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 June 30, 2003
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from to
-------- --------
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
------------------------------------------
(Address of principal executive offices)
(650) 366-2626
----------------------------------------------------
(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 July 31, 2003, the number of outstanding shares of the Company's
common stock, par value $.01, was 20,573,435.
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited):
Condensed Consolidated Balance Sheets
June 30, 2003 and December 31, 2002
Condensed Consolidated Statements of Operations
for the three and six months ended June 30,
2003 and 2002
Condensed Consolidated Statements of Cash Flows
for the six months ended June 30, 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 4. Submission of Matters to a Vote of Security Holders
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)
- ----------------------------------------------------
June 30, 2003 December 31, 2002
------------- -----------------
(Unaudited) (Note A)
ASSETS
Current assets:
Cash and cash equivalents $ 1,245 $ 3,282
Marketable securities 10,830 10,839
Accounts receivable, net 1,341 1,340
Prepaid expenses and other 511 280
Assets held for sale -- 225
------ ------
Total current assets 13,927 15,966
Property and equipment, net 1,505 1,626
Other long-term assets 477 189
------ ------
Total assets $ 15,909 $ 17,781
====== ======
LIABILITIES & SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 377 $ 268
Accrued expenses 1,019 945
Accrued disposition costs 286 514
Deferred revenue 474 250
------ ------
Total current liabilities 2,156 1,977
Deferred revenue - long-term 145 345
------ ------
Shareholders' equity:
Common stock 86,716 86,618
Accumulated deficit (73,162) (71,235)
Accumulated other comprehensive
income 54 76
------ ------
Total shareholders' equity 13,608 15,459
------ ------
Total liabilities and shareholders'
equity $ 15,909 $ 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, except per share amounts)
- ---------------------------------------
Three Months Ended June 30, Six Months
Ended June 30,
--------------------------- -----------
- --------------
2003 2002 2003
2002
---- ---- ----
- ----
Royalties $ 1,031 $ 930 $ 2,063
$ 1,833
Contract revenues 86 38 160
86
------ ------ ------
- ------
Total revenues 1,117 968 2,223
1,919
Costs and expenses:
Research & development 2,335 1,872 4,537
3,369
General & administration 766 813 1,544
1,573
------ ------ ------
- ------
Total operating expenses 3,101 2,685 6,081
4,942
------ ------ ------
- ------
Operating loss (1,984) (1,717) (3,858)
(3,023)
Interest income, net 64 178 141
364
Other income, net (10) (3) (12)
15
------- ------ ------
- ------
Loss from continuing operations (1,930) (1,542) (3,729)
(2,644)
Gain (loss) on disposition of
discontinued operations (30) 49 1,802
145
------ ------ ------
- ------
Net loss $(1,960) $(1,493) $(1,927)
$(2,499)
====== ====== ======
======
Basic and diluted loss per
share:
Loss from continuing operations $ (0.09) $ (0.08) $ (0.18)
$ (0.13)
====== ====== ======
======
Net loss $ (0.10) $ (0.07) $ (0.09)
$ (0.12)
====== ====== ======
======
Weighted average common shares
outstanding-basic and diluted 20,535 20,403 20,505
20,381
====== ====== ======
======
See accompanying notes.
A.P. PHARMA, INC.
