SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2003
[ ] 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.
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(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
--- ---
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Act).
Yes [ ] No [X ]
---- ----
At April 30, 2003, the number of outstanding shares of the Company's
common stock, par value $.01, was 20,522,151.
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets
March 31, 2003 and December 31, 2002
Condensed Consolidated Statements of Operations
for the three months ended March 31, 2003 and 2002
Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 2003 and 2002
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
ITEM 1. Legal Proceedings
ITEM 6. Exhibits and Reports on Form 8-K
Signatures
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. Financial Statements:
---------------------
A.P. PHARMA, INC.
- -----------------
CONDENSED CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
- ----------------------------------------------------
March 31, 2003 December 31, 2002
-------------- -----------------
(Unaudited) (Note A)
ASSETS
Current assets:
Cash and cash equivalents $ 3,632 $ 3,282
Marketable securities 10,836 10,839
Accounts receivable, net 1,386 1,340
Prepaid expenses and other 215 280
Assets held for sale -- 225
------ ------
Total current assets 16,069 15,966
Property and equipment, net 1,527 1,626
Other long-term assets 481 189
------ ------
Total assets $ 18,077 $ 17,781
====== ======
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 182 $ 268
Accrued expenses 1,392 945
Accrued disposition costs 395 514
Deferred revenue 450 250
------ ------
Total current liabilities 2,419 1,977
Deferred revenue - long-term 145 345
------ ------
Shareholders' equity:
Common stock 86,646 86,618
Accumulated deficit (71,201) (71,235)
Accumulated other comprehensive
income 68 76
------ ------
Total shareholders' equity 15,513 15,459
------ ------
Total liabilities and shareholders'
equity $ 18,077 $ 17,781
====== ======
Note A Information derived from audited financial statements which
are included in the 2002 Form 10-K filed with the Securities and
Exchange Commission.
See accompanying notes to condensed consolidated financial
statements.
A.P. PHARMA, INC.
- -----------------
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
- ----------------------------------------------------------
(in thousands)
- --------------
Three Months Ended March 31,
----------------------------
2003 2002
------ ------
Royalties $ 1,032 $ 904
Contract revenues 74 48
------ ------
Total revenues 1,106 952
Operating expenses:
Research & development 2,202 1,497
General & administration 778 760
------ ------
Total operating expenses 2,980 2,257
------ ------
Operating loss (1,874) (1,305)
Interest income, net 77 186
Other income (expense), net (1) 18
------ ------
Loss from continuing operations (1,798) (1,101)
Income (loss) from discontinued
operations (54) 95
Gain on disposition of
discontinued operations 1,886 --
------ ------
Net income (loss) $ 34 $(1,006)
====== ======
Basic earnings (loss) per share:
Loss from continuing operations $ (0.09) $ (0.05)
====== ======
Net income (loss) $ * $ (0.05)
====== ======
Diluted earnings (loss) per share:
Loss from continuing operations $ (0.09) $ (0.05)
====== ======
Net income (loss) $ * $ (0.05)
====== ======
Weighted average common shares
outstanding-basic 20,475 20,360
====== ======
Weighted average common shares
outstanding-diluted 20,516 20,360
====== ======
* Less than $0.01 per share.
See accompanying notes to condensed consolidated financial statements.
