U.S. 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, 2006
[ ] 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
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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 a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See
definition of "accelerated filer and large accelerated filer" in
Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [ ]
---- ----
Non-accelerated filer [X ]
----
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act.)
Yes [ ] No [X ]
---- ----
At July 31, 2006, the number of outstanding shares of the Company's
common stock, par value $.01, was 25,371,281.
INDEX
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited):
Condensed Balance Sheets
June 30, 2006 and December 31, 2005
Condensed Statements of Operations
for the three and six months ended June 30, 2006 and 2005
Condensed Statements of Cash Flows
for the six months ended June 30, 2006 and 2005
Notes to Condensed 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 1A. RISK FACTORS
ITEM 4. Submission of Matters to a Vote of Security Holders
ITEM 6. Exhibits
Signatures
PART I. FINANCIAL INFORMATION
---------------------
ITEM 1. Financial Statements:
---------------------
A.P. PHARMA, INC.
- -----------------
CONDENSED BALANCE SHEETS
(in thousands)
- ------------------------
June 30, December 31,
2006 2005
------------- ------------
(Unaudited) (Note 1)
ASSETS
Current assets:
Cash and cash equivalents $ 5,943 $ 790
Marketable securities 15,729 5,019
Accounts receivable, net 75 1,519
Prepaid expenses and other 607 320
------ ------
Total current assets 22,354 7,648
Property and equipment, net 1,020 1,164
Other long-term assets 122 157
------ ------
Total assets $ 23,496 $ 8,969
====== ======
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 147 $ 614
Accrued clinical trial expenses 1,119 892
Accrued disposition costs 195 248
Other accrued expenses 840 1,012
------ ------
Total current liabilities 2,301 2,766
------ ------
Stockholders' equity:
Common stock 99,533 99,248
Accumulated deficit (78,280) (93,029)
Accumulated other comprehensive
loss (58) (16)
------ ------
Total stockholders' equity 21,195 6,203
------ ------
Total liabilities and stockholders'
equity $ 23,496 $ 8,969
====== ======
See accompanying notes to condensed financial statements.
A.P. PHARMA, INC.
- -----------------
CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
- ----------------------------------------------
(in thousands, except per share amounts)
- ---------------------------------------
Three Months Ended June 30, Six Months Ended June 30,
--------------------------- -------------------------
2006 2005 2006 2005
---- ---- ---- ----
Royalties $ -- $ 1,187 $ -- $ 2,469
Contract revenues -- 63 -- 142
------ ------ ------ ------
Total revenues -- 1,250 -- 2,611
Operating expenses:
Research & development 3,856 3,078 7,325 4,900
General & administrative 933 823 1,865 1,672
------ ------ ------ ------
Total operating expenses 4,789 3,901 9,190 6,572
------ ------ ------ ------
Operating loss (4,789) (2,651) (9,190) (3,961)
Interest income, net 280 74 542 146
Gain on sale of interest in royalties 8 -- 23,429 --
Other income (expense), net (15) 13 (5) 1
------ ------ ------ ------
Income (Loss) from continuing
operations (4,516) (2,564) 14,776 (3,814)
Loss from discontinued operations (34) (44) (27) (50)
------ ------ ------ ------
Net income (loss) $(4,550) $(2,608) $14,749 $(3,864)
====== ====== ====== ======
Basic earnings (loss) per share:
Income (Loss) from continuing
operations $ (0.18) $ (0.10) $ 0.59 $ (0.15)
====== ====== ====== ======
Net income (loss) $ (0.18) $ (0.10) $ 0.58 $ (0.15)
====== ====== ====== ======
Diluted earnings (loss) per share:
Income (Loss) from continuing
operations $ (0.18) $ (0.10) $ 0.58 $ (0.15)
====== ====== ====== ======
Net income (loss) $ (0.18) $ (0.10) $ 0.58 $ (0.15)
====== ====== ====== ======
Weighted average common shares
outstanding-basic 25,254 25,107 25,230 25,073
====== ====== ====== ======
Weighted average common shares
outstanding-diluted 25,254 25,107 25,379 25,073
====== ====== ====== ======
See accompanying notes to condensed financial statements.
A.P. PHARMA, INC.