- -----------------
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)(in thousands)
- -------------------------------------------------------------------------
For the six months ended June 30,
---------------------------------
2003 2002
---------- ----------
Cash flows from operating activities:
Net loss $(1,927) $(2,499)
Adjustments to reconcile net loss
to net cash used in operating
activities:
Gain on disposition of discontinued
operations (1,802) (145)
Gain on sale of marketable
securities -- (21)
Depreciation and amortization 236 210
Provision for (recovery of)
doubtful accounts and note
receivable (8) 50
Stock and stock option
compensation awards to non-
employees 73 61
Restricted stock awards -- 33
Amortization of premium/discount
and accretion of marketable
securities (1) 52
Loss on retirements of property
and equipment 15 2
Changes in operating assets and
liabilities:
Accounts receivable (2) 11
Prepaid expenses and other (222) (77)
Other long-term assets (287) 12
Accounts payable 109 6
Accrued expenses 74 (359)
Deferred revenue 24 --
------ ------
Net cash used in continuing
operating activities (3,718) (2,664)
Net cash used in discontinued
operations (341) (68)
Cash flows from investing activities:
Proceeds from disposition of
discontinued operations 2,139 --
Purchases of property and equipment (130) (329)
Purchases of marketable securities (4,238) (7,002)
Maturities of marketable securities 4,226 8,237
------ ------
Net cash provided by investing
activities 1,997 906
------ ------
Cash flow from financing
activities:
Proceeds from issuance of shares
under Employee Stock Purchase
Plan 25 52
------ ------
Net cash provided by financing
activities 25 52
Net decrease in cash and cash
equivalents (2,037) (1,774)
Cash and cash equivalents, beginning
of the period 3,282 3,618
------ ------
Cash and cash equivalents, end
of the period $ 1,245 $ 1,844
====== ======
See accompanying notes to condensed consolidated financial statements.
A.P. PHARMA, INC.
- -----------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
- ----------------------------------------------------
June 30, 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 and six months ended
June 30, 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. (Analytical Standards) 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 and six months ended
June 30, 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 six months ended June
30, 2003 as compared to those 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 three and six months ended June 30, 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
and six months ended June 30, 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 accounts
receivable. Approximately 90% of the account receivables were
concentrated with two customers in the pharmaceutical industry
as of June 30, 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 the provisions of Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," (FAS 123), we have elected to continue to apply
the intrinsic value method 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 plans and the Employee Stock Purchase
Plan (ESPP). Under APB 25, if the exercise price of our
employee and director stock options equals or exceeds the fair
market value of the underlying stock on the date of grant, no
compensation expense is recognized.
Pro forma information regarding net loss and net loss per share
has been determined as if we had accounted for our employee
stock options and ESPP under the fair value method prescribed
by FAS 123. 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 (in thousands, except per share amounts):
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
Net loss, as reported $(1,960) $(1,493) $(1,927)
$(2,499)
Deduct:
Stock-based employee
compensation expense
determined under FAS 123 (110) (152) (230)
(293)
------ ------ ------ -----
- -
Pro forma net loss $(2,070) $(1,645) $(2,157)
$(2,792)
====== ====== ======
======
Basic and diluted loss per
common share as reported $ (0.10) $ (0.07) $ (0.09) $
(0.12)
====== ====== ======
======
Basic and diluted pro forma
loss per common share $ (0.10) $ (0.08) $ (0.11) $
(0.14)
====== ====== ======
======
Fair values of awards granted under the stock option plans and
ESPP were estimated at grant or purchase dates using a Black-
Scholes option pricing model. The following assumptions were
used:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2003 2002 2003 2002
---- ---- ---- ----
Expected life in
years (from
vesting date): 5 5 5 5
Discount rate: 2.4% 4.0% 2.4% 4.0%
Volatility 68% 58% 68% 58%
Expected dividend
yield -- -- -- --
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 measured 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 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.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and
Equity" (FAS 150). FAS 150 establishes standards on the
classification and measurement of financial instruments with
characteristics of both liabilities and equity. FAS 150 will
become effective for financial instruments entered into or
modified after May 31, 2003. The adoption of FAS 150 has not
had a material effect on the Company's financial position or
results of operations.
(2) Loss Per Share Information
--------------------------
Basic loss per share is calculated using the weighted average
number of common shares outstanding. Because the Company is in
a net loss position for the three and six months ended June 30,
2003 and 2002, diluted earnings per share is also calculated
using the weighted average number of common shares outstanding
and excludes the effects of options, warrants and convertible
securities which are antidilutive.
(3) Comprehensive Loss
------------------
Comprehensive loss for the three and six months ended June 30,
2003 and 2002 consists of the following (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2003 2002 2003 2002
---- ---- ---- ----
Net loss $(1,960) $(1,493) $(1,927) $(2,499)
Unrealized holding
losses arising
during the period (14) (6) (22) (130)
------ ------ ------ ------
Comprehensive loss $(1,974) $(1,499) $(1,949) $(2,629)
====== ====== ====== ======
(4) Discontinued Operations
-----------------------
In a strategic decision to focus on our core business, we
completed the sale of our Analytical Standards division and
certain technology rights for our topical pharmaceutical and
cosmeceutical product lines and other assets ("cosmeceutical
and toiletry business") in February 2003 and July 2000,
respectively.
