FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2002
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from to
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Commission file Number 0-16109
A.P. PHARMA, INC.
------------------------------
(Exact name of registrant as specified in its charter)
Delaware 94-2875566
- ------------------------------- ------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
123 Saginaw Drive, Redwood City, CA 94063
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(Address of principal executive offices)
(650) 366-2626
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(Registrant's 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
--- ---
At October 31, 2002, the number of outstanding shares of the Company's
common stock, par value $.01, was 20,450,186.
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets
September 30, 2002 and December 31, 2001
Condensed Consolidated Statements of Operations
for the three and nine months ended September 30, 2002
and 2001
Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 2002 and 2001
Notes to Condensed Consolidated Financial Statements
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
ITEM 3. Quantitative and Qualitative Disclosure About Market Risk
ITEM 4. Controls and Procedures
PART II. OTHER INFORMATION
Signatures
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. Financial Statements (unaudited) (in thousands):
------------------------------------------------
A.P. PHARMA, INC.
- -----------------
CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
- ----------------------------------------------------
September 30, 2002 December 31, 2001
------------------ -----------------
(Unaudited) (1)
ASSETS
Current assets:
Cash and cash equivalents $ 6,556 $ 3,618
Marketable securities 8,568 15,876
Trade accounts receivable, net 323 338
Receivables for royalties and
contract revenues 1,055 1,130
Inventory 66 61
Prepaid expenses and other 412 601
------ ------
Total current assets 16,980 21,624
Property and equipment, net 1,736 1,668
Other long-term assets 197 215
------ ------
Total assets $ 18,913 $ 23,507
====== ======
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 244 $ 347
Accrued expenses 1,246 1,409
Accrued disposition costs 750 1,479
Deferred revenue 265 315
------ ------
Total current liabilities 2,505 3,550
Deferred revenue - long-term 761 785
------ ------
Shareholders' equity:
Common stock 86,567 86,391
Accumulated deficit (71,007) (67,456)
Accumulated other comprehensive
income 87 237
------ -------
Total shareholders' equity 15,647 19,172
------ ------
Total liabilities and shareholders'
equity $ 18,913 $ 23,507
====== ======
(1) Information derived from audited financial statements included in the
Company's Form 10-K for the year ended December 31, 2001.
See accompanying notes.
A.P. PHARMA, INC.
- -----------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS,
- --------------------------------------------------------------------------
EXCEPT PER SHARE DATA)
- ----------------------
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------- ------------- ------------- ------------
Royalties $ 935 $ 722 $ 2,768 $ 2,066
Contract revenues 106 4 192 35
Product revenues 302 243 869 839
------ ------ ------ ------
Total revenues 1,343 969 3,829 2,940
Costs and expenses:
Cost of product revenues 109 87 331 294
Research & development 1,874 1,988 5,243 4,910
Selling & marketing 108 106 352 345
General & administration 696 720 2,225 2,159
------ ------ ------ ------
Operating loss (1,444) (1,932) (4,322) (4,768)
Interest income 127 237 491 861
Other (expense) income net 55 (12) 70 65
------ ------ ------ ------
Loss from continuing operations (1,262) (1,707) (3,761) (3,842)
Income from discontinued
operations -- 198 -- 15
Gain on disposition of
discontinued operations,
net of taxes 210 3,000 210 3,000
------ ------ ------ ------
Net income (loss) $(1,052) $ 1,491 $(3,551) $ (827)
====== ====== ====== ======
Basic income (loss) per
common share:
Loss from continuing operations $(0.06) $(0.08) $(0.18) $(0.19)
Net income (loss) $(0.05) $ 0.07 $(0.17) $(0.04)
Diluted income (loss) per
common share
Loss from continuing operations $(0.06) $(0.08) $(0.18) $(0.19)
Net income (loss) $(0.05) $ 0.07 $(0.17) $(0.04)
Weighted average common shares
outstanding-basic 20,417 20,278 20,393 20,259
====== ====== ====== ======
Weighted average common shares
outstanding-diluted 20,417 20,301 20,393 20,259
====== ====== ====== ======
See accompanying notes.
A.P. PHARMA, INC.
- -----------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN
- ---------------------------------------------------------------
THOUSANDS)
- ----------
For the nine months ended
September 30,
---------------------------------
2002 2001
---------- ----------
Cash flows from operating activities:
Net loss $(3,551) $ (827)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Gain on sale of discontinued
operations (210) (3,000)
Gain on sale of marketable
securities (81) (89)
Provision for doubtful accounts
and note receivable relating to
the discontinued operation 68 197
Depreciation and amortization 337 296
Amortization of deferred revenue (75) (10)
Stock and stock option
compensation awards to non-
employees 92 137
Restricted stock awards 33 80
Amortization of premium/discount
and accretion of marketable
securities 11 150
Loss on retirements of fixed
assets 2 4
Changes in operating assets and
liabilities:
Accounts receivable (18) 104
Receivables for royalties and
contract revenues 75 129
Inventory (5) (13)
Prepaid expenses and other 154 (5)
Other long-term assets 18 --
Accounts payable (103) 324
Accrued expenses (163) (354)
Income taxes payable relating
to the discontinued operations -- (255)
Cash used in discontinued
operations (519) (139)
------ ------
See accompanying notes.