- -----------------
CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
- ----------------------------------------------
(in thousands)
- --------------
Six months ended June 30,
-------------------------
2006 2005
---------- ----------
Cash flows from operating activities:
Net income (loss) $ 14,749 $(3,864)
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Loss from discontinued
operations 27 50
Loss (Gain) on sale of marketable
securities 1 (2)
Depreciation and amortization 200 190
SFAS123R stock compensation expense 167 --
Stock and stock option compensation
awards to non-employees 60 64
Restricted stock awards 19 8
Amortization of premium/discount
and accretion of marketable
securities (10) 42
Changes in operating assets and
liabilities:
Accounts receivable 1,407 68
Prepaid expenses and other
current assets (287) (45)
Other long-term assets 37 108
Accounts payable (467) (71)
Accrued clinical trial expenses 227 (412)
Other accrued expenses (172) (8)
------ ------
Net cash provided by (used in)
continuing operating activities 15,958 (3,872)
Net cash provided by (used in)
discontinued operations (45) 54
Cash flows from investing activities:
Purchases of property and equipment (55) (69)
Purchases of marketable securities (14,701) (6,814)
Maturities of marketable securities 1,800 7,793
Sales of marketable securities 2,158 1,695
------ ------
Net cash provided by (used in)
investing activities (10,798) 2,605
Cash flows from financing activities:
Proceeds from the exercise of stock
options 4 21
Proceeds from issuance of shares under
Employee Stock Purchase Plan 34 53
Proceeds from issuance of restricted
stock -- 1
------ ------
Net cash provided by financing
activities 38 75
Net increase (decrease) in cash and
cash equivalents 5,153 (1,138)
Cash and cash equivalents, beginning
of the period 790 3,110
------ ------
Cash and cash equivalents, end
of the period $ 5,943 $ 1,972
====== ======
See accompanying notes to condensed financial statements.
A.P. PHARMA, INC.
- -----------------
NOTES TO CONDENSED FINANCIAL STATEMENTS
- -----------------------------------
JUNE 30, 2006 and 2005 (UNAUDITED)
- -----------------------------------
(1) Basis of Presentation
---------------------
A.P. Pharma, Inc. (the "Company", "we", "our", or "us") is
developing patented polymer-based delivery systems to enhance
the safety and effectiveness of pharmaceutical compounds. New
products and technologies under development include bioerodible
polymers for injectable and implantable drug delivery. Projects
have also been conducted under feasibility and development
arrangements with pharmaceutical and biotechnology companies.
In the opinion of management, the accompanying unaudited
condensed financial statements have been prepared in accordance
with U.S. generally accepted accounting principles 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 U.S.
generally accepted accounting principles 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, 2006 are not necessarily
indicative of the results that may be expected for the year
ending December 31, 2006 or any other period. The condensed
balance sheet as of December 31, 2005 has been derived from the
audited financial statements as of that date but it does not
include all of the information and notes required by U.S.
generally accepted accounting principles for complete financial
statements. These condensed financial statements should be
read in conjunction with the financial statements and notes
thereto included in our Annual Report on Form 10-K for the year
ended December 31, 2005.
Summary of Critical Accounting Policies
- ---------------------------------------
Except for the adoption of FAS 123(R) (see Stock-Based
Compensation) we believe there have been no significant changes
in our critical accounting policies during the six months ended
June 30, 2006 compared to those previously disclosed in our
Annual Report on Form 10-K for the year ended December 31, 2005
filed with the U.S. Securities and Exchange Commission (SEC) on
March 31, 2006.
Use of Estimates
- ----------------
The preparation of our financial statements in conformity with
U.S. generally accepted accounting principles 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, accrued
clinical and preclinical expenses, valuation of stock-based
compensation and contingencies. Actual results could differ
materially from those estimates.
Revenue Recognition
- -------------------
Our revenue arrangements with multiple deliverables are divided
into separate units of accounting if certain criteria are met,
including whether the delivered element has stand-alone value
to the customer and whether there is objective and reliable
evidence of the fair value of the undelivered elements. The
consideration we receive is allocated among the separate units
based on their respective fair values, and the applicable
revenue recognition criteria are considered separately for each
of the separate units. Advance payments received in excess of
amounts earned are classified as deferred revenue until earned.
* Royalties
Royalties from licensees are based on third-party sales of
licensed products or technologies and recorded as earned in
accordance with contract terms when third-party results can
be reliably determined and collectibility is reasonably
assured.
