10QSB 1 pp10qsb.txt SEPTEMBER 30, 2004 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________________ to ____________________ Commission file number 0-19724 PROTEIN POLYMER TECHNOLOGIES, INC. (Exact name of small business issuer as specified in its charter) Delaware 33-0311631 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 10655 Sorrento Valley Road, San Diego, CA 92121 (Address of principal executive offices) (858) 558-6064 (Issuer's telephone number) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 ----- ----- State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: As of November 10, 2004, 39,443,374 shares of common stock were outstanding. Transitional Small Business Disclosure Format (check one): Yes No X ----- ----- ================================================================================ 1 PROTEIN POLYMER TECHNOLOGIES, INC. FORM 10-QSB INDEX Page No. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements (unaudited) Condensed Balance Sheets - September 30, 2004 and December 31, 2003 ................3 Condensed Statements of Operations - For the three months and nine months ended September 30, 2004 and 2003 and the period July 6, 1988 (inception) to September 30,2004 .......................................4 Condensed Statements of Cash Flows - For the nine months ended September 30, 2004 and 2003 and the period July 6, 1988 (inception) to September 30,2004 .......................................5 Notes to Condensed Financial Statements ........................7 Item 2. Management's Discussion and Analysis or Plan of Operation .....11 Item 3. Controls and Procedures .......................................15 PART II. OTHER INFORMATION Item 6. Exhibits ......................................................16 Signatures ....................................................17 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Balance Sheets
September 30, December 31, 2004 2003 (Unaudited) (Audited) --------------------------------- Assets Current assets: Cash and cash equivalents $ 177,471 $ 1,085,314 Contracts receivable - 252,026 Current portion of rent receivable 60,000 184,527 Prepaid expenses 26,567 25,799 --------------------------------- Total current assets 264,038 1,547,666 Equipment and leasehold improvements, net 92,172 114,411 Deposits 30,479 29,679 Rent Receivable, net of current portion 119,527 - --------------------------------- $ 506,216 $ 1,691,756 ================================= Liabilities and stockholders' equity (deficit) Current liabilities: Accounts payable $ 250,553 $ 168,659 Notes payable 860,532 - Accrued expenses 166,878 162,609 Advance 147,883 - Deferred rent 6,028 24,111 --------------------------------- Total current liabilities 1,431,874 355,379 Stockholders' equity (deficit): Convertible Preferred Stock, $.01 par value, 5,000,000 shares authorized, 84,245 and 86,095 shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively - liquidation preference of $8,424,500 and $8,609,500 at September 30, 2004 and December 31, 2003, respectively 7,879,917 8,064,917 Common stock, $.01 par value, 120,000,000 shares authorized, 38,293,062 and 36,830,857 shares issued and outstanding at September 30, 2004 and December 31, 2003, respectively 382,942 368,319 Additional paid-in capital 40,896,073 40,376,185 Deficit accumulated during development stage (50,084,590) (47,473,044) --------------------------------- Total stockholders' equity (deficit) (925,658) 1,336,377 --------------------------------- $ 506,216 $ 1,691,756 =================================
See accompanying notes. 3 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Statements of Operations (unaudited)
For the period July 6, 1988 Three months ended Nine months ended (inception) to September 30, September 30, Sept. 30, 2004 2003 2004 2003 2004 ---------------------------------------------------------------------------------------- Revenues: Contract revenue $ 19,523 $ 95,796 $ 407,939 $ 1,289,475 $ 11,263,940 Interest income 273 5,378 3,098 16,224 1,269,948 Product and other income - - 6 - 694,785 ---------------------------------------------------------------------------------------- Total revenues 19,796 101,174 411,043 1,305,699 13,228,673 Expenses: Research and development 530,056 603,850 1,756,610 1,781,802 36,502,358 Selling, general and administrative 461,332 338,871 1,265,979 1,034,697 21,489,274 ---------------------------------------------------------------------------------------- Total expenses 991,388 942,721 3,022,589 2,816,499 57,991,632 ---------------------------------------------------------------------------------------- Net loss (971,592) (841,547) (2,611,546) (1,510,800) (44,762,959) Undeclared, imputed and/or paid dividends on preferred stock 69,980 69,980 207,659 1,580,906 7,931,116 ---------------------------------------------------------------------------------------- Net loss applicable to common shareholders $ (1,041,572) $ (911,527) $ (2,819,205) $ (3,091,706) $(52,694,075) ======================================================================================== Basic and diluted net loss per common share $ (0.03) $ (0.02) $ (0.07) $ (0.09) ===================================================================== Shares used in computing basic and diluted net loss per common share 38,113,618 36,720,701 37,840,496 33,542,290 =====================================================================
See accompanying notes. 4 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Statements of Cash Flows (unaudited)