A.P. PHARMA, INC.
- -----------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN
- ---------------------------------------------------------------
THOUSANDS)
- ----------
For the nine months ended
September 30,
---------------------------------
2002 2001
---------- ----------
Net cash used in operating activities (3,935) (3,271)
------- -------
Cash flows from investing activities:
Purchases of property and equipment (407) (179)
Purchase of intangibles -- (14,407)
Purchases of marketable securities (9,076) --
Maturities and sales of marketable
securities 16,304 13,963
------- -------
Net cash provided by investing
activities 6,821 (623)
------ -------
Cash flows from financing activities:
Proceeds from issuance of shares
under the Employee Stock Purchase
Plan 52 28
------- -------
Net cash provided by financing
activities 52 28
------- -------
Net (decrease) increase in cash
and cash equivalents 2,938 (3,866)
Cash and cash equivalents, beginning
of the period 3,618 6,493
------- -------
Cash and cash equivalents, end
of the period $ 6,556 $ 2,627
======= =======
See accompanying notes.
A.P. PHARMA, INC.
- -----------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------
SEPTEMBER 30, 2002 AND 2001 (UNAUDITED)
- ---------------------------------------
(1) Basis of Presentation
---------------------
A.P. Pharma, Inc. ("APP" or the "Company") is developing
patented polymer-based delivery systems to enhance the safety
and effectiveness of pharmaceutical compounds. Projects are
currently conducted under feasibility and development
arrangements with pharmaceutical and biotechnology companies.
New products and technologies under development include
bioerodible polymers for injectable and implantable drug
delivery.
In the opinion of management, the accompanying unaudited
condensed consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in
the United States for interim financial information and with
the instructions to Form 10-Q and Article 10 of regulation S-X.
Accordingly, they do not include all of the information and
footnotes required by accounting principles generally accepted
in the United States for complete financial statements. In the
opinion of management, all adjustments of a normal recurring
nature considered necessary for a fair presentation have been
included. Operating results for the three and nine month
periods ended September 30, 2002 are not necessarily indicative
of the results that may be expected for the year ending
December 31, 2002. The condensed consolidated balance sheet as
of December 31, 2001 has been derived from the audited
financial statements as of that date. For further information,
refer to the consolidated financial statements and notes
thereto included in our Annual Report on Form 10-K for the year
ended December 31, 2001.
The condensed consolidated financial statements include the
financial statements of the Company and its subsidiary, APS
Analytical Standards, Inc. All significant intercompany
balances and transactions have been eliminated in
consolidation.
Reclassification
- ----------------
Certain reclassifications have been made to the prior period
financial statements to conform with the presentation in 2002.
Such reclassifications have not impacted previously reported
revenues, operating loss, or net income (loss).
Critical Accounting Policies
- ----------------------------
Use of Estimates
- ----------------
The preparation of our 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 our financial statements and
accompanying notes. Estimates were made relating to useful
lives of fixed assets, valuation allowances, impairment of
assets and accruals. Actual results could differ materially
from those estimates.
Revenue Recognition
- -------------------
Product revenues relate to the Company's sales of water
standards for the calibration of turbidimeters used to test
water purity and are recorded upon shipment of products when
four basic criteria are met: 1) persuasive evidence of an
arrangement exists, 2) delivery has occurred or services have
been rendered, 3) the fee is fixed and determinable, and 4)
collectibility is reasonably assured. Determination of
criteria 3 and 4 are based on management's judgments regarding
the fixed nature of the fees charged for products delivered and
the collectibility of those fees. Should changes in conditions
cause management to determine these criteria are not met for
certain future transactions, revenues recognized for any
reporting period could be adversely affected.
The Company's licensing agreements generally provide for the
Company to receive periodic minimum payments, royalties,
milestone payments and/or non-refundable license fees. These
licensing agreements typically require a non-refundable license
fee and allow partners to sell the Company's proprietary
products in a defined field or territory for a defined period.
The license agreements provide for APP to earn future revenue
through royalty payments. These non-refundable license fees
are initially reported as deferred revenues and recognized as
contract revenues over the estimated life of the product to
which they relate as long as the Company has continuing
involvement with licensees and until the related product is
discontinued. Revenue recognized from deferred license fees is
classified as contract revenue in the accompanying consolidated
statements of operations. License fees received in connection
with arrangements where the Company has no continuing
involvement are recognized as revenue when the amounts are
received or when collectibility is assured, whichever is
earlier. No such fees were recorded in the third quarter of
2002.