Generally, 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.
* License Fees
Licensing agreements generally provide for periodic minimum
payments, royalties, and/or non-refundable license fees.
These licensing agreements typically require a non-
refundable license fee and allow partners to sell our
proprietary products in a defined field or territory for a
defined period. License agreements provide for the Company
to earn future revenue through royalty payments. These non-
refundable license fees are initially reported as deferred
revenues and recognized as revenues over the estimated life
of the product to which they relate as we have continuing
involvement with licensees until the related product is
discontinued or the related patents expire, whichever is
earlier. License fees received in connection with
arrangements where we have no continuing involvement are
recognized as license fees when the amounts are received or
when collectibility is assured, whichever is earlier. No
such fees were recorded during the six months ended June 30,
2006.
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 license fees
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
fees were recorded during the six months ended June 30,
2006.
* Contract Revenues
Contract revenues relate to research and development
arrangements that generally provide for the Company to
invoice research and development fees based on full-time
equivalent hours for each project. Revenues from these
arrangements are recognized as the related development costs
are incurred. These revenues approximate the costs
incurred. No such revenues were recorded during the six
months ended June 30, 2006.
Sale of Royalty Revenues
------------------------
In January 2006, we completed the sale of our rights to
royalties on sales of Retin-A Micro(R) and Carac(R) for up to
$30 million. We received proceeds of $25 million upon the
closing of the transaction and we are entitled to receive an
additional $5 million based on the satisfaction of certain
predetermined milestones. The royalty interest agreement was
entered into by the parties in January 2006, but the effective
date of the sale of the royalty interest was October 1, 2005.
The royalties recognized by the Company from October 1, 2005
through December 31, 2005 were accounted for as an offset
against the $25 million gain.
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 of three months or longer are classified as
marketable securities in the accompanying condensed balance
sheets. Marketable securities are classified as available for
sale at the time of purchase and carried at fair value.
Unrealized gains or losses, if any, are recorded as other
comprehensive income or loss in stockholders' equity.
Unrealized losses recorded as of June 30, 2006 were $58,000.
Accrued Disposition Costs
- -------------------------
Costs relating to disposal of discontinued operations are
reported as accrued disposition costs in the accompanying
condensed balance sheets. Accrued disposition costs include
severance costs and gross profit guarantees.
Concentrations of Credit Risk
- -----------------------------
Financial instruments that potentially subject us to
concentrations of credit risk consist primarily of cash
equivalents, short-term investments and trade accounts
receivable. We invest excess cash in a variety of high grade
short-term, interest-bearing securities. This diversification
of risk is consistent with our policy to ensure safety of
principal and to maintain liquidity.
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 have been derived from domestic customers.
Stock-Based Compensation
- ------------------------
Refer to Note 2 "Stock-Based Compensation" and Note 8
Stockholders' Equity in our 2005 Annual Report for further
information regarding our adoption of SFAS 123(R) and our
stock-based compensation arrangements, including related
disclosures required upon the adoption of SFAS 123(R). On
January 1, 2006, we adopted the provisions of Financial
Accounting Standards Board Statement No. 123R, "Share-Based
Payment" (SFAS 123R). SFAS 123R revised SFAS 123, "Accounting
for Stock-Based Compensation" and supersedes APB Opinion No.
25, "Accounting for Stock Issued to Employees." SFAS 123R
requires companies to measure and recognize compensation
expense for all employee share-based payments at fair value
over the service period underlying the arrangement. Therefore,
we are required to record the grant-date or purchase-date fair
value of stock options issued to employees and employee stock
purchases. We have recorded the compensation expense for stock
options issued to non-employees and restricted stock awards to
employees and directors. Compensation related to options
granted to non-employees is periodically remeasured as earned.
We adopted SFAS 123R using the "modified prospective" method,
whereby fair value of all previously-granted employee share-
based arrangements that remained unvested at January 1, 2006,
based on the grant-date value estimated in accordance with the
pro forma provisions of SFAS 123, and all grants made on or
after January 1, 2006, based on fair value estimated in
accordance with SFAS 123(R), have been included in our
determination of share-based compensation expense for the three
and six months ended June 30, 2006. We have not restated our
operating results for the three and six months ended June 30,
2005 to reflect charges for the fair value of share-based
arrangements.