A.P. PHARMA, INC.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)(in thousands)
- -------------------------------------------------------------------------
Three months ended March 31,
----------------------------
2003 2002
---------- ----------
Cash flows from operating activities:
Net income (loss) $ 34 $(1,006)
Adjustments to reconcile net income
(loss) to net cash used in operating
activities:
Income (loss) from discontinued
operations 54 (95)
Gain on disposition of discontinued
operations (1,886) --
Gain on sale of marketable
securities -- (20)
Depreciation and amortization 117 104
Provision for (recovery of)
doubtful accounts and note
receivable (8) 50
Amortization of deferred revenue -- (10)
Stock and stock option
compensation awards to non-
employees 28 32
Restricted stock awards -- 33
Amortization of premium/discount
and accretion of marketable
securities (23) 19
Loss on retirements of property
and equipment 8 --
Changes in operating assets and
liabilities:
Accounts receivable (46) 33
Prepaid expenses and other 73 198
Other long-term assets (292) 6
Accounts payable (86) (215)
Accrued expenses 447 (417)
Deferred revenue -- 20
------ ------
Net cash used in continuing
operating activities (1,580) (1,268)
Net cash used in discontinued
operations (211) (54)
Cash flows from investing activities:
Proceeds from disposition of
discontinued operations 2,149 --
Purchases of property and equipment (26) (9)
Purchases of marketable securities (2,836) (2,519)
Maturities of marketable securities 2,854 5,034
------ ------
Net cash provided by investing
activities 2,141 2,506
------ ------
Net increase in cash and cash
equivalents 350 1,184
Cash and cash equivalents, beginning
of the period 3,282 3,618
------ ------
Cash and cash equivalents, end
of the period $ 3,632 $ 4,802
====== ======
See accompanying notes to condensed consolidated financial statements.
A.P. PHARMA, INC.
- -----------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------
MARCH 31, 2003 and 2002 (UNAUDITED)
- -----------------------------------
(1) Basis of Presentation
---------------------
A.P. Pharma, Inc. ("APP", the "Company", "we". "our", or "us")
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 months ended March
31, 2003 are not necessarily indicative of the results that may
be expected for the year ending December 31, 2003. The
condensed consolidated balance sheet as of December 31, 2002
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, 2002.
The condensed consolidated financial statements include the
financial statements of the Company and its subsidiary, APS
Analytical Standards, Inc through the date of sale (February
13, 2003). 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 2003.
The operations and related assets of the Analytical Standards
division were reclassified to discontinued operations and
assets held for sale, respectively in the statements of
operations and cash flows for the three months ended March 31,
2002 and in the balance sheet as of December 31, 2002.
Critical Accounting Policies
- ----------------------------
We believe there have been no significant changes in our
critical accounting policies during the three months ended
March 31, 2003 as compared to what was previously disclosed in
our Annual Report on Form 10-K for the year ended December 31,
2002 filed with the SEC on March 28, 2003.
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
- -------------------
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 end customer by our licensees based
on information provided to us by our licensees.
We have licensing agreements that generally provide for
periodic minimum payments, royalties, milestone payments and/or
non-refundable license fees. These licensing agreements
typically require a non-refundable license fee and allow our
partners to sell our 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 we have 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 we have 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 first quarter of 2003.
A milestone payment is a payment made by a third party or
corporate partner to us 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 we have completed all milestone related services
such that the milestone payment is currently due and is non-
refundable. No such payments were received during the three
months ended March 31, 2003.
Contract revenues from research and development arrangements
are recognized as the related development costs are incurred.
These revenues approximate the costs incurred.
Cash Equivalents and Short-term Investments
- -------------------------------------------
We consider 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, gross profit guarantees, and costs of disposition, all
of which are payable over the next year.
Concentrations of Credit Risk
- -----------------------------
Financial instruments which potentially expose our company to
concentrations of credit risk consist primarily of trade
accounts receivable and receivables from royalties and contract
revenues. Approximately 74% of the recorded trade receivables
and receivables from royalties and contract revenues were
concentrated with two customers in the pharmaceutical industry
as of March 31, 2003. To reduce credit risk, we perform
ongoing credit evaluations of our customers' financial
conditions. We do not generally require collateral for
customers with account receivable balances.
Segment and Geographic Information
- ----------------------------------
Our 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.
Employee Stock Plans
- --------------------
As permitted by Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation," (FAS 123) we
have elected to continue to apply the provisions of Accounting
Principle Board Opinion No. 25, "Accounting for Stock Issued to
Employees," (APB 25) and related interpretations in accounting
for our employee stock option and stock purchase plans. The
Company is generally not required under APB 25 and related
interpretations to recognize compensation expense in connection
with its employee stock option and stock purchase plans.
