Securities Purchase Agreement (the Amended Securities Purchase Agreement) with the investors, which amended and restated in its entirety the Original Purchase Agreement. The transaction was consummated on May 18, 2011 (the Closing Date).
Pursuant to the Amended Securities Purchase Agreement, in May 2011 the Company issued to the investors: (i) 835,217 shares (the Initial Shares) of common stock, at a purchase price of $1.333 per share; (ii) series A warrants (the Series A warrants) which initially represented the right to purchase up to 626,413 shares of common stock, up to a maximum of 2,250,564 shares ; and (iii) series B warrants (the Series B warrants) which initially represented the right to purchase up to 2,165,534 shares of common stock. In addition, the Company agreed to issue certain additional shares of common stock (the Adjustment Shares) to the extent the price of the common stock is below $1.333 per share, but greater than or equal to $0.75 per share, on certain dates (Adjustment Dates) during the period ending June 26, 2012, including as a result of a subsequent offering by the Company of its securities at a price below the purchase price of the Initial Shares. The number of Adjustment Shares issuable was initially limited to 649,242, subject to proportionate increases to the extent the Series B warrants have been exercised prior to the applicable Adjustment Date, up to a maximum of 2,332,583 shares. If the trading price of the Companys common stock is below $0.75 per share on any Adjustment Date, the Company will, in addition to issuing the applicable number of Adjustment Shares, refund to the investors an amount per share of common stock received by the investors in the transaction equal to the difference between $0.75 and the price of the common stock on such Adjustment Date. Additionally, upon the closing of the May 2011 private placement, the Company issued warrants to the placement agent, for the purchase of up to 210,053 shares of common stock, which warrants were exercisable on the same terms as the Series A warrants.
Terms of Warrants
The Series A warrants will be exercisable any time on or after the six month anniversary of the May 18, 2011 closing of the May 2011 private placement. The Series A warrants will expire on the fifth anniversary of the date on which the Series A warrants first become exercisable. Prior to the amendment of the warrant terms in September 2011 in conjunction with entry into the Supplemental Agreement, as defined and described below, the Series A warrants were initially exercisable at an exercise price of $1.57 per share, subject to adjustment as provided in the Series A warrant agreements. Under the original terms of the warrant agreements, the number of shares of common stock issuable upon exercise of the Series A warrants would be increased by an amount equal to 75% of the number of shares of common stock issued upon each exercise of the Series B warrants.
Prior to the amendment of the warrant terms in September 2011 in conjunction with consummation of a Supplemental Agreement as described below, the initial exercise price per share of the Series B warrants was equal to the lower of (i) $1.333, and (ii) 85% of the arithmetic average of the lowest eight weighted average prices of the common stock during the 20 consecutive trading day period in the case of a voluntary exercise by the holders, ending on the trading day immediately preceding the date of delivery of a notice of exercise. The Series B warrants expire on the first anniversary of the May 18, 2011 closing of the May 2011 private placement.
In July and August 2011, the investors exercised an aggregate of 1,294,000 Series B warrants for 1,294,000 shares of common stock. The Company received net proceeds of $1,094,000 in conjunction with the exercise of the Series B warrants. Pursuant to the terms of the Amended Securities Purchase Agreement, an additional 970,500 Series A warrants became exercisable as a result of these Series B warrant exercises.
On September 28, 2011, the Company entered into a Supplemental Agreement (the Supplemental Agreement) with each of the investors party to the Amended Securities Purchase Agreement.
Pursuant to the Supplemental Agreement, each of the Series A warrants and the Series B warrants issued pursuant to the Amended Securities Purchase Agreement were amended and restated (the Amended Series A Warrants and Amended Series B Warrants, respectively). The exercise price of each of the Series A warrants and Series B warrants was reduced to $1.00 per share. As amended, the exercise price of the Amended Series A Warrants is no longer subject to further reduction upon the occurrence of certain events, including the subsequent sale or deemed sale by the Company of shares of common stock at a price per share below the exercise price of the Amended Series A Warrants; however, the Amended Series A Warrants continue to provide for certain customary anti-dilution adjustments.
The Series B warrants were amended to permit the exercise of such warrants on a cashless basis. Pursuant to the terms of the Supplemental Agreement, on September 28, 2011, the investors exercised, on a cashless basis, the Amended Series B Warrants for all of the remaining shares of Common Stock for which such Amended Series B Warrants were exercisable, resulting in the issuance by the Company of an aggregate of 305,603 shares of Common Stock.