Contractually required minimum royalties are recorded ratably
throughout the contractual period. Royalties in excess of
minimum royalties are recognized as earned when the related
product is shipped to the customer by the Company's licensees
based on information received by the Company from its
licensees.
A milestone payment is a payment made by a third party or
corporate partner to the Company upon the achievement of a
predetermined milestone as defined in a legally binding
contract. Milestone payments are recognized as revenue when
the milestone event has occurred and the Company has completed
all milestone related services such that the milestone payment
is currently due and is non-refundable. No such payments were
received during the nine months ended September 30, 2002.
Contract revenues relate to research and development
arrangements that generally provide for the Company to invoice
research and development fees based on full-time equivalent
hours for each project. Revenues from these arrangements are
recognized as the related development costs are incurred.
These revenues approximate the costs incurred.
Cash Equivalents and Short-term Investments
- -------------------------------------------
The Company considers all short-term investments in debt
securities which have original maturities of less than three
months at date of purchase to be cash equivalents. Investments
which have original maturities longer than three months are
classified as marketable securities in the accompanying balance
sheets.
Accrued Disposition Costs
- -------------------------
Costs relating to disposal of discontinued operations are
reported as accrued disposition costs in the accompanying
balance sheets. Accrued disposition costs include severance
costs and indemnification claims related to inventory and gross
profit guarantees, all of which are payable over the next year.
Concentrations of Credit Risk
- -----------------------------
Financial instruments which potentially expose the Company to
concentrations of credit risk consist primarily of trade
accounts receivable and receivables from royalties, license
fees and research and development fees. Approximately 62% of
the recorded trade receivables and receivables from royalties
and contract revenues were concentrated with two customers in
the pharmaceutical, cosmetic and personal care industries as of
September 20, 2002.
Segment and Geographic Information
- ----------------------------------
The Company's operations are confined to a single business
segment, the design and commercialization of polymer
technologies for pharmaceutical and other applications.
Substantially all of our revenues are derived from domestic
customers.
Recent Accounting Pronouncements
- --------------------------------
In July 2001, the FASB issued FAS 141, "Business Combinations"
(FAS 141). FAS 141 supersedes APB 16, "Business Combinations,"
and FAS 38, "Accounting for Preacquisition Contingencies of
Purchased Enterprises." FAS 141 requires the purchase method
of accounting for all business combinations initiated after
June 30, 2001 and eliminates the pooling-of-interests method.
FAS 141 also includes guidance on the initial recognition and
measurement of goodwill and other intangible assets arising
from business combinations completed after June 30, 2001.
Adoption of this statement on January 1, 2002 did not have a
material effect on the Company's financial condition or results
of operations.
In July 2001, the FASB issued FAS 142, "Goodwill and Other
Intangible Assets" (FAS 142). FAS 142 supersedes APB 17,
"Intangible Assets," and requires the discontinuance of
goodwill amortization. In addition, FAS 142 includes
provisions regarding the reclassification of certain existing
recognized intangibles as goodwill, reassessment of the useful
lives of existing recognized intangibles, reclassification of
certain intangibles out of previously reported goodwill and the
testing for impairment of existing goodwill and other
intangibles out of previously reported goodwill and other
intangibles. FAS 142 is required to be applied for fiscal
years beginning after December 15, 2001, with certain early
adoption permitted. Adoption of this statement on January 1,
2002 did not have a material effect on the Company's financial
condition or results of operations.
In August 2001, the FASB issued FAS 143, "Accounting for Asset
Retirement Obligations" (FAS 143). FAS 143 addresses financial
accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated
retirement costs. Adoption of this statement on January 1,
2002 did not have a material effect on the Company's financial
condition or results of operations.
In October 2001, the FASB issued FAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (FAS 144), which
supersedes FAS 121, "Accounting for the Impairment of Long-
Lived Assets and for Long-Lived Assets to be Disposed Of" (FAS
121). FAS 144 addresses financial accounting and reporting for
the impairment of long-lived assets and for long-lived assets
to be disposed of. However, FAS 144 retains the fundamental
provisions of FAS 121 for: 1) recognition and measurement of
the impairment of long-lived assets to be held and used; and 2)
measurement of long-lived assets to be disposed of by sale.
FAS 144 is effective for fiscal years beginning after December
15, 2001. Adoption of this statement on January 1, 2002 did
not have a material effect on the Company's financial condition
or results of operations.
In June 2002, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards, "Accounting
for Costs Associated with Exit or Disposal Activities" (FAS
146)." FAS 146 addresses financial accounting and reporting
for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force Issue (EITF) No. 94-3 "
Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs
Incurred in a Restructuring)" (EITF 94-3). FAS 146 requires
that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred, not at
the date of an entity's commitment to an exit plan, as required
under EITF 94-3. The provisions of FAS 146 are effective for
exit or disposal activities initiated after December 31, 2002,
with earlier application encouraged. The Company is currently
analyzing the effect, if any, the adoption of this standard
will have on the financial condition or results of operations.