Pro forma information regarding net loss and net loss per share
is required by FAS 123 and has been determined as if we had
accounted for our employee stock options under the fair value
method prescribed by the FAS 123. The fair value for these
options was estimated at the date of grant using the Black-
Scholes option pricing model with the following weighted
average assumptions: risk-free interest rates of 3.8% and 4.8%
for the three months ended March 31, 2003 and 2002,
respectively; a dividend yield of zero for the three months
ended March 31, 2003 and 2002; volatility factors of the
expected market price of the Company's common stock of 1.015
and 0.631 as of March 31, 2003 and 2002, respectively; and a
weighted average expected life of the options of 5 years for
the three months ended March 31, 2003 and 2002.
For purposes of pro forma disclosures, the estimated fair value
of the options is amortized to expense over the vesting period
of the options using the straight-line method. Our pro forma
information is set forth in the table below:
Three Months Ended
March 31,
------------------
2003 2002
------------ -----------
(In thousands, except per
share amounts)
Net income (loss), as reported $ 34 $(1,006)
Deduct:
Stock-based employee
compensation expense
determined under FAS 123 (132) (140)
------ ------
Pro forma net loss $ (98) $(1,146)
====== ======
Basic income (loss) per common
share as reported $ * $ (0.05)
====== ======
Basic pro forma loss per
common share $ ** $ (0.06)
====== ======
Diluted income (loss) per
common share as reported $ 0.00 $ (0.05)
====== ======
Diluted pro forma loss per
common share $ (0.00) $ (0.06)
====== ======
* Less than $0.01 per share.
** Less than $(0.01) per share.
Recent Accounting Pronouncements
- --------------------------------
In June 2002, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting standards No. 146,
"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 supersedes Emerging Issues Task Force Issue No.
94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)" and requires that a
liability for a cost associated with an exit or disposal
activity be recognized and initially measure at fair value only
when the liability is incurred rather than at the date of an
entity's commitment to an exit plan. FAS 146 further
establishes fair value as the objective for initial measurement
of the liability and that employee benefit arrangements
requiring future service beyond a "minimum retention period" be
recognized over the future service period. FAS 146 is
effective for exit or disposal activities initiated after
December 31, 2002. We adopted this accounting principle on
January 1, 2003 and have applied it to the costs associated
with the discontinued operations of the Analytical Standards
division (see Note 4 "Discontinued Operations").
In November 2002, the FASB issued Financial Interpretation No.
45, "Guarantor's Accounting and Disclosure requirement for
Guarantees, Including Indirect Guarantees of Indebtedness of
Others" (FIN 45). The initial recognition and initial
measurement provisions apply on a prospective basis to
guarantees issued or modified after December 31, 2002,
regardless of the guarantor's fiscal year-end. The disclosure
requirements in FIN 45 are effective for financial statements
of interim or annual periods ending after December 15, 2002.
The adoption of FIN 45 has not had a material effect on our
financial condition or results of operations.
In November 2002, the FASB issued Emerging Issues Task Force
(EITF) Issue No. 00-21, "Revenue Arrangements with Multiple
Deliverables." EITF 00-21 addresses certain aspects of the
accounting by a company for arrangements under which it will
perform multiple revenue-generating activities. EITF 00-21
addresses when and how an arrangement involving multiple
deliverables should be divided into separate units of
accounting. EITF 00-21 provides guidance with respect to the
effect of certain customer rights due to company nonperformance
on the recognition of revenue allocated to delivered units of
accounting. EITF 00-21 also addresses the impact on the
measurement and/or allocation of arrangement consideration of
customer cancellation provisions and consideration that varies
as a result of future actions of the customer or the company.
Finally, EITF 00-21 provides guidance with respect to the
recognition of the cost of certain deliverables that are
excluded from the revenue accounting arrangement. The
provisions of EITF 00-21 will apply to revenue arrangements
entered into in fiscal periods beginning after June 15, 2003.