The Supplemental Agreements also affected certain amendments to the Amended Securities Purchase Agreement, including the extension, through September 28, 2013, of the period during which the investors have the right to participate in subsequent equity offerings of the Company. In connection with the amendments described above, the Company made cash payments to the investors in an aggregate amount of $365,000, which, together with $32,000 that the Company paid to reimburse the investors legal expenses related to the Supplemental Agreement, have been classified as Financing Costs in the Consolidated Statement of Operations.
The Company accounted for the Series A and B warrants and the Adjustment Shares feature associated with the common stock pursuant to the Amended Securities Purchase Agreement in accordance with accounting guidance for derivatives. The accounting guidance provides a two-step model to be applied in determining whether a financial instrument or an embedded feature in a financial instrument is indexed to an entitys own stock that would qualify such financial instruments or embedded features for a scope exception. This scope exception specifies that a contract that would otherwise meet the definition of a derivative financial instrument would not be considered as such if the contract is both (i) indexed to the entitys own stock and (ii) classified in the stockholders equity section of the balance sheet. The Company determined that the Series A and Series B warrants, prior to their amendment, were ineligible for equity classification as a result of the anti-dilution provisions in the Series A and Series B warrants that may result in an adjustment to the warrant exercise price. Additionally, the Company determined that the adjustment shares feature related to the common stock, as specified in the Amended Securities Purchase Agreement, resulted in an embedded derivative. As a result of amending the Series A and Series B warrant terms pursuant to the Supplemental Agreement, and the exercise of the Amended Series B Warrants, as described above, the Series A and Series B warrants are no longer considered to be derivatives as of September 30, 2011.
The estimated fair values of the derivative liabilities as of September 30, 2011 and June 30, 2011 are summarized as follows (in thousands):
On September 30, 2011, the total value of the derivative liabilities was $423,000. The decrease in the estimated fair value of the derivative liabilities for the three months ended September 30, 2011 resulted in other income of $702,000. Such decrease in the estimated fair value was primarily due to the amendment of the Series A warrant terms and the exercise of the Series B warrants, as well as updates to the assumptions used in the option pricing model. Additionally, the Company recorded a gain of $14,000 in conjunction with amending the Series A warrant terms, based on the fair value of the Amended Series A Warrants, classified as Adjustments to Fair Value of Derivative Liabilities in the Consolidated Statement of Operations.
The derivative liabilities were valued at September 30, 2011 and at June 30, 2011 using a Monte Carlo valuation model with the following assumptions:
Warrants and Options to Purchase Common Stock
As of September 30, 2011, there were outstanding warrants to purchase 248,003 shares of the Companys common stock at exercise prices ranging from $21.70 to $36.00 per share, which expire at various dates in calendar years 2012 and 2013, and outstanding Series A warrants and warrants issued to the Companys placement agent for the May 2011 Private Placement to purchase up to 2,460,617 shares of common stock at $1.00, which expire in November 2016. Additionally, as of September 30, 2011 there were options outstanding to purchase 736,715 shares of common stock at exercise prices from $0.77 to $6.30 per share, which expire at various dates in calendar years 2014 through 2016.
Series A Convertible Preferred Stock
In connection with the closing of the Isoflavone Transaction in May 2011, the Company designated and issued 1,000 shares of Series A Convertible Preferred Stock to Novogen. Each share of the Series A Convertible Preferred Stock is convertible into 4,827 shares of Common Stock. In the event a Phase II clinical trial involving any of the isoflavone technology acquired by the Company pursuant to the Asset Purchase Agreement has achieved a statistically significant result (p=0.05 or less) or a first patient is enrolled in a Phase III clinical trial involving the such technology, whichever is earlier, each share of the Series A Convertible Preferred Stock not already converted may be converted into 9,654 shares of Common Stock.
Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act) and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). All statements other than statements of historical facts contained in this Quarterly Report, including statements regarding the future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. The words believe, may, will, estimate, continue, anticipate, intend, should, plan, expect, and similar expressions, as they relate to us, are intended to identify forward-looking statements. We have based these forward-looking statements largely on current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including, among other things:
These risks are not exhaustive. Other sections of this Quarterly Report on Form 10-Q may include additional factors which could adversely impact our business and financial performance. In addition, our business and financial performance may be affected by the factors that are discussed under Risk Factors in the Annual Report on Form 10-K for the year ended June 30, 2011, filed on September 28, 2011. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for us to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
You should not rely upon forward looking statements as predictions of future events. We cannot assure you that the events and circumstances reflected in the forward looking statements will be achieved or occur. Although we believe that the expectations reflected in the forward looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.