(2) Net Loss Per Share Information
------------------------------
The Company reports both basic earnings (loss) per share, which
is computed by dividing net income (loss) by the weighted-
average number of common shares outstanding, and diluted
earnings per share, which is computed by dividing net income
(loss) by the total of weighted-average number of common shares
outstanding and dilutive potential common shares outstanding.
Because the Company is in a net loss position for the three and
nine months ended September 30, 2002 diluted earnings per share
excludes the effects of options, warrants and convertible
securities which are antidilutive.
(3) Comprehensive Loss
------------------
Comprehensive loss for the three and nine months ended
September 30, 2002 and 2001 consists of the following (in
thousands):
Three Months Ended Nine Months Ended
------------------ -----------------
September 30, September 30, September 30, September 30,
2002 2001 2002 2001
------------- ------------- ------------- ------------
Net income (loss) $(1,052) $ 1,491 $(3,551) $ (827)
Unrealized holding gains
arising during the period (20) 141 (150) 207
------ ------ ------ ------
Comprehensive income (loss) $(1,072) $ 1,632 $(3,701) $ (620)
====== ====== ====== ======
(4) Inventory
---------
The major components of inventory are as follows (in
thousands):
September 30, 2002 December 31, 2001
------------------ -----------------
Raw materials $ 33 $ 28
Finished goods 33 33
--- ---
Total inventory $ 66 $ 61
=== ===
(5) Discontinued Operations
-----------------------
On July 25, 2000, the Company completed the sale of certain
technology rights for topical pharmaceuticals and its
cosmeceutical product lines and other assets ("cosmeceutical
and toiletry business") to RP Scherer Corporation, a subsidiary
of Cardinal Health, Inc. The Company received $25 million on
closing and is entitled to receive further earnout amounts for
the subsequent three years up to a maximum of $26.5 million,
the amounts of which are dependent on the performance of the
business sold. During the first two years of the earnout
period, the Company received an aggregate of $3.8 million. The
earnout is calculated based on gross profit earned by the
business sold over a three-year period. The terms of the
agreement with RP Scherer provide for an earnout of 20% to 60%
of gross profit of the business sold over a threshold which
increases each year. Each earnout year has a different minimum
level of gross profit that should be achieved before any
earnout income can be received. In addition to the minimum
gross profit levels, each earnout period has three additional
gross profit hurdles that correspond to a specific earnout
percentage up to a maximum of 60%. Earnout hurdles for the
third and final year are higher than the first two years. The
cosmeceutical and toiletry business is reported as a
discontinued operation for all periods presented in the
accompanying Condensed Consolidated Statements of Operations.
Income from discontinued operations represents changes in
estimates relating to the discontinued operations and consists
of the following:
For the nine months ended
September 30, 2002 September 30, 2001
------------------ -----------------
Change in estimate for
professional fees $ (8) $(168)
Change in estimate for
Kligman lawsuit
settlement -- 138
Provision for doubtful
accounts and note
receivable (68) (180)
Change in estimate for
guarantees 25 (50)
Change in estimate of
provision for income
taxes and tax refunds 51 275
---- ----
Total change in estimate $ -- $ 15
==== ====
Basic and diluted loss per common share from discontinued
operations excluding the gain on sale of the cosmeceutical
product lines was $0.00 for the three and nine months ended
September 30, 2002. Basic and diluted income per share from
discontinued operations was $0.01 and $0.00 for the three and
nine months ended September 30, 2001, respectively.
As of September 30, 2002, net assets relating to the
discontinued operation include trade receivables of $195,000, a
note receivable of $453,000 and a provision for doubtful
accounts and note receivable of $486,000. Liabilities related
to the discontinued operation in the amount of $750,000 include
severance costs and accruals for indemnification claims related
to inventory and gross profit guarantees. These liabilities
are reported as accrued disposition costs in the accompanying
balance sheets.
Cash used in discontinued operations primarily relates to
payments of severance costs to former employees who were
terminated as a result of the sale of the cosmeceutical and
toiletry business. A total of 56 positions, primarily in the
manufacturing, marketing and research and development
departments and associated general and administrative staff,
were eliminated as a result of the sale. During the year ended
December 31, 2000, the Company recorded severance charges
related to salaries and benefits in gain on disposition of
discontinued operations. The total amount of severance-related
charges was approximately $3,685,000, of which approximately
$3,478,000 has been paid to date, including $62,000 in the
current quarter. Approximately $207,000 remains accrued as of
September 30, 2002. The accrued severance of approximately
$207,000 is expected to be paid by July 31, 2003.