We are currently evaluating the impact that the adoption of
EITF 00-21 will have on our financial position and results of
operations.
In January 2003, The FASB issued Financial Interpretation No.
46, "Consolidation of Variable Interest Entities" (FIN 46).
The consolidation requirements of FIN 46 apply immediately to
variable interest entities created after January 31, 2003. The
consolidation requirements apply to older entities in the first
fiscal year or interim periods beginning after June 15, 2003.
Certain of the disclosure requirements apply in all financial
statements issued after January 31, 2003, regardless of when
the variable interest entity was established. We do not have
variable interest entities and do not expect the adoption of
FIN 46 to have a material effect on our financial position or
results of operations.
(2) Earnings (Loss) Per Share Information
-------------------------------------
Basic earnings (loss) per share is computed by dividing net
income (loss) by the weighted-average number of common shares
outstanding. Diluted earnings (loss) per share is computed by
dividing net income (loss) by the total of weighted-average
number of common shares outstanding and dilutive potential
common shares outstanding.
The following table sets forth the computation of our basic and
diluted earnings (loss) per share (in thousands, except per
share amounts):
Three months ended
March 31,
------------------
2003 2002
---- ----
Loss from continuing operations $ (1,798) $ (1,101)
======= =======
Net income (loss) 34 (1,006)
======= =======
Shares calculation:
Weighted average shares
outstanding - basic 20,475 20,360
Effect of dilutive securities:
Stock options, employee stock
purchase plan and stock to be
issued to directors 41 --
------- -------
Weighted average shares
outstanding - diluted 20,516 20,360
======= =======
Basic earnings (loss) per common
share:
Loss from continuing operations $ (0.09) $ (0.05)
======= =======
Net income (loss) $ * $ (0.05)
======= =======
Diluted earnings (loss) per common
Share:
Loss from continuing operations $ (0.09) $ (0.05)
======= =======
Net income (loss) $ * $ (0.05)
======= =======
* Less than $0.01 per share.
The following stock options were outstanding during the periods
presented, but were not included in the computation of diluted
earnings (loss) per share since inclusion of these potentially
dilutive securities would have been anti-dilutive for the
periods presented (in thousands, except exercise prices):
Three months ended
March 31,
------------------
2003 2002
---- ----
Number outstanding 2,929 3,218
Range of exercise prices $1.01 - $10.25 $2.00 - $10.88
(3) Comprehensive Income (Loss)
---------------------------
Comprehensive income (loss) for the three months ended March
31, 2003 and March 31, 2002 consists of the following (in
thousands):
Three Months Ended
March 31,
------------------
2003 2002
---- ----
Net income (loss) $ 34 $(1,006)
Unrealized holding losses
arising during the period (8) (124)
------ ------
Comprehensive income (loss) $ 26 $(1,130)
====== ======
(4) Discontinued Operations
-----------------------
On February 13, 2003, we completed the sale of our Analytical
Standards division to GFS Chemicals, Inc. ("GFS"), a private
company based in Columbus, Ohio. The Analytical Standards
division was no longer considered to be part of our strategic
focus. In this transaction, we received $2.1 million on
closing and are entitled to receive royalty payments over the
next five years. Under the terms of the sale, we are entitled
to receive royalties on sales of Analytical Standards products
of 15% for the first year, 10% for the second through fourth
years, and 5% for the fifth year. The net present value of the
guaranteed minimum royalties is included in the gain on
disposition of discontinued operations.
On July 25, 2000, we completed the sale of certain technology
rights for our topical pharmaceutical and cosmeceutical product
lines and other assets ("cosmeceutical and toiletry business")
to RP Scherer Corporation, a subsidiary of Cardinal Health,
Inc. We received $25 million on closing and are 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, we 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.