The following discussion is qualified in its entirety by, and should be read in conjunction with, the more detailed information set forth in the financial statements and the notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.
Our business purpose is the development of drugs for the treatment of cancer. We are currently focused on the clinical development of our two lead isoflavone-based drug candidates, ME-143 and ME-344, which we acquired in the Isoflavone Transaction in May 2011, and prior to the consummation of such transaction had licensed from a subsidiary of Novogen.
We believe that our existing cash balances, which were $4.8 million as of September 30, 2011, together with the expected proceeds of $2 million from future purchases of our common stock that Novogen has committed to make on or before June 30, 2012, will be sufficient to fund our operations until late calendar year 2012. Changes in our research and development plans or other changes affecting our operating expenses may affect actual future use of existing cash resources. In any event, however, we will need additional financing to fund our operations in the future, including the continued development of our two lead drug candidates. To date, our operations have been funded primarily through the sale of equity securities. We have not generated any revenues from operations since inception other than interest and dividends from cash and investments. We have incurred losses since inception and expect to incur operating losses and generate negative cash flows from operations for the foreseeable future. As of September 30, 2011, we had accumulated losses of $79.2 million since our inception in December 2000.
Expenses to date have consisted primarily of costs associated with conducting the clinical trials of Phenoxodiol, and costs incurred under various product license and services agreements with Novogen. The services agreements were terminated in December 2010. In connection with the consummation of the Isoflavone Transaction, the license agreements, and other key agreements with Novogen, were terminated.
As of the date of this Quarterly Report, Novogen owns approximately 55.6% of the outstanding shares of our common stock.
Critical Accounting Policies and Estimates
Managements discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, expenses and related disclosures. Actual results could differ from those estimates. We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our consolidated financial statements:
Clinical Trials Expenses
Estimates have been used in determining the expense liability under certain clinical trial contracts where services have been performed but not yet invoiced. Generally, the costs associated with clinical trial contracts are based on the number of patients in each trial, the service contracts associated with clinical sites, service providers and drug development contracts. The length of time before actual amounts can be determined will vary, and are therefore estimated, depending on length of the drug administration cycles and the timing of the invoices by the clinical trial partners and contractors.
In conjunction with our May 2011 private placement, we issued common stock on terms that included certain embedded derivative features, as well as warrants that are accounted for as derivative liabilities (see Note 6 to our consolidated financial statements included in this Quarterly Report on Form 10-Q). The Series A and Series B warrants, prior to their subsequent amendment in September 2011, and adjustment shares features related to the common stock issued in the private placement, were determined to be ineligible for equity classification due to certain price protection and anti-dilution provisions.
The resulting derivative liabilities were initially recorded at their estimated fair value on the date of issuance of the common stock and warrants, and are subsequently adjusted to reflect the estimated fair value at each period end, with any decrease or increase in the estimated fair value being recorded as other income or expense. The fair value of these liabilities is estimated using option pricing models that are based on the individual characteristics of the common stock, the derivative liabilities on the valuation date, probabilities related to future financings, as well as assumptions for volatility, remaining expected life, and risk-free interest rate. The option pricing models of our derivative liabilities are estimates and are sensitive to changes to inputs and assumptions used in the option pricing models.
Share-based compensation expense for employees and directors is recognized in the statement of operations based on estimated amounts, including the grant date fair value and the expected service period. For stock options, we estimate the grant date fair value using a binomial valuation model, which requires the use of multiple subjective inputs including estimated future volatility, expected forfeitures and the expected term of the awards. We estimate our expected future volatility based on our stocks historical price volatility. Our stocks future volatility may differ from our estimated volatility at the grant date. Share-based compensation recorded in our statement of operations is based on awards expected to ultimately vest and has been reduced for estimated forfeitures. Our estimated forfeiture rates may differ from actual forfeiture rates which would affect the amount of expense recognized during the period. We recognize the value of the awards on a straight-line basis over the awards requisite service periods. The requisite service period is generally the time over which our share-based awards vest.
Results of Operations
Three Months Ended September 30, 2011 and 2010
We incurred losses of $1,612,000 and $1,759,000 for the three months ended September 30, 2011 and 2010, respectively.