ITEM 2. Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations (all dollar amounts rounded to the
------------------------------------------------------------
nearest thousand)
-----------------
Except for statements of historical fact, the statements herein are
forward-looking and are subject to a number of risks and
uncertainties that could cause actual results to differ materially
from the statements made. These include, among others, uncertainty
associated with timely development, approval, launch and acceptance
of new products, establishment of new corporate alliances, progress
in research and development programs, and other risks described
below or identified from time to time in the Company's Securities
and Exchange Commission filings.
The preparation of the Company's 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 our financial statements and accompanying
notes. Estimates were made relating to useful lives of fixed
assets, valuation allowances, impairment of assets and accruals.
Actual results could differ materially from those estimates. The
items in the Company's financial statements requiring significant
estimates and judgments are as follows:
CRITICAL ACCOUNTING POLICIES
- ----------------------------
Revenue Recognition
- -------------------
Product revenues relate to the Company's sales of water standards
for the calibration of turbidimeters used to test water purity and
are recorded upon shipment of products when four basic criteria are
met: 1) persuasive evidence of an arrangement exists, 2) delivery
has occurred or services have been rendered, 3) the fee is fixed and
determinable, and 4) collectibility is reasonably assured.
Determination of criteria 3 and 4 are based on management's
judgments regarding the fixed nature of the fees charged for
products delivered and the collectibility of those fees. Should
changes in conditions cause management to determine these criteria
are not met for certain future transactions, revenue recognized for
any reporting period could be adversely affected.
The Company's has licensing agreements that generally provide for
the Company to receive periodic minimum payments, royalties,
milestone payments and/or non-refundable license fees. These
licensing agreements typically require a non-refundable license fee
and allow partners to sell the Company's proprietary products in a
defined field or territory for a defined period. The license
agreements provide for APP to earn future revenue through royalty
payments. These non-refundable license fees are initially reported
as deferred revenues and recognized as revenues over the estimated
life of the product to which they relate as the Company has
continuing involvement with licensees until the related product is
discontinued. Revenue recognized from deferred license fees is
classified as contract revenues in the accompanying condensed
consolidated statements of operations. License fees received in
connection with arrangements where the Company has no continuing
involvement are recognized as revenue when the amounts are received
or when collectibility is assured, whichever is earlier. No such
fees were recorded in the third quarter of 2002.
Contractually required minimum royalties are recorded ratably
throughout the contractual period. Royalties in excess of minimum
royalties are recognized as earned when the related product is
shipped to the customer by the Company's licensees based on
information received by the Company from its licensees.
A milestone payment is a payment made by a third party or corporate
partner to the Company upon the achievement of a predetermined
milestone as defined in a legally binding contract. Milestone
payments are recognized as revenue when the milestone event has
occurred and the Company has completed all milestone related
services such that the milestone payment is currently due and is
non-refundable. No such payments were received during the nine
months ended September 30, 2002.
Contract revenues relate to research and development arrangements
that generally provide for the Company to invoice research and
development fees based on full-time equivalent hours for each
project. Revenues from these arrangements are recognized as the
related development costs are incurred. These revenues approximate
the costs incurred.
Results of Operations for the Three Months Ended September 30, 2002
- -------------------------------------------------------------------
and 2001
- --------
The Company's revenues are derived principally from royalties from
third party sales of topical prescription products, license fees,
contract revenues and product sales of water standards. Under
strategic alliance arrangements entered into with certain
corporations, APP can receive non-refundable upfront fees, future
milestone payments and royalties based on third party product sales.
Royalties for the third quarter of 2002 increased by 30% or $213,000
to $935,000 from $722,000 in the corresponding quarter of the prior
year. This increase was due primarily to increased sales of Retin-A
Micro(R), a prescription acne treatment which is marketed and
distributed by Ortho Neutrogena, following the launch of a low dose
product line extension in July 2002, and increased sales of
Carac(TM)for the treatment of actinic keratoses, which is marketed
and distributed by Dermik Laboratories, an Aventis Company.
Contract revenues for the three months ended September 30, 2002 were
$106,000 compared with $4,000 in the corresponding period of the
prior year, due to the initiation of more collaborative research and
development arrangements.
Product revenues for the third quarter of 2002 relating to sales of
analytical standards products increased by $59,000 or 24% to
$302,000 from $243,000 in the third quarter of the prior year.
Gross profit margin on sales of analytical standards for the third
quarter of 2002 was essentially flat compared with the corresponding
quarter of the prior year.