For the period July 6, 1988 Nine months ended (inception) to September 30, Sept. 30, 2004 2003 2004 ---------------------------------------------------- Operating activities Net loss $ (2,611,546) $ (1,510,800) $(44,762,959) Adjustments to reconcile net loss to net cash used for operating activities: Stock issued for compensation and interest - - 472,676 Depreciation and amortization 23,757 47,487 2,438,717 Amortization of discount on note payable 73,966 - 73,966 Write-off of purchased technology - - 503,500 Changes in assets and liabilities: Contract receivable 252,026 (95,796) 252,026 Other current assets 123,759 (151,962) (338,593) Other non-current assets (120,327) (800) (150,006) Accounts payable 81,894 (157,042) 250,553 Accrued employee benefits (7,383) 20,443 125,008 Other accrued expenses 11,652 (28,528) 41,870 Advance 147,883 - 147,883 Deferred rent (18,083) (18,083) 6,028 ---------------------------------------------------- Net cash used for operating activities (2,042,402) (1,895,081) (40,939,331) Investing activities Purchase of technology - - (570,000) Purchase of equipment and improvements (1,517) (79,946) (2,088,861) Purchases of short-term investments - - (16,161,667) Sales of short-term investments - - 16,161,667 -------------------------------------------------- Net cash used for investing activities $ (1,517) $ (79,946) $ (2,658,861)
See accompanying notes. 5 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Statements of Cash Flows (unaudited)
For the period July 6, 1988 Nine months ended (inception) to September 30, Sept. 30, 2004 2003 2004 -------------------------------------------------------- Financing activities Net proceeds from exercise of options and warrants, and sale of common stock $ 236,076 $ 361,762 $ 23,456,335 Net proceeds from issuance and conversion of preferred stock - 2,889,650 18,398,068 Net proceeds from convertible notes and detachable warrants - - 1,068,457 Payment on capital lease obligations - - (288,770) Payment on note payable - - (242,750) Proceeds from notes payable 900,000 - 1,384,323 -------------------------------------------------------- Net cash provided by financing activities 1,136,076 3,251,412 43,775,663 -------------------------------------------------------- Net increase (decrease) in cash and cash equivalents (907,843) 1,276,385 177,471 Cash and cash equivalents at beginning of period 1,085,314 733,978 - -------------------------------------------------------- Cash and cash equivalents at end of period $ 177,471 $ 2,010,363 $ 177,471 ======================================================== Supplemental disclosures of cash flow information Equipment purchased by capital leases $ - $ - $ 288,772 Interest paid 86,132 - 233,665 Imputed dividend on Series E stock - - 3,266,250 Imputed dividend on Series I stock - 1,373,247 1,373,247 Conversion of Series D preferred stock to common stock - - 2,142,332 Conversion of Series E preferred stock to common stock - 1,921,513 5,277,813 Conversion of Series G preferred stock to common stock - 15,000 585,000 Conversion of Series I preferred stock to common stock - 105,000 155,000 Series D stock issued for Series C stock - - 2,073,925 Series C dividends paid with Series D stock - - 253,875 Series D dividends paid with common stock - - 422,341
See accompanying notes. 6 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Notes to Condensed Financial Statements (unaudited) Note 1. Basis of Presentation The condensed financial statements of Protein Polymer Technologies, Inc. (the "Company") for the three and nine months ended September 30, 2004 and 2003 are unaudited. These financial statements reflect all adjustments, consisting of only normal recurring adjustments which, in the opinion of management, are necessary to state fairly the financial position at September 30, 2004 and the results of operations for the three and nine months ended September 30, 2004 and 2003. The results of operations for the three and nine months ended September 30, 2004 are not necessarily indicative of the results to be expected for the year ended December 31, 2004. For more complete financial information, these financial statements and the notes thereto should be read in conjunction with the audited financial statements included in our Annual Report on Form 10-KSB for the year ended December 31, 2003, filed with the Securities and Exchange Commission. Accounting for Stock-Based Compensation SFAS No. 123, "Accounting for Stock-Based Compensation", encourages but does not require companies to record compensation cost for stock-based employee compensation plans at fair value. The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. Had compensation cost for the Company's stock option awards been determined based upon the fair value at the grant date and recognized on a straight-line basis over the related vesting period, in accordance with the provisions of SFAS No. 123, the Company's net loss and earnings per share would have been reduced to the proforma amount indicated below:
For the three months For the nine months Ended September 30, Ended September 30, 2004 2003 2004 2003 ---- ---- ---- ---- Net loss applicable to common shareholders, as reported $ (1,041,572) $(911,527) $(2,819,205) $(3,091,706) Deduct: total stock-based employee compensation expense determined under fair value based methods for all options, net of related tax effects (440,073) (31,555) (1,828,433) (108,218) Pro forma net loss $ (601,499) $(943,082) $ (990,772) $(3,199,924) Earnings per share: Basic - as reported 0.03 0.02 0.07 0.09 Basic - pro forma 0.02 0.03 0.03 0.10