Research and Development: Research and development expenses consist primarily of clinical trial costs (including payments to contract research organizations or CROs), pre-clinical study costs, cost to manufacture our drug candidates for pre-clinical and clinical studies, related party service charges paid to Novogen and salaries and other personnel costs.
Research and development expenses increased by $359,000 to $1,044,000 for the three months ended September 30, 2011 compared to $685,000 for the three months ended September 30, 2010. The increase is primarily due to pre-clinical work associated with the development of ME-143 and ME-344, and the commencement of Phase I clinical trials for ME-143. Additionally, costs incurred during the three months ended September 30, 2011 include salaries and benefit costs associated with employees hired during fiscal year 2011. The increase in expenses was offset in part by a decrease in costs related to the services agreement with Novogen, which was terminated effective December 31, 2010.
General and Administrative: General and administrative expenses decreased by $256,000 to $889,000 for the three months ended September 30, 2011 compared to $1,145,000 for the three months ended September 30, 2010. The decrease primarily relates to non-recurring costs incurred during the three months ended September 30, 2010 associated with the establishment of the Companys operations in the United States, to legal and professional fees associated with the Isoflavone Transaction with Novogen, and the elimination of expenses for administrative services provided under the services agreement with Novogen, which was terminated effective December 31, 2010.
Other income or expense: During the year ended June 30, 2011, we issued securities that are accounted for as derivative liabilities. As of September 30, 2011, the derivative liabilities were revalued to $423,000, resulting in a net decrease in value of $702,000 from June 30, 2011, based primarily upon a change in the terms of Series A warrants and exercise of Series B warrants, which had been accounted for as derivative liabilities. The decrease in value was recorded as non-operating income for the three months ended September 30, 2011. Additionally, we recorded a reversal of a prior expense of $14,000 in conjunction with amending the Series A Warrant terms, based on the fair value of the Amended Series A Warrants.
We received interest on cash and cash equivalents of $3,000 for the three months ended September 30, 2011 compared to $14,000 for the three months ended September 30, 2010. The decrease was due to lower cash balances and lower interest rates earned by our cash deposits. We also received dividends of $57,000, from a small investment in a privately-held company, during the three months ended September 30, 2010. We did not receive dividends during the three months ended September 30, 2011.
In connection with the Supplemental Agreement, we made cash payments to the investors in the amount of $365,000, which, together with $32,000 that we paid to reimburse the investors legal expenses related to the Supplemental Agreement, have been classified as Financing costs in the Consolidated Statement of Operations for the three months ended September 30, 2011.
Liquidity and Capital Resources
Our sources of liquidity include our cash and cash equivalents. We believe that our existing cash balances, which were approximately $4.8 million as of September 30, 2011 and the expected proceeds of $2 million from future purchases of our common stock that Novogen has committed to make, will be sufficient to fund our operations until late calendar year 2012. Our current business operations are focused on continuing the development of our two lead isoflavone based drug candidates. Specifically we intend to commence the clinical development of the drug candidate ME-143 and continue the pre-clinical development of ME-344, a next-generation analogue of NV-128, necessary to file an IND with the FDA. Changes to our research and development plans or other changes affecting our operating expenses may affect actual future use of existing cash resources. To date, we have obtained cash and funded our operations primarily through the sale of equity securities. We have accumulated losses of $79.2 million since inception and expect to incur operating losses and generate negative cash flows from operations for the foreseeable future. We will need additional financing to fund our operations in the future, including the continued development of our drug candidates. We intend to seek additional capital through additional equity transactions; however, there can be no assurance that any such transactions will be completed. Pursuant to the terms of a private placement we have agreed not to offer or sell any of our or our subsidiaries equity securities, including securities that are convertible or exchangeable for our common stock, or to file any new registration statement,
other than as required by the Amended Registration Rights Agreement between us and the investors in the May 2011 private placement, until the earlier of (i) June 18, 2012 and (ii) 90 days after the registration of all of the securities we have agreed to register pursuant to the Amended Registration Rights Agreement. The foregoing restrictions on securities issuances do not apply to certain permitted issuances, specifically the issuance of up to $4,000,000 of common stock and warrants to purchase common stock on or after September 15, 2011. On September 30, 2011, we completed a $2 million sale of common stock to Novogen. If the Company is unable to obtain additional funds on favorable terms or at all, the Company may be required to cease or reduce its operations.