Under the terms of the agreement with RP Scherer, we guaranteed
a minimum gross profit percentage on RP Scherer's combined
sales of products to Ortho Neutrogena and Dermik ("Gross Profit
Guaranty"). The guaranty period commenced on July 1, 2000 and
ends on the earlier of July 1, 2010 or the end of two
consecutive guaranty periods where the combined gross profit on
sales to Ortho and Dermik equals or exceeds the guaranteed
gross profit. Payments for the Gross Profit Guaranty
aggregated $243,000 for the first two guaranty years. We expect
the annual Gross Profit Guaranty payments to range from
approximately $100,000 to $200,000 for the remainder of the
guaranty period. As there is no minimum amount of Gross Profit
Guaranty due, no accrual for the guaranty for future years is
estimable.
The Analytical Standards division and cosmeceutical and
toiletry business are reported as discontinued operations for
all periods presented in the accompanying Condensed
Consolidated Statements of Operations.
Income from discontinued operations represents the operations
of the Analytical Standards division and changes in estimates
relating to the discontinued cosmeceutical and toiletry
business and consists of the following (in thousands):
Three months ended
March 31,
------------------
2003 2002
---- ----
Income from Analytical
Standards operations $ 9 $ 44
Recovery of doubtful
accounts receivable 4 --
Change in estimate for
guarantees (67) --
Change in estimate of
provision for income
taxes and tax refunds -- 53
Other changes in
estimate -- (2)
--- ---
Total income (loss) from
discontinued operations $(54) $ 95
=== ===
Basic and diluted income (loss) per common share from
discontinued operations excluding the gain on sale of the
Analytical Standards and cosmeceutical product lines were less
than ($0.01) and $0.01 per share for the three months ended
March 31, 2003 and 2002, respectively.
As of March 31, 2003, net assets relating to the discontinued
cosmeceutical and toiletry business include trade receivables
of $192,000 and a provision for doubtful accounts receivable of
$24,000. Liabilities related to the discontinued cosmeceutical
and toiletry operation in the amount of $226,000 include
severance costs and accruals for gross profit guarantees.
These liabilities are reported as accrued disposition costs in
the accompanying balance sheet.
Cash used in discontinued operations primarily relates to
payments of severance costs to former employees who were
terminated as a result of the sales of the Analytical Standards
division and cosmeceutical and toiletry business. A total of
60 positions, primarily in the manufacturing, marketing and
research and development departments and associated general and
administrative staff, were eliminated as a result of the
dispositions. During the year ended December 31, 2000, we
recorded severance charges related to salaries and benefits in
gain on disposition of the cosmeceutical business. The total
amount of severance charges relating to the sale of the
cosmeceutical and toiletry business was approximately
$3,685,000, of which approximately $3,603,000 has been paid to
date, including $63,000 in the current quarter. The remaining
accrued severance of approximately $82,000 is expected to be
paid by July 31, 2003.
In the quarter ended March 31, 2003, we recorded severance
charges of $197,000 as an offset to the gain on disposition of
the Analytical Standards division. Approximately $44,000 of
these severance charges has been paid to date.
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 our Securities and Exchange
Commission filings.
Certain reclassifications have been made to the prior period
financial statements to conform with the presentation in 2003. The
operations and related assets of the Analytical Standards division
were reclassified to discontinued operations and assets held for
sale, respectively, in the statements of operations and cash flows
for the three months ended March 31, 2002 and in the balance sheet
as of December 31, 2002.
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. The
items in our financial statements requiring significant estimates
and judgments are as follows:
CRITICAL ACCOUNTING POLICIES
We believe there have been no significant changes in our critical
accounting policies during the three months ended March 31, 2003 as
compared to what was previously disclosed in our Annual Report on
Form 10-K for the year ended December 31, 2002 filed with the SEC on
March 28, 2003.
Revenue Recognition
- -------------------
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 end customer by our licensees based on information
provided to us by our licensees.
We have licensing agreements that generally provide for periodic
minimum payments, royalties, milestone payments and/or non-
refundable license fees. These licensing agreements typically
require a non-refundable license fee and allow our partners to sell
our 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 we have 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 we have
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 first quarter of 2003.