Research and development expense for the third quarter of 2002
decreased by $114,000 to $1,874,000 due mainly to postponed spending
on Phase II clinical studies, offset by increased headcount and
related expenses as the Company undertook a variety of new product
development activities. In July 2002, the Company submitted to the
Food and Drug Administration (FDA) the protocol for a Phase II
clinical study for the Company's first product candidate, APF112,
for the treatment of post-surgical pain. In August 2002, the
Company withdrew the proposed protocol for a Phase II clinical study
for APF112 in response to FDA concerns regarding observed irritation
in preclinical studies. This mild to moderate irritation lasted
beyond the planned 24 - 36 hours of pain relief following
administration into the knee joint. A comprehensive proposal on the
scope of animal studies required for the resumption of human
clinical studies has been submitted to the FDA and the Company
anticipates meeting with FDA officials during the fourth quarter of
2002. The delay caused by the withdrawal of the Phase II protocol
will defer a portion of the anticipated increase in research and
development spending until 2003, assuming that the Company is
successful in gaining FDA clearance to proceed with the study.
Additional costs will be incurred in the near-term to conduct animal
studies as part of the Company's plan to resume human clinical
testing. These additional costs are not expected to be material.
If the Company is successful in gaining FDA clearance to proceed
with the protocol, the delay in the commencement of a Phase II
clinical study could result in a delay in the filing of a New Drug
Application (NDA) for APF112, and hence could result in a delay in
the product candidate's marketing clearance and initiation of
revenue streams. If the Company is not successful in gaining FDA
clearance to proceed with the protocol, there will be a delay in the
development of the Company's first product candidate while
reformulation work is carried out prior to clinical trials.
Selling and marketing expense for the third quarter of 2002
increased by $2,000 or 2% to $108,000. Selling and marketing
expense is expected to remain essentially unchanged for fiscal 2002
as compared with fiscal 2001.
General and administrative expense for the third quarter of 2002
decreased by $24,000 or 3% from $720,000 to $696,000. General and
administrative expense is expected to increase only moderately for
fiscal 2002 as compared with fiscal 2001, primarily due to increased
investor relations activities.
Interest income for the third quarter of 2002 decreased by $110,000
or 46% to $127,000 from $237,000 due to lower interest rates earned
on lower average cash balances.
The gain on disposal of discontinued operations of $210,000
represents the second year earnout payment from the sale of the
cosmeceutical and toiletries business to RP Scherer in July 2000.
This compares with an earnout payment of $3,000,000 reported in the
third quarter of the prior year. The decrease of $2,790,000 is
principally due to lower sales of the divested product lines and
resulting lower gross profit. Under the agreement, the Company can
receive up to $26.5 million over the first three years of the
earnout period, based on the gross profit of the business sold.
Income from discontinued operations in the prior year included a
reserve of $400,000 relating to a note receivable arising from the
Company's sale of certain proprietary rights to a consumer product
in 1999. As payments on the note were not received on a timely
basis, a reserve was recorded against the remaining outstanding
balance on the note. This was partially offset by the recovery from
a customer of $220,000 for which the Company had previously recorded
a reserve.
Results of Operations for the Nine Months Ended September 30, 2002
- ------------------------------------------------------------------
and 2001
- --------
Royalties for the nine months ended September 30, 2002 of $2,768,000
increased by $702,000 or 34% over the corresponding period of the
prior year. This increase was due primarily to increased sales of
Carac(TM) by Dermik Laboratories, an Aventis company, and the launch
of a new product line extension of Retin-A Micro(R) by Ortho
Neutrogena, a Johnson & Johnson company.
Contract revenues for the nine months ended September 30, 2002 were
$192,000 compared with $35,000 in the corresponding period of the
prior year, due to the initiation of more collaborative research and
development arrangements.
Product revenues for the nine months ended September 30, 2002
increased by $30,000 or 4% to $869,000 due to increased sales of
analytical standards.
Research and development expense increased by $333,000 or 7% to
$5,243,000 due mainly to increased headcount and related expenses
offset by deferred expenditures on the Company's first product
candidate, APF112, for the treatment of post-surgical pain. In
August 2002, the Company withdrew the proposed protocol for a Phase
II clinical study for APF112 in response to FDA concerns regarding
observed irritation in preclinical studies. This mild to moderate
irritation lasted beyond the planned 24 - 36 hours of pain relief
following administration into the knee joint. A comprehensive
proposal on the scope of animal studies required for the resumption
of human clinical studies has been submitted to the FDA and the
Company anticipates meeting with FDA officials during the fourth
quarter of 2002. The delay caused by the withdrawal of the Phase II
protocol will defer a portion of the anticipated increase in
research and development spending until 2003, assuming that the
Company is successful in gaining FDA clearance to proceed with the
study. Additional costs will be incurred in the near-term to
conduct animal studies as part of the Company's plan to resume human
clinical testing. These additional costs are not expected to be
material. If the Company is successful in gaining FDA clearance to
proceed with the protocol, the delay in the commencement of a Phase
II clinical study could result in a delay in the filing of a New
Drug Application (NDA) for APF112, and hence could result in a delay
in the product candidate's marketing clearance and initiation of
revenue streams. If the Company is not successful in gaining FDA
clearance to proceed with the protocol, there will be a delay in the
development of the Company's first product candidate while
reformulation work is carried out prior to clinical trials.