Note 2. Revenue and Expense Recognition Research and development contract revenues are recorded as earned in accordance with the terms and performance requirements of the contracts. If the research and development activities are not successful, we are not obligated to refund payments previously received. Fees from the sale or license of technology are recognized on a straight-line basis over the term required to complete the transfer of technology or the substantial satisfaction of any performance related responsibilities. License fee payments received in advance of amounts earned are recorded as deferred revenue. Milestone payments are recorded as revenue based upon the completion of certain contract specified events that measure progress toward completion 7 under certain long-term contracts. Royalty revenue related to licensed technology is recorded when earned and in accordance with the terms of the license agreement. Research and development costs are expensed as incurred. 8 Note 3. Rent Receivable The Company subleases 6,183 square feet of its office and research facilities under a month to month arrangement for $13,000 per month plus utilities. From December 2002 until July 2004, the sublessee was unable to make monthly rental payments due to a lack of funding. In August 2004 the sublessee resumed making rental payments and as of September 2004 an additional $5000 per month is being paid for credit against previous rental obligations. Obligations under the sublease are secured by certain listed property and equipment of the sublessee. At September 30, 2004 the amount past due from the sub-lessee is $279,000. Note 4. Exercise and Exchange of Warrants In March 2004, certain holders of warrants exercised their warrants to purchase common stock. These warrants were due to expire at the end of March 2004. The exercise prices of such warrants were $0.40 and $0.55 per share. As an incentive to exercise the warrant early the Company offered to reduce the exercise price of the warrants to $0.25 per share and offered each holder the issuance of a new warrant, for a similar number of shares, at an exercise price of $0.55 per share. As a result, the Company raised $246,250. The newly issued warrants will expire on the last day of January 2005. Note 5. Notes Payable On July 2, 2004, the Company issued notes with detachable warrants payable to several of its current shareholders in exchange for $150,000 in cash. The notes have a two-month term with interest at a rate of 10% per annum. The detachable warrants were for the purchase of 60,000 shares of the Company's common stock at $0.37 per share. The warrants have a term of three years and become exercisable upon issue. At September 30, 2004 the notes have not been repaid. The Company allocated the investment proceeds to the debt and warrants based on their relative fair values. The relative fair value of the warrants was determined to be $13,730, which was recorded as debt discount, a reduction of the carrying amount of the debt. This amount is being amortized to interest expense over the term of the debt. The fair value of the warrants was based on the Black-Scholes model. The Black-Scholes calculation incorporated the following assumptions: 0% dividend yield, 138% volatility, 1.98% average risk-free interest rate, a three-year life and an underlying common stock value of $0.33 per share. For the nine months ended September 30, 2004, debt discount of $13,730 was amortized to interest expense. On August 2, 2004, the Company issued a note with detachable warrants payable to one of its current shareholders in exchange for $250,000 in cash. The note has a two-month term with interest at a rate of 10% per annum. The detachable warrants were for the purchase of 100,000 shares of the Company's common stock at $0.37 per share. The warrants have a term of three years and become exercisable upon issue. At September 30, 2004 the note has not been repaid. The Company allocated the investment proceeds to the debt and warrants based on their relative fair values. The relative fair value of the warrants was determined to be $23,995, which was recorded as debt discount, a reduction of the carrying amount of the debt. This amount is being amortized to interest expense over the term of the debt. The fair value of the warrants was based on the Black-Scholes model. The Black-Scholes calculation incorporated the following assumptions: 0% dividend yield, 133% volatility, 1.98% average risk-free interest rate, a three-year life and an underlying common stock value of $0.35 per share. For the nine months ended September 30, 2004, debt discount of $23,156 was amortized to interest expense. On August 19, 2004, the Company issued a note with detachable warrants payable to one of its current shareholders in exchange for $250,000 in cash. The note has a two-month term with interest at a rate of 10% per annum. The detachable warrants were for the purchase of 100,000 shares of the Company's common stock at $0.45 per share. The warrants have a term of three years and become exercisable upon issue. As of September 30, 2004 the note has not been repaid. The Company allocated the investment proceeds to the debt and warrants based on their relative fair values. The relative fair value of the warrants was determined to