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.
Our gain(loss) from disposition of discontinued operations
consists of the gain on sale of the Analytical Standards
division, the operating results of the Analytical Standards
division through the sale on February 13, 2003 and changes in
estimates relating to the discontinued cosmeceutical and
toiletry business as follows (in thousands):
Six months ended
June 30,
----------------
2003 2002
---- ----
Gain on Sale of Analytical
Standards division $1,865 $ --
Income from Analytical
Standards operations 7 101
Recovery of doubtful
accounts receivable 4 --
Change in estimate for
guarantees (84) --
Change in estimates for
professional fees -- (8)
Change in estimate of
provision for income
taxes and tax refunds 10 53
Other changes in
estimate -- (1)
----- ---
Total gain from
disposition of
discontinued operations $1,802 $145
===== ===
Basic and diluted income (loss) per common share from
discontinued operations, excluding the gain on sale of the
Analytical Standards division and cosmeceutical and toiletry
business, were less than ($0.01) and $0.01 per share for the
six months ended June 30, 2003 and 2002, respectively.
Analytical Standards Division
- -----------------------------
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. In this transaction, we
received $2.1 million on closing and 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.
As a result of the sale of the Analytical Standards division,
we recorded severance charges of $209,000 in the six months
ended June 30, 2003 as a partial offset to the gain on
disposition of the Analytical Standards division.
Approximately $110,000 of these severance charges has been paid
to date, including $66,000 in the current quarter.
Cosmeceutical and Toiletry Business
- -----------------------------------
On July 25, 2000, we completed the sale of our cosmeceutical
and toiletry business to RP Scherer Corporation, a subsidiary
of Cardinal Health, Inc. We received $25 million on closing
and were 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. We received an aggregate of $3.8 million of
these earnout amounts, which were based on gross profit earned
by the business sold over the three-year period.
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 $404, 000 for the first three 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.
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 disposition. During the year ended December
31, 2000, we recorded severance charges of $3,685,000 as a
partial offset to the gain on disposition of the cosmeceutical
business of which approximately $3,665,000 has been paid to
date, including $62,000 in the current quarter. The remaining
accrued severance of approximately $20,000 was paid by July 31,
2003.
As of June 30, 2003, net assets relating to the discontinued
cosmeceutical and toiletry business include trade receivables
of $149,000 and a provision for doubtful accounts receivable of
$24,000. Liabilities related to the discontinued cosmeceutical
and toiletry operation in the amount of $181,000 include
severance costs and accruals for gross profit guarantees.
These liabilities are reported as accrued disposition costs in
the accompanying balance sheet.
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 and six months ended June 30, 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 six months ended June 30, 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 three and six months
ended June 30, 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 and six months ended June
30, 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
- ---------------------
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 three and six months ended June 30, 2003 were
$1,031,000 and $2,063,000, respectively, compared to $930,000 and
$1,833,000, respectively, in the same periods in 2002. These
increases were 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 increased approximately $463,000
and $1,168,000 for the three and six months ended June 30, 2003,
respectively, from $1,872,000 and $3,369,000, respectively, for the
same periods in 2002. These increases were due mainly to the cost
of Biochronomer studies which were designed to demonstrate the
biocompatibility of the polymer, and preclinical safety studies
using the enhanced APF112 formulation as agreed in discussions with
the U.S. Food and Drug Administration (FDA). APF112 is designed to
provide 24 to 36 hours of pain relief following surgery, initially
inguinal hernia repair, and avoid or minimize the use of opioids
which can have harmful side affects. A full package incorporating
extensive safety and biocompatibility studies and the Phase II
protocol was submitted to the FDA. In addition, costs associated
with the manufacture of GMP product for human clinical trials were
incurred during the second quarter of 2003. We expect to initiate
Phase II human clinical trials for the treatment of post-surgical
pain in the third quarter of 2003.
