Business context and reporting period
This filing is a Form 10-Q for the quarter and nine months ended September 30, 2011. The filing identifies the registrant as Biozone Pharmaceuticals, Inc. (formerly International Surf Resorts, Inc.), not Cocrystal Pharma, Inc.; investors should verify the company and filing identity.
Biozone shifted from its surf-resort business toward pharmaceuticals in 2011. It acquired Aero Pharmaceuticals’ assets in May and the BioZone Lab Group in June; the latter was treated as the accounting acquirer in a reverse acquisition. The acquired businesses develop, manufacture, and market dermatological, over-the-counter, cosmetic, and nutritional products. The company also described development of proprietary drug-delivery technology. It planned to exit its original surf business in exchange for cancellation of approximately 13.95 million shares; the filing says that cancellation is not reflected in these statements.
Financial performance and position
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Revenue, 2011 / 2010 | $3.93M / $4.52M | $8.94M / $11.13M |
| Gross profit, 2011 / 2010 | $1.79M / $2.12M | $4.27M / $5.58M |
| Gross margin, 2011 / 2010 | 45% / 47% | 48% / 50% |
| Operating income (loss), 2011 / 2010 | $(2.22)M / $0.29M | $(3.11)M / $0.72M |
| Net income (loss) attributable to Biozone, 2011 / 2010 | $(2.50)M / $0.26M | $(3.61)M / $0.40M |
For the nine months, operating cash outflow was $41,000, compared with $386,000 in the prior-year period. Investing activities provided $428,000, including $586,000 of cash acquired in the Aero transaction. Financing activities provided $143,000; $2.75M of convertible-note proceeds were largely offset by debt repayments and financing costs. Cash at September 30 was $782,000, versus $251,000 at December 31, 2010.
At September 30, current assets were $6.06M and current liabilities $7.80M, yielding negative working capital of $1.74M. Total assets were $10.71M; shareholders’ deficiency was $178,000. Debt included $2.75M of convertible notes, $1.10M due to a shareholder, and $3.37M of long-term debt including the current portion. The filing also reports $685,000 of cash above federally insured limits.
Material changes and unusual items
- Nine-month revenue fell 19.7% year over year. Management attributed lower sales to delayed customer orders and weaker end-user demand. Gross margin declined from 50% to 48%, primarily due to higher raw-material costs.
- Nine-month operating expenses rose $2.52M to $7.38M. Management cited stock issued for strategic consulting services, higher deferred-financing-cost amortization, and other increases. Cash-flow disclosures report $1.95M of stock-based compensation.
- The company issued $2.25M of secured 10% convertible notes in March and a further $500,000 unsecured 10% convertible note in September. The March notes matured October 29, 2011 and were unpaid; the company reported default on $2.25M principal plus $131,918 accrued interest. The notes’ conversion terms and warrants depend on a planned financing.
- In October, March-note holders agreed to a maturity extension to October 29 in return for 112,500 shares and $135,000 additional interest. The filing nevertheless reports the notes in default as of October 29. On November 3, the company sold 455,000 shares for $1.00 per share, or $455,000 gross proceeds.
- A subsidiary received a bank default notice. The company says it advanced $1.553M to the subsidiary to pay the loan balance in full; two executives personally guaranteed repayment of the subsidiary’s obligations to the company.
Outlook, risks, and controls
There is no quantified revenue or earnings guidance. Management expected continuing operating losses while investing in research and development and stated that existing cash would not meet working-capital and capital-expenditure needs for the next 12 months. It expected to rely on external financing but gave no assurance financing would be available on acceptable terms. Management cited actions to revise operating and financial requirements as support for continuing operations; the filing states that the circumstances raise substantial doubt about the company’s ability to continue as a going concern.
Other disclosed risks include customer demand and order timing, raw-material costs, financing availability and potential dilution, debt default, and the ability to execute the pharmaceutical strategy. Disclosure controls were deemed ineffective because of a material weakness involving insufficient segregation of duties over cash disbursements, attributed to limited accounting staff. No legal proceedings were reported. Operating leases were approximately $372,000 annually through September 2014.
Investor verification points
- Confirm that this Biozone Pharmaceuticals filing is the intended filing; it does not identify Cocrystal Pharma as the registrant.
- Verify the status and full repayment, extension, or other resolution of the March notes, including default interest, and the terms of the proposed financing tied to conversion rights and warrants.
- Assess near-term liquidity, the going-concern uncertainty, and the availability and terms of additional financing; verify use of the November share-sale proceeds.
- Confirm the status of the bank default notice and the company’s intercompany advance to BioZone Laboratories.
- Reconcile reported figures: MD&A gives third-quarter net loss as $2,499,903, while the financial statements report $2,499,703. The filing’s 2010 nine-month net-income attribution also differs between statement lines ($394,916 including noncontrolling interest and $395,612 attributable to Biozone); clarify the comparable figures.
- Verify the planned cancellation of approximately 13.95 million shares and the post-quarter share count. The filing reports 67,543,310 shares outstanding at September 30 and 68,110,810 as of November 21.