be $33,802, which was recorded as debt discount, a reduction of the carrying amount of the debt. This amount is being amortized to interest expense over the term of the debt. The fair value of the warrants was based on the Black-Scholes model. The Black-Scholes calculation incorporated the following assumptions: 0% dividend yield, 140% volatility, 1.98% average risk-free interest rate, a three-year life and an underlying common stock value of $0.52 per share. For the nine months ended September 30, 2004, debt discount of $23,098 was amortized to interest expense. On September 9, 2004, the Company issued a note with detachable warrants payable to one of its current shareholders in exchange for $250,000 in cash. The note has a two-month term with interest at a rate of 10% per annum. The detachable warrants were for the purchase of 100,000 shares of the Company's common stock at $0.45 per share. The warrants have a term of three years and become exercisable upon issue. As of September 30, 2004 the note has not been repaid. The Company 9 allocated the investment proceeds to the debt and warrants based on their relative fair values. The relative fair value of the warrants was determined to be $41,949, which was recorded as debt discount, a reduction of the carrying amount of the debt. This amount is being amortized to interest expense over the term of the debt. The fair value of the warrants was based on the Black-Scholes model. The Black-Scholes calculation incorporated the following assumptions: 0% dividend yield, 141% volatility, 1.98% average risk-free interest rate, a three-year life and an underlying common stock value of $0.67 per share. For the nine months ended September 30, 2004, debt discount of $13,983 was amortized to interest expense. Note 6. Subsequent Events In October 2004, certain holders of warrants issued in conjunction with sale of Series I Convertible Preferred Stock of the Company exercised their warrants to purchase common stock. Certain of the Series I warrants were due to expire at the end of September 2004, but the Company extended the exercise period of these Series I warrants until the end of October 2004. The exercise prices of the Series I warrants were between $0.58 and $1.73 per share. As an incentive to exercise the warrants early, the Company reduced the exercise price to $0.50 per share for all of the Series I warrants to the extent such warrants were exercised on or before October 29, 2004. As a result, the Company raised $545,156. Note 7. Liquidity The Company's continued existence is dependent upon its ability to resolve its liquidity problems, principally by obtaining additional debt and equity capital. While pursuing additional debt and equity funding, the Company must continue to operate on limited capital. Management believes our existing available cash, cash commitments, and cash equivalents as of November 13, 2004, plus contractual amounts receivable, is sufficient to meet our anticipated capital requirements until December 2004. Substantial additional capital resources will be required to fund future expenditures related to our research, development, clinical trials, and product marketing activities. If adequate funds are not available, we will be required to significantly curtail our operating plans and may have to sell or license out significant portions of our technology or potential products, or cease operations. (See Management Discussion and Analysis: Liquidity and Capital Resources) 10 Item 2. Management's Discussion and Analysis or Plan of Operation Forward Looking Statements Certain statements contained or incorporated by reference in this Quarterly Report on Form 10-QSB constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements of the company, or industry results, to be materially different from any future results, performance or achievements expressed or implied by forward-looking statements. Such risks and uncertainties include, among others, history of operating losses, raising adequate capital for continuing operations, early stage of product development, scientific and technical uncertainties, competitive products and approaches, reliance upon collaborative partnership agreements and funding, regulatory testing and approvals, patent protection uncertainties and manufacturing scale-up and required qualifications. While these statements represent management's current judgment and expectations for the company, such risks and uncertainties could cause actual results to differ materially from any future results suggested herein. The company undertakes no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date hereof. General Overview Incorporated in 1988, Protein Polymer Technologies, Inc., a Delaware corporation with corporate offices and laboratories located in San Diego, California, is a development-stage biotechnology company engaged in the research, development, production and clinical testing of medical products based on its proprietary protein-based biomaterials and tissue engineering technology. Since 1992, we have focused primarily on developing technology and products to be used in the surgical repair, augmentation, and regeneration of tissue; surgical adhesives and sealants; soft tissue augmentation products; matrices for wound healing and tissue engineering; and drug delivery formulations. We have been unprofitable to date, and as of September 30, 2004 had an accumulated deficit of $50,085,000. Protein polymers are synthetic