The fair value of each employee and director grant of options
to purchase common stock is estimated on the date of the grant
using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants for the quarter
ended June 30, 2006: 1) risk-free interest rate of 5.05% for
stock options and 4.95% for employee stock purchase plan; 2)
expected dividend yield of 0% for both stock options and
employee stock purchase plan; 3) expected holding period of
6.25 years based on the simplified method provided in Staff
Accounting Bulletin No. 107 for "plain vanilla options" and
expected term of 1.25 years for employee stock purchase plan
based on weighted-average purchase period of the plan; 4)
expected volatility of 240% for stock options and 71% for
employee stock purchase plan based on the Company's historical
stock prices; and 5) an estimated forfeiture rate of 3.3% of
the options granted based on historical data.
The SFAS 123R share-based compensation expenses recorded for
awards granted under the stock option plans and employee stock
purchase plan were approximately $53,000 and $167,000, net of
estimated forfeitures, for the three and six months ended June
30, 2006. The share-based compensation expense of $71,000 and
$96,000 was recorded in research and development expense and
general and administrative expense for the six months ended
June 30, 2006, respectively. No tax benefit was recognized
related to share-based compensation expense since we have
incurred operating losses and we have established a full
valuation allowance to offset all the potential tax benefits
associated with our deferred tax assets.
During the quarter ended June 30, 2006 we granted 25,000 shares
of restricted stock awards to directors. The weighted average
grant-date fair value of shares of restricted stock awards
granted during the three months ended June 30, 2006 was $1.73.
As of June 30, 2006, we had a total of 235,000 shares of
restricted stock awards granted to employees and directors, of
which 135,000 shares have been vested. The compensation costs
charged as operating expenses for restricted stock awards were
$11,000 and $19,000 for the three and six months ended June 30,
2006, respectively, and $8,000 for the three and six months
ended June 30, 2005.
During the quarter ended June 30, 2006 we granted 50,000
options to directors to purchase common stock. The following
table summarizes option activity for the six months ended June
30, 2006:
Weighted
Weighted Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Shares Price Term Value
------ -------- ----------- ---------
Outstanding at January 1, 2006 2,165,966 $3.40
Granted 214,940 $1.62
Exercised (1,797) $1.55
Expired and forfeited (11,335) $1.66
---------
Outstanding at March 31, 2006 2,367,774 $3.25 5.5 $429,453
Granted 50,000 $1.74
Exercised (1,090) $1.05
Expired and forfeited (69,421) $9.10
---------
Outstanding at June 30, 2006 2,347,263 $3.04 5.5 $239,426
=========
Options exercisable at
June 30, 2006 1,903,025 $3.37 4.71 $155,429
As of June 30, 2006 there was approximately $555,521 of total
unrecognized compensation expense related to nonvested stock
options. This expense is expected to be recognized over a
weighted-average period of 1.33 years.
Prior to January 1, 2006, we accounted for employee stock-based
grants in accordance with SFAS No. 123, "Accounting for Stock-
Based Compensation," as amended by SFAS No. 148, "Accounting
for Stock-Based Compensation-Transition and Disclosure". We
have provided below the pro forma disclosures of the effect on
net loss and net loss per share as if SFAS No. 123 had been
applied in measuring compensation expense for the three and six
months ended June 30, 2005.
Three Months Six Months
Ended Ended
June 30, June 30,
------------ ----------
2005 2005
---- ----
Net loss, as reported $(2,608) $(3,864)
Deduct:
Stock-based employee
compensation expense
determined under FAS 123 (75) (159)
------ ------
Pro forma net loss $(2,683) $(4,023)
====== ======
Basic and diluted loss per
share, as reported $ (0.10) $ (0.15)
====== ======
Basic and diluted pro forma
loss per share $ (0.11) $ (0.16)
====== ======
Fair values of awards granted under the stock option plans and
employee stock purchase plan were estimated at grant date using
the Black-Scholes option pricing model. For pro forma
disclosure, the estimated fair value of the options is
amortized to expense over the vesting period of the options
using the straight line method. Forfeitures have been
accounted for in the period in which they occurred. The
multiple option approach is used to value the purchase rights
granted under the employee stock purchase plan. We used the
following assumptions for the three and six months ended June
30, 2005:
Three Months Six Months
Ended Ended
June 30, June 30,
------------ ----------
2005 2005
---- ----
Expected life in years (from
grant date):
Stock options 5 5
Employee stock purchase plan 1.5 - 2 1.5 - 2
Interest rate:
Stock options 3.7% 4%
Employee stock purchase plan 1.47 - 3.63% 1.47 - 3.63%
Volatility:
Stock options 78% 78%
Employee stock purchase plan 65 - 111% 65 - 111%
Expected dividend yield: 0% 0%
Reclassifications
- -----------------
Certain amounts in the prior quarter condensed financial
statements have been reclassified to conform with the current
presentation of the financial statements. Amortization of
premium/discount and accretion of marketable securities in the
prior quarter have been reclassified from investing activities
to operating activities on the Condensed Statements of Cash
Flows.