General and administrative expense decreased moderately for the
three and six months ended June 30, 2003 compared to the
corresponding periods in 2002. General and administrative costs are
expected to increase only moderately in 2003.
Net interest income for the three and six months ended June 30, 2003
decreased by $114,000 and $223,000, respectively, from $178,000 and
$364,000, respectively, for the corresponding periods in 2002.
These decreases were due to lower interest rates earned on lower
average cash balances.
Gain (loss) on disposition of discontinued operations represents the
gain on sale of the Analytical Standards division netted with the
net gain (loss) attributable to the Analytical Standards division,
and the cosmeceutical and toiletries product lines. The loss on
disposition of discontinued operations totaled $30,000 for the three
months ended June 30, 2003, compared with the gain on disposition of
discontinued operation of $49,000 in the three months ended June 30,
2002. The gain on disposition of discontinued operations totaled
$1,802,000 for the six months ended June 30, 2003, compared with
$145,000 in the six months ended June 30, 2002.
Capital Resources and Liquidity
- -------------------------------
Total assets as of June 30, 2003 were $15,909,000 compared with
$17,781,000 at December 31, 2002. Cash, cash equivalents and
marketable securities decreased by $2,046,000 to $12,075,000 at June
30, 2003 from $14,121,000 at December 31, 2002 due to cash used in
operations, partially offset by cash received for the sale of the
Analytical Standards division.
Net cash used in continuing operating activities for the six months
ended June 30, 2003 and 2002 was $3,718,000 and $2,664,000,
respectively. The increase in net cash used in operating activities
was due mainly to 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 by third
party licensees; our ability to enter into a joint venture agreement
for the APF112 project with a partner with whom we will share costs
and profits; 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 measured 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 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.
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150, "Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity" (FAS 150). FAS
150 establishes standards on the classification and measurement of
financial instruments with characteristics of both liabilities and
equity. FAS 150 will become effective for financial instruments
entered into or modified after May 31, 2003. The adoption of FAS
150 has not had a material effect on the Company's 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 4. Submission of Matters to a Vote of Security Holders
The Company's annual shareholder's meeting was held on May 28, 2003, at
which the following proposal was approved:
Proposal I: Election for the following directors:
Votes For Votes Withheld
--------- --------------
Paul Goddard
Chairman of the Board 19,168,558 164,229
Stephen Drury 19,169,243 163,544
Michael O'Connell 19,107,163 225,624
Peter Riepenhausen 19,125,278 207,509
Toby Rosenblatt 19,132,413 200,374
Gregory Turnbull 19,132,898 199,889
Dennis Winger 19,170,943 161,844
Robert Zerbe 19,174,543 158,244
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibit
Exhibit 31.1 Certification of Chief Executive Officer pursuant
to Rules 13A-15(e) and 15D-15(e) Promulgated under the Securities
Exchange Act of 1934 as amended.
Exhibit 31.2 Certification of Chief Financial Officer pursuant
to Rules 13A-15(e) and 15D-15(e) Promulgated under the Securities
Exchange Act of 1934 as amended.
Exhibit 32 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 May 5, 2003, the Company furnished a press release current report
on Form 8-K reporting the earnings for the first quarter of 2003.
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: August 11, 2003 By: /S/ Michael O'Connell
----------------- ----------------------------
Michael O'Connell
President and Chief
Executive Officer
Date: August 11, 2003 By: /S/ Gordon Sangster
----------------- ----------------------------
Gordon Sangster
Chief Financial Officer
Exhibit 33.1 SECTION 302 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 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be design under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, 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 and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 11, 2003 /s/ Michael O'Connell - --------------------- Michael O'Connell President and Chief Executive Officer
Exhibit 31.2 SECTION 302 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 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 report; 3. Based on my knowledge, the financial statements, and other financial information included in this 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 report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be design under our supervision, 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 report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, 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 and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 11, 2003 /s/ Gordon Sangster - ------------------- Gordon Sangster Chief Financial Officer
Exhibit 32 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 A signed original of this written statement required by Section 906 has been provided to A.P. Pharma, Inc. and will be retained by A.P. Pharma, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.