proteins created "from scratch" through chemical DNA (gene) synthesis, and produced in quantity by traditional large-scale microbial fermentation methods. As a result, protein polymers contain no human or animal components that could potentially transmit or cause disease. Due to their synthetic design, protein polymers are capable of combining the biological functionality of natural proteins with the chemical functionality and exceptional physical properties of synthetic polymers. A common goal is to develop materials that beneficially interact with human cells, enabling cell growth and the regeneration of tissues with improved outcomes as compared to current products and practices. Our product candidates for surgical repair, augmentation and regeneration of human tissues are in various stages of research and development. The more advanced programs are bulking agents for soft tissue augmentation, particularly for use in dermal tissue for cosmetic and reconstructive procedures and in urethral tissue for the treatment of female stress incontinence, and tissue adhesive formulations for the repair of spinal discs damaged due to injury or aging and as surgical sealants for use in pulmonary, cardiovascular and abdominal surgical procedures. We currently are devoting the majority of our resources to the development and registration of these products. Because of our technology's breadth of commercial opportunity, we are pursuing multiple routes for commercial development. Currently, we independently are developing the incontinence and the dermal augmentation products, which share similar technology and product characteristics. We have established a comprehensive license and development agreement with Genencor International for the use of our biomaterials and technology to develop, manufacture and commercialize products for industrial markets. Genencor International is one of the world's largest manufacturers of industrial enzymes and other biologically derived products. Through this arrangement, we will receive milestone payments, and eventually royalties on the sale of products. For development and commercialization of our spinal disc repair product, we joined with Windamere Venture Partners to establish a new company, Spine Wave, Inc., that provides us with both near term research and development support and eventually royalties on the sale of licensed products. Except for the industrial products, we have retained manufacturing rights. Significant Collaborative Agreements Our collaborative development agreements generally contain provision for specific payments for defined activities, services, royalties on the sales of developed products, and/or the accomplishment of performance benchmarks. These agreements also may provide for equity investments or other financial incentives. Technology license agreements usually are associated with collaborative development agreements, but occasionally we will agree to a license without an accompanying development agreement. 11 Spine Wave ---------- In April 2001, we entered into agreements with Spine Wave, Inc., to develop and commercialize an injectable protein-based formulation for the repair of spinal discs damaged either by injury or aging. As consideration for entering into an exclusive, worldwide license agreement with Spine Wave, we received one million shares of the founding common stock in Spine Wave, valued initially at $10,000. The shares of founding common stock were subject to a vesting schedule; however, Spine Wave's right to repurchase unvested shares terminated in 2002 upon their merger with VERTx, Inc. Royalties from the sale or sublicensing of licensed products will be determined in the future based on the gross margin (sales revenue less the cost of goods) realized by Spine Wave from the sale of the products. In connection with the license agreement, we entered into a separate supply and services agreement to provide Spine Wave with a variety of research and development services, and to supply materials to Spine Wave for pre-clinical and clinical testing. Spine Wave, in return, agreed to reimburse us for both our direct costs and the associated overhead costs for the services provided. During 2001, we recognized contract revenues of $450,000 related to activities performed under the collaborative agreement. In March 2002, we executed additional agreements with Spine Wave that expanded our contractual research and development relationship, and that offered us additional equity incentives in the form of Spine Wave common stock and warrants. Under the amended supply and services agreement, we, on behalf of Spine Wave, are proceeding with pre-clinical safety and performance studies of a product for spinal disc repair to support Spine Wave's filing of an investigational device exemption with the FDA to obtain approval to initiate human clinical testing. During the subsequent period leading to regulatory marketing approval, our contractual responsibilities include the supply of product to be used in clinical testing and preparation for commercial manufacturing operations. Research and development services performed for Spine Wave are reimbursed including both direct costs and associated overhead costs. Spine Wave is responsible for clinical testing, regulatory approvals, and commercialization. For the quarter ended September 30, 2004 and for the period of project inception to date we received $20,000 and $4,869,000, respectively, in contract revenue