(2) Income (Loss) Per Share Information
-----------------------------------
Basic income (loss) per share is computed by dividing net
income (loss) by the weighted-average number of common shares
outstanding. Because the Company is in a net loss position for
the three months ended June 30, 2006 and 2005 and six months
ended June 30, 2005, diluted earnings per share is also
calculated using the weighted average number of common shares
outstanding and excludes the effects of options which are
antidilutive. For the six months ended June 30, 2006, diluted
earnings per share is calculated using the weighted average
number of common shares outstanding and other dilutive
securities.
The following is a reconciliation of the numerators and
denominators of the basic and diluted earnings per share
computations (in thousands):
Three Months Six Months
Ended Ended
June 30, June 30,
------------ ----------
2006 2005 2006 2005
---- ---- ---- ----
Numerator:
Net income (loss) $(4,550) $(2,608) $14,749 $(3,864)
====== ====== ====== ======
Denominator:
Weighted-average shares
outstanding used to compute
basic earnings per share 25,254 25,107 25,230 25,073
Effect of dilutive stock options,
employee stock purchase
and restricted stock awards -- -- 149 --
------ ------ ------ ------
Weighted-average shares
outstanding and dilutive
securities used to compute
diluted earnings per share 25,254 25,107 25,379 25,073
====== ====== ====== ======
(3) Comprehensive Income (Loss)
---------------------------
Comprehensive income (loss) for the three and six months ended
June 30, 2006 and 2005 consists of the following (in
thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
2006 2005 2006 2005
---- ---- ---- ----
Net income (loss) $(4,550) $(2,608) $14,749 $(3,864)
Unrealized gains (losses) on
available-for-sale securities (13) -- (42) 3
------ ------ ------ ------
Comprehensive income (loss) $(4,563) $(2,608) $14,707 $(3,861)
====== ====== ====== ======
(4) Stockholders' Equity
--------------------
During the six months ended June 30, 2006, 91,311 shares of
common stock were issued primarily through the exercise of
stock options, employee stock purchase, issuance of restricted
stock awards and for the payment of directors' fees.
(5) Discontinued Operations
-----------------------
We completed the sale of certain assets of our Analytical
Standards division as well as 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 Statements
of Operations.
Income (loss) from discontinued operations represents the
income (loss) attributable to our Analytical Standards division
that was sold to GFS Chemicals on February 13, 2003, and
changes in estimates for our cosmeceutical and toiletry
business that was sold to RP Scherer on July 25, 2000, as
follows (in thousands):
For the Three For the Six
Months Ended Months Ended
June 30, June 30,
------------- ------------
2006 2005 2006 2005
---- ---- ---- ----
Analytical Standards Division
- -----------------------------
Royalties earned in excess of
minimum amount recorded $ 16 $ 1 $ 23 $ 13
Cosmeceutical and Toiletry Business
- -----------------------------------
Change in estimates for gross
profit guarantees (50) (45) (50) (63)
---- ---- ---- ----
Total income (loss) from discontinued
operations $ (34) $ (44) $ (27) $ (50)
==== ==== ==== ====
Basic and diluted income (loss) per common share from
discontinued operations were less than $0.01 per share for the
six months ended June 30, 2006 and 2005, respectively.
Liabilities related to the discontinued operations at June 30,
2006 in the amount of $195,000 include severance costs and
accruals for gross profit guarantees. These liabilities are
reported as accrued disposition costs in the accompanying
condensed balance sheets.
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. We expect the annual Gross Profit Guaranty
payments to range from approximately $100,000 to $150,000 for
the remainder of the guaranty period. As the minimum amount of
Gross Profit Guaranty due is based on sales by RP Scherer and
can not be estimated, no accrual has been recorded relating to
sales in future periods.