Selling and marketing expense for the nine months ended September
30, 2002 of $352,000 increased by $7,000 or 2% from $345,000 in the
corresponding period of the prior year. Selling and marketing
expense is expected to remain essentially unchanged for fiscal 2002
as compared to fiscal 2001.
General and administrative expense for the first nine months of 2002
increased by $66,000 or 3% to $2,225,000 due mainly to increased
investor relations activities and the addition of the business
development function in May 2001. General and administrative
expense is expected to increase moderately in 2002, primarily due to
increased investor relations activities.
Interest income for the first nine months of 2002 decreased by
$370,000 or 43% to $491,000 due to lower interest rates earned on
lower average cash balances.
The gain on disposal of discontinued operations of $210,000
represents the second year earnout payment from the sale of the
cosmeceutical and toiletries business to RP Scherer in July 2000.
This compares with an earnout payment of $3,000,000 reported in the
third quarter of the prior year. The decrease of $2,790,000 is
principally due to lower sales of the divested product lines and
resulting lower gross profit. Under the agreement, the Company can
receive up to $26.5 million over the first three years of the
earnout period, based on the gross profit of the business sold.
Income from discontinued operations in the prior year included a
reserve of $400,000 relating to a note receivable arising from the
Company's sale of certain proprietary rights to a consumer product
in 1999. As payments on the note were not received on a timely
basis, a reserve was recorded against the remaining outstanding
balance on the note. This was partially offset by the recovery from
a customer of $220,000 for which the Company had previously recorded
a reserve.
Capital Resources and Liquidity
- -------------------------------
Total assets as of September 30, 2002 were $18,913,000 compared with
$23,507,000 at December 31, 2001. Cash, cash equivalents and
marketable securities decreased by $4,370,000 to $15,124,000 at
September 30, 2002 from $19,494,000 at December 31, 2001.
Net cash used in operating activities for the nine months ended
September 30, 2002 and 2001 was $3,935,000 and $3,271,000,
respectively. The increase in net cash used in operating activities
was due principally to a lower earnout payment from the sale of the
cosmeceutical and toiletries business to RP Scherer compared with
the prior year.
Cash provided by investing activities for the nine months ended
September 30, 2002 was $6,821,000 compared with cash used in
investing activities of $623,000 for the comparable period of the
prior year. The increase is due to maturities and sales of
marketable securities.
The Company has financed its operations, including technology and
product research and development, from royalties on sales of Retin-A
Micro and Carac, proceeds from the sale of the cosmeceutical and
toiletry business to RP Scherer, the sales of analytical standard
products, interest earned on short-term investments and research and
development fees received from corporate collaborators.
The Company's existing cash and cash equivalents, marketable
securities, collections of trade accounts receivable, together with
interest income and other revenue-producing activities including
royalties, license and option fees and research and development
fees, are expected to be sufficient to meet the Company's cash needs
for at least two years, assuming no changes to business plans.
The Company's future capital requirements will depend on numerous
factors including, among others, royalties from sales of products by
third party licensees; the Company's ability to enter into
collaborative research and development and licensing agreements;
progress of product candidates in preclinical and clinical trials;
investment in new research and development programs; time required
to gain regulatory approvals; resources that the Company devotes to
self-funded products; the Company's ability to obtain and retain
funding from third parties under collaborative agreements; and the
costs of defending or prosecuting any patent opposition or
litigation necessary to protect the Company's proprietary
technology.
New Accounting Standards
- ------------------------
In July 2001, the FASB issued FAS 141, "Business Combinations" (FAS
141). FAS 141 supersedes APB 16, "Business Combinations," and FAS
38, "Accounting for Preacquisition Contingencies of Purchased
Enterprises." FAS 141 requires the purchase method of accounting
for all business combinations initiated after June 30, 2001 and
eliminates the pooling-of-interests method. FAS 141 also includes
guidance on the initial recognition and measurement of goodwill and
other intangible assets arising from business combinations completed
after June 30, 2001. Adoption of this statement on January 1, 2002
did not have a material effect on the Company's financial condition
or results of operations.
In July 2001, the FASB issued FAS 142, "Goodwill and Other
Intangible Assets" (FAS 142). FAS 142 supersedes APB 17,
"Intangible Assets," and requires the discontinuance of goodwill
amortization. In addition, FAS 142 includes provisions regarding
the reclassification of certain existing recognized intangibles as
goodwill, reassessment of the useful lives of existing recognized
intangibles, reclassification of certain intangibles out of
previously reported goodwill and the testing for impairment of
existing goodwill and other intangibles out of previously reported
goodwill and other intangibles. FAS 142 is required to be applied
for fiscal years beginning after December 15, 2001, with certain
early adoption permitted. Adoption of this statement on January 1,
2002 did not have a material effect on the Company's financial
condition or results of operations.