from Spine Wave which represents the reimbursement of direct costs plus overhead costs allocated to the research and development resources used in performing the collaborative activities. Additional equity incentives offered in conjunction with the expanded supply and services agreement of March 17, 2002 consist of a three year warrant to purchase 1,000,000 shares of Spine Wave common stock at an exercise price of $0.50 per share (recently issued Spine Wave preferred stock was priced at $0.55 per share), and 400,000 shares of common stock valued at $0.05 per share subject to repurchase at cost until each of three performance goals is achieved. The performance goals consist of: (i) completion of certain studies for filing an investigational device exemption application (100,000 shares); (ii) completion of additional studies for filing of the investigational device exemption and provision of inventory for the pilot clinical study (150,000 shares); and (iii) completion of certain manufacturing arrangements, and production of certain quantities of product (150,000 shares). As of September 30, 2004, the first two of the three performance goals had been met. In October 2003, we executed a second amendment to the supply and services agreement with Spine Wave. The amendment, effective for one year, extended Spine Wave's right to certain research and development services, and further defined the cost basis for reimbursement of services provided by us to Spine Wave. License Agreements Our license agreements usually include provision for up-front compensation and eventual royalties on the sale of licensed products. Terms of license agreements typically commence as of the date executed and continue for a period of the greater of twenty (20) years from execution date or the date upon which the last of the patented technology under license expires. Femcare, Ltd. ------------- In January 2000, we entered into a strategic alliance agreement with Femcare, Ltd. ("Femcare"), for the commercialization in Europe and Australia of our product for treatment of stress urinary incontinence. Under the terms of the license agreement, Femcare paid a $1 million non-refundable license fee in exchange for the patented technology and a three year commitment from us to provide support to Femcare in its efforts to clinically test our products in Great Britain and to achieve European regulatory approval. We have not incurred any research and development costs associated with our support efforts to date. As a result of the arrangement, we recognized approximately $333,000 in deferred license fee revenue for 2000 and 2001, and 2002. 12 Genencor International, Inc. ---------------------------- In December 2000, we signed a broad-based, worldwide exclusive license agreement with Genencor International, Inc. ("Genencor") enabling Genencor to potentially develop a wide variety of new products for industrial markets. In October 2002, the license agreement was amended to provide Genencor with an additional one-year option to initiate development of products in the field of non-medical personal care. As a result of the agreements, Genencor may use our patented protein polymer design and production technology, in combination with Genencor's extensive gene expression, protein design, and large-scale manufacturing technology, to design and develop new products with improved performance properties for defined industrial fields and the field of non-medical personal care products. In return for the licensed rights, Genencor paid us an up-front license fee of $750,000, and will pay royalties on the sale of any products commercialized by Genencor under the agreement. The licensed technology was transferred to Genencor upon execution of the license agreement without any further product development obligation on our part. Future royalties on the net sales of products incorporating the technology under license and developed by Genencor will be calculated based on a royalty rate to be determined at a later date. In addition, we are entitled to receive up to $5 million in milestone payments associated with Genencor's achievement of various industrial product development milestones incorporating the licensed technology. There is no limitation on the amount of milestone payments we can receive from Genencor for Genencor's product development in the field of non-medical personal care products. In December 2002 we received a license milestone payment of $250,000 from Genencor for Genencor's initiation of a product development project based on technology licensed from us. In connection with the license agreement, Genencor was issued two warrants, each convertible by formula into $500,000 of our common stock. The first warrant could be converted into 442,478 shares at an exercise price of $1.13 per share. The second warrant could be converted into 1,250,000 shares at an exercise price of $0.40 per share. As a result of the collaboration, in 2000 we recognized $750,000 in license fee revenue (less the issuance of warrants to purchase $1 million of our common stock valued at $319,000). The agreement terminates on the date of expiration of the last remaining patent. Research and Development We currently maintain detailed project costs (direct costs plus allocated overhead) for contractual research and development services. However, we do not maintain cost breakdowns for our internal research and development projects due to the extensive degree of overlap between