Cash provided by (used in) discontinued operations primarily
relates to royalty payments received from GFS Chemicals for the
sale of certain products offset by a payment of $100,000
relating to the gross profit guaranty.
Below is a summary of activity for liabilities related to the
discontinued operations for the six months ended June 30, 2006
(in thousands):
Accrual at December 31, 2005 $248
Additional accrual for gross profit
guaranty 50
Payment for gross profit guaranty (100)
Payment under severance agreement (3)
---
Accrual at June 30, 2006 $195
===
ITEM 2. Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations (all dollar amounts rounded to the
------------------------------------------------------------
nearest thousand)
-----------------
FORWARD-LOOKING STATEMENTS
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. Except as may be required by law, we do not
intend to update any forward-looking statement to reflect events
after the date of this report.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of our financial statements in conformity with U.S.
generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in our
financial statements and accompanying notes. On an ongoing basis,
we evaluate our estimates including those related to the useful
lives of fixed assets, valuation allowances, impairment of assets,
accrued clinical and preclinical expenses, valuation of stock-based
compensation and contingencies. Actual results could differ
materially from those estimates.
Except for the adoption of SFAS 123(R) we believe there have been no
significant changes in our critical accounting policies and
estimates during the six months ended June 30, 2006 compared to
those previously disclosed in our Annual Report on Form 10-K for the
year ended December 31, 2005 filed with the SEC on March 31, 2006.
For a description of our critical accounting policies and estimates,
please refer to our Annual Report on Form 10-K for the year ended
December 31, 2005.
On January 1, 2006, we adopted the provisions of Financial
Accounting Standards Board Statement No. 123R, "Share-Based Payment"
(SFAS 123R). SFAS 123R revised SFAS 123, "Accounting for Stock-
Based Compensation" and supersedes APB Opinion No. 25, "Accounting
for Stock Issued to Employees." SFAS 123R requires companies to
measure and recognize compensation expense for all employee share-
based payments at fair value over the service period underlying the
arrangement. Therefore, we are required to record the grant-date or
purchase-date fair value of stock options issued to employees and
employee stock purchases. We have recorded the compensation
expenses for stock options issued to non-employees and restricted
stock awards to employees and directors. Compensation related to
options granted to non-employees is periodically remeasured as
earned. We adopted SFAS 123R using the "modified prospective"
method, whereby fair value of all previously-granted employee share-
based arrangements that remained unvested at January 1, 2006 and all
grants made on or after January 1, 2006 have been included in our
determination of share-based compensation expense for the three and
six months ended June 30, 2006. We have not restated our operating
results for the three and six months ended June 30, 2005 to reflect
charges for the fair value of share-based arrangements.
Results of Operations for the Three and Six Months Ended June 30,
- -----------------------------------------------------------------
2006 and 2005
- -------------
Our revenues have been derived principally from royalties and
contract revenues. Under strategic alliance arrangements entered
into with certain companies, we received non-refundable upfront
fees, milestone payments and royalties based on third party product
sales.
In January 2006, we completed the sale of our rights to royalties on
sales of Retin-A Micro(R) and Carac(R) for up to $30 million. We
received proceeds of $25 million upon the closing of the transaction
and we are entitled to receive an additional $5 million based on the
satisfaction of certain predetermined milestones. The royalty
interest agreement was entered into by the parties in January 2006,
but the effective date of the sale of the royalty interest was
October 1, 2005. The royalties recognized by the Company from
October 1, 2005 through December 31, 2005 were accounted for as an
offset against the $25 million gain. As a result of this
transaction, royalties for the second quarter of 2006 decreased to
$0 from $1,187,000 in the corresponding quarter of the prior year
and decreased in the first six months of 2006 to $0 from $2,469,000
in the first six months of 2005. We will not record additional
royalty revenue on sales of Retin-A Micro and Carac in future
periods.
Contract revenues, which are derived from work performed under
collaborative research and development arrangements, decreased from
$63,000 to $0 in the second quarter of 2006 and decreased from
$142,000 to $0 in the first six months of 2006. The amount of
contract revenues varies from period to period depending on the
level of activity requested of us by our collaborators. Therefore
we can not predict the amount of contract revenues in future
periods.