A milestone payment is a payment made by a third party or corporate
partner to us 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 we
have completed all milestone related services such that the
milestone payment is currently due and is non-refundable. No such
payments were received during the three months ended March 31, 2003.
Contract revenues from research and development arrangements are
recognized as the related development costs are incurred. These
revenues approximate the costs incurred.
Results of Operations for the Three Months Ended March 31, 2003 and
- -------------------------------------------------------------------
2002
- ----
Our revenues are derived principally from royalties, license and
research and development fees. Under strategic alliance
arrangements entered into with certain corporations, we can receive
non-refundable upfront fees, milestone payments and royalties based
on third party product sales.
Royalties for the first quarter of 2003 increased by $128,000 to
$1,032,000 from $904,000 in the corresponding quarter of the prior
year. This increase was due mainly to increased sales of Retin-A
Micro(R) following the launch of a new low-dose formulation in July
2002 after FDA marketing clearance.
Research and development expense for the first quarter of 2003
increased by $705,000 from $1,497,000 to $2,202,000 due mainly to
the cost of preclinical studies using the modified APF112
formulation as agreed with the U.S. Food and Drug Administration
(FDA). We are preparing a full package for submission to the FDA
prior to initiation of Phase II human clinical trials with its
APF112 formulation for the treatment of post-surgical pain.
General and administrative expense for the first quarter of 2003
increased by $18,000 from $760,000 to $778,000. General and
administrative expense is expected to increase only moderately in
2003.
Interest income for the first quarter of 2003 decreased by $107,000
to $78,000 from $186,000 due to lower interest rates earned on lower
average cash balances.
Income/loss from discontinued operations represents the net
contribution/loss attributable to the Analytical Standards division
which was sold to GFS Chemicals, Inc. in February 2003 and the
cosmeceutical and toiletries product lines which were sold to RP
Scherer Corporation in July 2000. Net loss from discontinued
operations totaled $54,000 for the three months ended March 31,
2003, compared with the net gain from discontinued operation of
$95,000 in the three months ended March 31, 2002.
Gain on disposition of discontinued operations of $1,886,000 relates
to the sale of the Analytical Standards division on February 13,
2003 to GFS Chemicals, Inc., a private company based in Columbus,
Ohio. We received $2,149,000 million in cash on the closing date
and are entitled to receive royalties on sales varying from 5% to
15% for five years following the closing, with guaranteed minimum
annual royalty payments.
Capital Resources and Liquidity
- -------------------------------
Total assets as of March 31, 2003 were $18,077,000 compared with
$17,781,000 at December 31, 2002. Cash, cash equivalents and
marketable securities increased by $347,000 to $14,468,000 at March
31, 2003 from $14,121,000 at December 31, 2002 due to proceeds
received from the sale of the Analytical Standards division, net of
cash used in operating activities.
Net cash used in operating activities for the three months ended
March 31, 2003 and 2002 was $1,580,000 and $1,268,000, respectively.
The increase in net cash used in operating activities was mainly due
to an increase in loss from continuing operations resulting from
increased preclinical study costs.
We have financed our operations, including technology and product
research and development, from royalties on Retin-A Micro and Carac,
proceeds from the sale of the cosmeceutical and toiletry business to
RP Scherer, proceeds from the sale of the Analytical Standards
division to GFS Chemicals, Inc., interest earned on short-term
investments and research and development fees received from
corporate collaborators.
Our 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 our cash needs for at least two
years, assuming no changes to our current business plan.
Our future capital requirements will depend on numerous factors
including, among others, royalties from sales of products of third
party licensees; our 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 we devote to self-funded products; our
ability to obtain and retain funding from third parties under
collaborative agreements; potential acquisitions of technology,
product candidates or businesses; and the costs of defending or
prosecuting any patent opposition or litigation necessary to protect
the our proprietary technology.