our tissue augmentation projects such as common manufacturing, quality control, and developmental product testing. Our tissue augmentation product for use in cosmetic and reconstructive surgery applications is in pilot human clinical testing. In February 2004, the Food and Drug Administration approved a supplement to our Investigational Device Exemption that simplifies the protocol for the pilot clinical trials and expands the number of patients that can be included. We are implementing improvements in the product manufacturing process to complete the pilot study. We now project beginning pivotal clinical testing during 2005. We expect these trials, including patient follow-up, will take approximately 15 months, and the subsequent Food and Drug Administration review of our pre-market approval submission may take up to an additional 12 months. Assuming this schedule is met and the product is approved, U.S. sales are projected to begin in 2007. The pivotal clinical trial is estimated to cost approximately $2.2 million. This product is based on the same manufacturing technology as our product for the treatment of female stress urinary incontinence, and thus, the incremental cost of manufacturing development is estimated to be approximately $0.1 million. Our product for the treatment of female stress urinary incontinence is in pilot human clinical testing. We project beginning pivotal clinical testing during 2005. We expect these trials, including patient follow-up, will take approximately 24 months, and the subsequent Food and Drug Administration review of our pre-market approval submission may take an additional 12 months. Assuming this schedule is met and the product is approved, U.S. sales of the product are projected to begin in 2008. Commercial manufacturing process development and completion of the clinical trials are estimated to cost approximately $10 million. Our surgical sealant product for use in lung, bowel, and cardiovascular surgery is currently in pre-clinical testing. Assuming the pre-clinical testing results continue to be favorable, we project filing in 2005 an Investigational Device Exemption application with the Food and Drug Administration requesting permission to begin human clinical testing. Until the Investigational Device Exemption is approved by the Food and Drug Administration, we cannot predict the timing of the completion of human clinical studies, but typically such trials would take approximately two years to complete. 13 We currently do not have sufficient cash to complete the development of these products. We anticipate obtaining the necessary cash either by additional equity financings, or by sharing the cost of development with potential marketing partners, or a combination of both methods. If we are unable to obtain the necessary cash, it will have a material adverse effect on us. Our spinal disc repair product being developed for our licensee, Spine Wave, is awaiting approval to begin human clinical testing in the United States and has received approval to begin clinical testing in Europe. The timing of this project is under the control of Spine Wave. Under our contract with Spine Wave, we are responsible for development of the formulated product, its manufacturing process, and product production for both clinical trials. Spine Wave is responsible for funding all expenses associated with these activities. Contract revenue received from Spine Wave is approximately equal to our cost (direct project costs plus allocated laboratory and corporate overhead expenses) of the work performed. Total research and development costs plus certain administrative costs, for the three month period ended September 30, 2004 and for the period of project inception to date are approximately $20,000 and $4,849,000 respectively. To the extent sufficient capital resources are available, we continue to research the use of our patented technology to produce proteins of unique design for other tissue repair and medical device applications, principally for use in supporting the wound healing process, including devices based on tissue engineering, and in drug delivery devices. Our strategy for most of our programs is to enter into collaborative development agreements with product marketing and distribution companies. Although these relationships, to the extent any are consummated, may provide significant near-term revenues through up-front licensing fees, research and development payments and milestone payments, we expect to continue incurring operating losses for the next several years. Results of Operations We recognized $20,000 in contract and licensing revenue for the three months ended September 30, 2004 as compared to $96,000 for the three months ended September 30, 2003. For the nine-month period ended September 30, 2004, we recognized $408,000 in contract and licensing income as compared to $1,289,000 for the same period in 2003. The contract and licensing revenue for the three and nine months ended September 30, 2004 was for research and development services for Spine Wave associated with the development of an injectable spinal disc nucleus product for the treatment of lower back pain. The decrease in contract revenue in 2004 is due to a reduction in preclinical testing and production of the injectable spinal disc nucleus product. During the period, Spine Wave focused on regulatory filings including an Investigational Device exemption with the Food and Drug Administration requesting