Research and development expense for the second quarter of 2006
increased by $778,000 from $3,078,000 to $3,856,000 due mainly to
expenditures in the second quarter on initiation of our Phase 3
trial program for APF530, our product candidate for the prevention
of chemotherapy-induced nausea and vomiting. Research and
development expense for the first six months of 2006 increased by
$2,425,000 from $4,900,000 to $7,325,000 due mainly to the
preparations and initiation of our Phase 3 trial program for APF530.
We expect research and development expense to increase in the second
half of 2006 as we conduct our Phase 3 trial program for APF530.
General and administrative expense increased for the second quarter
of 2006 by $110,000 from $823,000 to $933,000 and for the first six
months of 2006 by $193,000 from $1,672,000 to $1,865,000 due
primarily to increased outside consultant fees and share-based
compensation expense. We expect general and administrative expense
for the second half of 2006 to remain relatively constant with the
first half of the year.
With the adoption of SFAS 123R, we expect our non-cash operating
expenses for employee share-based compensation for the second half
of 2006 to remain relatively constant with the first half of the
year.
Interest income, net, increased for the second quarter of 2006 by
$206,000 to $280,000 from $74,000 and for the first six months of
2006 by $396,000 from $146,000 to $542,000 due to higher interest
rates earned on higher average cash and marketable securities
balances.
Loss from discontinued operations represents the net loss
attributable to the Analytical Standards division which was sold to
GFS Chemicals, Inc. in February 2003 and the cosmeceutical and
toiletries business which was sold to RP Scherer Corporation in July
2000. Net loss from discontinued operations totaled $34,000 for the
three months ended June 30, 2006, compared with a net loss of
$44,000 in the three months ended June 30, 2005. For the six months
ended June 30, 2006, net loss from discontinued operations decreased
by $23,000 to $27,000 from $50,000 in the year-ago period.
Capital Resources and Liquidity
- -------------------------------
Cash, cash equivalents and marketable securities increased by
$15,863,000 to $21,672,000 at June 30, 2006 from $5,809,000 at
December 31, 2005 due to the sale of our interest in royalties on
sales of Retin-A Micro and Carac in January 2006, partially offset
by cash used in operating activities.
Net cash provided by continuing operating activities for the six
months ended June 30, 2006 was $15,958,000, compared to net cash of
$3,872,000 used in continuing operating activities for the six
months ended June 30, 2005. The increase in net cash provided by
operating activities from 2005 to 2006 was mainly due to proceeds
from the sale of our interest in royalties in January 2006.
Net cash used in investing activities for the six months ended June
30, 2006 was $10,798,000 compared to net cash of $2,605,000 provided
by investing activities for the six months ended June 30, 2005. The
increase in the cash used in investing activities was primarily due
to the purchases of $14,701,000 of marketable securities.
Our future capital requirements will depend on numerous factors
including, among others, 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; potential acquisitions of technology, product candidates
or businesses; and the costs of defending or prosecuting any patent
opposition or litigation necessary to protect our proprietary
technology.
To date, we have financed our operations including technology and
product research and development, primarily through royalties
received on sales of Retin-A Micro and Carac, income from
collaborative research and development fees, the proceeds received
from the sale of our Analytical Standards division, the sale of our
cosmeceutical and toiletry business and the sale of our interest in
royalties on sales of Retin-A Micro(R) and Carac(R), the sale of
common stock in June 2004, and interest earned on short-term
investments. Our existing cash, cash equivalents and marketable
securities, together with interest income and other revenue-
producing activities including license and option fees and research
and development fees, are expected to be sufficient to meet our cash
needs at least through the first quarter of 2007. We are actively
seeking partners in the U.S. and abroad to take over the funding of
the Phase 3 clinical trial of APF530, and to commercialize the
product upon approval by the FDA. If we are unable to reach terms
with a partner, we will have to raise additional funds. We may be
unable to raise sufficient additional capital when we need it or to
raise capital on favorable terms. The sale of equity or convertible
debt securities in the future may be dilutive to our stockholders,
and debt financing arrangements may require us to pledge certain
assets and enter into covenants that could restrict certain business
activities or our ability to incur further indebtedness and may
contain other terms that are not favorable to us or our
stockholders. If we are unable to obtain adequate funds on
reasonable terms, we may be required to curtail operations
significantly or to obtain funds by entering into financing, supply
or collaboration agreements on unattractive terms.