Recent Accounting Pronouncements
- --------------------------------
In June 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting standards No. 146, "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 supersedes Emerging
Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" and requires
that a liability for a cost associated with an exit or disposal
activity be recognized and initially measure at fair value only when
the liability is incurred rather than at the date of an entity's
commitment to an exit plan. FAS 146 further establishes fair value
as the objective for initial measurement of the liability and that
employee benefit arrangements requiring future service beyond a
"minimum retention period" be recognized over the future service
period. FAS 146 is effective for exit or disposal activities
initiated after December 31, 2002. We adopted this accounting
standard on January 1, 2003.
In November 2002, the FASB issued Financial Interpretation No. 45,
"Guarantor's Accounting and Disclosure requirement for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" (FIN 45).
The initial recognition and initial measurement provisions apply on
a prospective basis to guarantees issued or modified after December
31, 2002, regardless of the guarantor's fiscal year-end. The
disclosure requirements in FIN 45 are effective for financial
statements of interim or annual periods ending after December 15,
2002. The adoption of FIN 45 has not had a material effect on our
financial condition or results of operations.
In November 2002, the FASB issued Emerging Issues Task Force (EITF)
Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables."
EITF 00-21 addresses certain aspects of the accounting by a company
for arrangements under which it will perform multiple revenue-
generating activities. EITF 00-21 addresses when and how an
arrangement involving multiple deliverables should be divided into
separate units of accounting. EITF 00-21 provides guidance with
respect to the effect of certain customer rights due to company
nonperformance on the recognition of revenue allocated to delivered
units of accounting. EITF 00-21 also addresses the impact on the
measurement and/or allocation of arrangement consideration of
customer cancellation provisions and consideration that varies as a
result of future actions of the customer or the company. Finally,
EITF 00-21 provides guidance with respect to the recognition of the
cost of certain deliverables that are excluded from the revenue
accounting arrangement. The provisions of EITF 00-21 will apply to
revenue arrangements entered into in fiscal periods beginning after
June 15, 2003. We are currently evaluating the impact that the
adoption of EITF 00-21 will have on our financial position and
results of operations.
In January 2003, The FASB issued Financial Interpretation No. 46,
"Consolidation of Variable Interest Entities" (FIN 46). The
consolidation requirements of FIN 46 apply immediately to variable
interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or
interim periods beginning after June 15, 2003. Certain of the
disclosure requirements apply in all financial statements issued
after January 31, 2003, regardless of when the variable interest
entity was established. We do not have variable interest entities
and do not expect the adoption of FIN 46 to have a material effect
on our financial position or results of operations.
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk
----------------------------------------------------------
Since December 31, 2002, there have been no material changes in the
Company's market risk exposure.
ITEM 4. Controls and Procedures
-----------------------
Based on their evaluation as of a date within 90 days of the filing
date of the Quarterly Report on Form 10-Q, the Company's principal
executive officer and principal financial officer have concluded
that the Company's disclosure controls and procedures as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of
1934 (the Exchange Act) are effective to ensure that 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 Securities and
Exchange Commission rules and forms.
PART II. OTHER INFORMATION
-----------------
ITEM 1. Legal Proceedings
None.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 2.2
The Asset Purchase Agreement between the Company and GFS Chemicals,
Inc. filed as Exhibit 99.1 to the Company's Form 8-K filed on February
13, 2003 and incorporated herein by reference.
Exhibit 99.1 Certifications of Chief Executive Officer and Chief
Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
On February 28, 2003, the Company filed a current report on Form
8-K reporting the completion of the sale of the assets of its wholly
owned subsidiary, APS Analytical Standards, Inc. on February 13,
2003 to GFS Chemicals, Inc., a private company based in Columbus,
Ohio.
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: May 14, 2003 By: /S/ Michael O'Connell
----------------- ----------------------------
Michael O'Connell
President and Chief
Executive Officer
Date: May 14, 2003 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: May 14, 2003
/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: May 14, 2003
/s/ Gordon Sangster
- -------------------
Gordon Sangster
Chief Financial Officer
Exhibit 99.2 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 March 31, 2003 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 March 31, 2003 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