In August 2001, the FASB issued FAS 143, "Accounting for Asset
Retirement Obligations" (FAS 143). FAS 143 addresses financial
accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated
retirement costs. Adoption of this statement on January 1, 2002 did
not have a material effect on the Company's financial condition or
results of operations.
In October 2001, the FASB issued FAS 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (FAS 144), which
supersedes FAS 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" (FAS 121). FAS
144 addresses financial accounting and reporting for the impairment
of long-lived assets and for long-lived assets to be disposed of.
However, FAS 144 retains the fundamental provisions of FAS 121 for:
1) recognition and measurement of the impairment of long-lived
assets to be held and used; and 2) measurement of long-lived assets
to be disposed of by sale. FAS 144 is effective for fiscal years
beginning after December 15, 2001. Adoption of this statement on
January 1, 2002 did not have a material effect on the Company's
financial condition or results of operations.
In June 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards, "Accounting for Costs
Associated with Exit or Disposal Activities" (FAS 146). FAS 146
addresses financial accounting and reporting for costs associated
with exit or disposal activities and nullifies Emerging Issues Task
Force Issue (EITF) No. 94-3 " Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" (EITF 94-3).
FAS 146 requires that a liability for a cost associated with an exit
or disposal activity be recognized when the liability is incurred,
not at the date of an entity's commitment to an exit plan, as
required under EITF 94-3. The provisions of FAS 146 are effective
for exit or disposal activities initiated after December 31, 2002,
with earlier application encouraged. The Company is currently
analyzing the effect, if any, the adoption of this standard will
have on the financial condition or results of operations.
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk
---------------------------------------------------------
Since December 31, 2001, there have been no material changes in the
Company's market risk exposure.
ITEM 4. Controls and Procedures
-----------------------
Evaluation of Disclosure Controls and Procedures: The Company's
Chief Executive Officer and Chief Financial Officer, after
evaluating the effectiveness of the Company's disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-
14(c)) within 90 days before the filing date of this quarterly
report, have concluded that the Company's disclosure controls and
procedures were adequate and effective to ensure that material
information relating to the Company was made known to them
particularly during the period in which this Form 10-Q was being
prepared.
Changes in Internal Controls: There were no significant changes in
the Company's internal controls or in other factors that could
significantly affect these controls subsequent to the date of their
evaluation, nor were there any significant deficiencies or material
weaknesses in the Company's internal controls. Accordingly, no
corrective actions were required or undertaken.
We intend to review and evaluate the design and effectiveness of our
disclosure controls and procedures on an ongoing basis and to
improve our controls and procedures over time and to correct any
deficiencies that we may discover in the future. Our goal is to
ensure that our senior management has timely access to all material
financial and non-financial information concerning our business.
Wile we believe the present design of our disclosure controls and
procedures is effective to achieve our goal, future events affecting
our business may cause us to significantly modify our disclosure
controls and procedures.
PART II. OTHER INFORMATION
-----------------
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.
A.P. PHARMA, INC.
Date: November 14, 2002 By: /S/ Michael O'Connell
------------------ -------------------------
Michael O'Connell
President and Chief
Executive Officer
Date: November 14, 2002 By: /S/ Gordon Sangster
------------------ -------------------------
Gordon Sangster
Chief Financial Officer
CERTIFICATIONS
Certifications:
I, Michael O'Connell, certify that:
1. I have reviewed this quarterly report on Form 10-Q of A.P.
Pharma, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-
14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within 90
days prior to the filing date of this quarterly report
(the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002
/s/ Michael O'Connell
- ---------------------
Michael O'Connell
President and Chief Executive Officer
Certifications:
I, Gordon Sangster, certify that:
1. I have reviewed this quarterly report on Form 10-Q of A.P.
Pharma, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules 13a-
14 and 15d-14) for the registrant and have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during
the period in which this quarterly report is being
prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this quarterly report (the
"Evaluation Date"); and
c. presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
functions):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant role
in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated
in this quarterly report whether there were significant changes
in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective actions
with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
/s/ Gordon Sangster
- -------------------
Gordon Sangster
Chief Financial Officer
EXHIBIT INDEX
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED - ------------------------------------------------------------ PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 - --------------------------------------------------------- In connection with the Quarterly Report of A.P. Pharma, Inc. (the "Company") on Form 10-Q for the period ending September 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Michael O'Connell, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Michael O'Connell - --------------------- Michael O'Connell, Chief Executive Officer CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED - ------------------------------------------------------------ PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 - --------------------------------------------------------- In connection with the Quarterly Report of A.P. Pharma, Inc. (the "Company") on Form 10-Q for the period ending September 30, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Gordon Sangster, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Gordon Sangster - ------------------- Gordon Sangster, Chief Financial Officer