Below is a summary of fixed payments related to certain contractual
obligations (in thousands). This table excludes amounts already
recorded on our condensed balance sheet as current liabilities at
June 30, 2006.
Less More
than 2 to 3 4 to 5 than
Total 1 year years years 5 years
----- ------ ------ ------ -------
Operating Leases $2,260 $479 $950 $831 $ --
===== === === === ===
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk
----------------------------------------------------------
Since December 31, 2005, there have been no material changes in the
Company's market risk exposure.
ITEM 4. Controls and Procedures
-----------------------
Evaluation of disclosure controls and procedures: We carried out an
evaluation, under the supervision and with the participation of our
management, including the Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operations
of our disclosure controls and procedures pursuant to Rule 13a-15(b)
of the Exchange Act. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that as of
June 30, 2006, the end of period covered by this report, our
disclosure controls and procedures were effective at the reasonable
assurance level to alert them in a timely manner to material
information relating to the Company required to be included in our
Exchange Act filings.
Changes in internal controls: During the three months ended June
30, 2006, there have been no significant changes in our internal
control over financial reporting that materially affected, or are
reasonably likely to materially affect, our internal control over
financial reporting.
PART II. OTHER INFORMATION
-----------------
ITEM 1A. Risk Factors
There have been no material changes to the risk factors set forth
in the "RISK FACTORS" section of our Annual Report on Form 10-K for the
fiscal year ended December 31, 2005.
ITEM 4. Submission of Matters to a Vote of Security Holders
The Company's annual shareholder's meeting was held on May 31, 2006, at
which the following proposal was approved.
Proposal I: Election of the following directors:
Votes For Votes Withheld
--------- --------------
Paul Goddard
Chairman of the Board 23,430,675 786,542
Michael O'Connell 23,392,675 824,542
Peter Riepenhausen 23,124,154 1,093,063
Toby Rosenblatt 20,146,647 4,070,570
Gregory Turnbull 23,165,414 1,051,803
Dennis Winger 23,423,305 793,912
Robert Zerbe 23,422,705 794,512
Proposal II: To amend the Company's 1997 Employee Stock Purchase Plan
to increase by 150,000 the number of shares of common stock reserved
for issuance under the Plan.
Votes For Votes Against Abstain Votes Withheld
--------- ------------- ------- --------------
9,167,295 1,087,990 109,837 13,852,095
Proposal III: To amend the Company's 2002 Equity Incentive Plan to
increase by 400,000 the number of shares of common stock reserved for
issuance under the Plan.
Votes For Votes Against Abstain Votes Withheld
--------- ------------- ------- --------------
8,789,814 1,438,733 136,575 13,852,095
Proposal IV: To ratify the appointment of Odenberg, Ullakko,
Muranishi & Co., LLP as A.P. Pharma'a independent registered public
accounting firm.
Votes For Votes Against Abstain
--------- ------------- -------
23,462,980 144,026 610,211
ITEM 6. Exhibits
Exhibit 31.1 Certification of Chief Executive Officer pursuant to
Rules 13A-14(a) Promulgated under the Securities Exchange Act of 1934
as amended.
Exhibit 31.2 Certification of Chief Financial Officer pursuant to
Rules 13A-14(a) 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.
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, 2006 By: /S/ Michael O'Connell
------------------ -----------------------
Michael O'Connell
President and Chief
Executive Officer
Date: August 11, 2006 By: /S/ Gordon Sangster
------------------ ---------------------
Gordon Sangster
Chief Financial Officer
Exhibit 31.1
SECTION 302 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 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 officers 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
designed under our supervision, to ensure that
material information relating to the registrant 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 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 officers 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:
a) All significant deficiencies and material weaknesses
in the design or operation of internal control over
financial reporting which could be 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, 2006
/s/ Michael O'Connell
- ---------------------
Michael O'Connell
President and Chief Executive Officer
Exhibit 31.2
SECTION 302 CERTIFICATIONS
--------------------------
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 officers 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
designed under our supervision, to ensure that
material information relating to the registrant 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 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 officers 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:
a) All significant deficiencies and material weaknesses
in the design or operation of internal control over
financial reporting which could be 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, 2006
/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 June 30, 2006 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 June 30, 2006 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