Sources and Uses of Our Cash
Net cash used in operations for the three months ended September 30, 2011 was $1,730,000 compared to $1,504,000 in the three months ended September 30, 2010 due to our net loss resulting from expenses incurred for research and development and general and administrative costs.
Net cash used in investing activities was $48,000 for three months ended September 30, 2010 was for the purchase of property and equipment. We did not use any cash in investing activities for the three months ended September 30, 2011.
Net cash provided by financing activities was $2,672,000 for the three months ended September 30, 2011. Cash raised during the three months ended September 30, 2011 reflected net proceeds of $1,094,000 raised through the issuance of common stock from the exercise of Series B warrants and $1,975,000 through the issuance of common stock to Novogen. Additionally, during the three months ended September 30, 2011, the Company paid $397,000 in financing costs. No cash was raised through financing activities during the three months ended September 30, 2010.
For discussion of our contractual obligations at September 30, 2011 see Note 3 to the financial statements Commitments in this Quarterly Report on Form 10-Q.
During fiscal year 2011, we received deficiency notices from Nasdaq regarding non-compliance with the minimum stockholders equity and the minimum Market Value of Publicly Held Shares in accordance with Nasdaq Listing Standards for the Nasdaq Global Market. In March 2011 we received a positive response from the Nasdaq Listing Qualifications Staff indicating that our request for a transfer and continued listing on the Nasdaq Capital Market had been granted. Our common stock began trading on the Nasdaq Capital Market effective with the open of business on March 16, 2011.
Under Nasdaq rules, failure to maintain minimum stockholders equity of $2.5 million may result in the delisting of our common stock from the Nasdaq Capital Market, in which case we would have 45 calendar days from the date of notification by Nasdaq to submit a plan to regain compliance. If the plan is accepted, Nasdaq can grant an extension of up to 180 calendar days from the date of the original notification for us to evidence compliance with this requirement. As a result of continuing losses from operations and the recognition of other expense for the fair value of derivative liabilities related to the securities issued in the May 2011 Private Placement, our stockholders equity fell below $2.5 million as of June 30, 2011; however, as a result of our financing activities during the three months ended September 30, 2011, our stockholders equity exceeded the $2.5 million requirement as of September 30, 2011.
Board of Directors
On October 25, 2011, we announced the appointment of Charles V. Baltic III to our board of directors. The appointment of Mr. Baltic increases the number of board members to six and the number of independent directors to five.
Interest Rate Risk
Our exposure to market interest rates relates primarily to the investments of cash balances.
We have cash reserves held primarily in U.S. and Australian dollars and we place funds on deposit with financial institutions and are generally at call.
We do not use derivative financial instruments to hedge our risks related to cash balances. We place our cash deposits with high credit quality financial institutions, and, by policy, limit the amount of credit exposure to any single counter-party. We are adverse to principal loss and we ensure the safety and preservation of our invested funds by limiting default risk, market risk and reinvestment risk.
We seek to mitigate default risk by depositing funds with high credit quality financial institutions and by constantly positioning its portfolio to respond appropriately to a significant reduction in a credit rating of any financial institution.
We have no interest rate exposure due to rate changes for long-term debt.
We do not consider the effects of interest rate movements to be a material risk to our financial condition.
Foreign Currency Risk
We conduct our operations principally in U.S. dollars. However, we also have some exposure to Australian dollars, Euros and British pounds. At September 30, 2011, we had not established a foreign currency hedging program. Net foreign exchange losses during the three months ended September 30, 2011 were $14,000 compared with net foreign exchange losses of $72,000 during the three months ended September 30, 2010. Foreign exchange gains and losses occur as a result of transactions in foreign currencies, and upon consolidation of MEPL, which uses U.S. dollars as its functional currency. MEPLs accounts are denominated in Australian dollars. Translation of MEPLs financial statements into U.S. dollars did not have a material impact on our financial position. We do not consider the effects of foreign currency movements to be a material risk to our financial condition.
Evaluation of Disclosure Controls and Procedures
At the end of the period covered by this Quarterly Report on Form 10-Q, the Companys management, with the participation of the Companys Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Companys disclosure controls and procedures. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuers management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on that evaluation, the Companys Chief Executive Officer and Chief Financial Officer have concluded that the Companys disclosure controls and procedures are effective to ensure that the information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms.
There were no changes in our internal control over financial reporting during the period covered by this Quarterly Report that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report to be signed on its behalf by the undersigned, thereunto duly authorized.