permission to initiate human clinical trials in the United States, and similar foreign filings requesting permission to begin clinical trials in Europe. Interest income was $300 and $3,000 respectively for the three months and nine months ended September 30, 2004 versus $5,000 and $16,000 respectively for the same periods in 2003. Research and development expenses for the three and nine month periods ended September 30, 2004 were $530,000 and $1,757,000 respectively, as compared to $604,000 and $1,782,000 respectively for the same periods in 2003. We expect, in general, that our research and development, human clinical testing and manufacturing expenses will increase over time if our incontinence and dermal products, and other products in development, successfully progress and additional capital is obtained. Selling, general and administrative expenses for the three and nine month periods ended September 30, 2004 were $461,000 and $1,266,000, respectively as compared to $339,000 and $1,035,000 respectively for the same periods in 2003. Increased health care and product liability insurance were the main contributors to the increased expense over the nine month period in 2004 as compared to 2003. We expect that our selling, general and administrative expenses will remain largely unchanged in the near term, but may increase in the future as support for our research and development and manufacturing efforts require additional resources and to the extent additional capital is obtained. For the three months ended September 30, 2004, we recorded a net loss applicable to common shareholders of $1,042,000 or $0.03 per share, as compared to a loss of $912,000, or $0.02 per share for the same period in 2003. For the nine months ended September 30, 2004, we recorded a net loss applicable to common shareholders of $2,819,000 or $0.07 per share, as compared to a loss of $3,092,000, or $0.09 per share for the same period in 2003. Included in the net loss per share for the nine months ended September 30, 2003 is a one-time, non-cash "imputed dividend" of $1,373,000 from the sale and issuance of our Series I Preferred Stock. The net loss and the net loss per share also included in each of the three month and the nine month periods of 2004 and 2003, $70,000 and $208,000 for undeclared dividends related to our preferred stock. In general, there can be significant fluctuation in revenue from quarter to quarter due to variability in outside contract and licensing payments. In general, we expect to incur increasing operating losses in the future (to the extent additional capital is obtained), due primarily to increases in our soft tissue augmentation program's development, manufacturing and business development activities, and the continuation of our tissue adhesive and sealant product development activities. Our financial 14 results depend on our ability to establish strategic alliances and generate contract revenues, increased research, development and manufacturing efforts, pre-clinical and clinical product testing and commercialization expenditures, expenses incurred for regulatory compliance and patent prosecution, and other factors. To date we believe that inflation and changing prices have had only a modest effect on our continuing operations. However, increases in utility costs, insurance, and employee benefits may have a greater impact in the future. Liquidity and Capital Resources As of September 30, 2004, we had cash, cash equivalents and short-term investments totaling $177,000 as compared to $1,085,000 at December 31, 2003. As of September 30, 2004, we had a negative working capital of $1,168,000, compared to a working capital of $1,192,000 at December 31, 2003. As of September 30, 2004, we did not have any off balance sheet financing activities and did not have any special purpose entities. During the three months ending September 30, 2004, we received $900,000 from existing shareholders in return for promissory notes and warrants to purchase up to 360,000 shares of common stock. The promissory notes can be redeemed two months following issuance and carry an interest rate of 10% per annum. In addition, three-year warrants to purchase up to 360,000 shares of common stock exercisable at exercise prices ranging from $0.37 to $0.45 per share were issued in conjunction with the promissory notes. We had no long-term capital lease obligations as of September 30, 2004 or December 31, 2003. For the three month period ended September 30, 2004, our cash expenditures for capital equipment and leasehold improvements totaled $1,500, compared with $80,000 for the same period in the prior year. To the extent capital is available, we anticipate that these expenditures will be increased in 2004 for laboratory renovations and additional equipment required to meet the FDA's applicable Quality System regulation as we scale up our manufacturing operations to meet product requirements for expanded clinical testing. We may enter into capital equipment lease arrangements in the future if available at appropriate rates and terms. We believe our existing available cash, cash commitments, cash equivalents and short-term investments as of November 13, 2004, in combination with continuing contractual commitments will be sufficient to meet our anticipated capital requirements until December 2004. Substantial additional capital resources will be required to fund continuing expenditures related to our research, development, manufacturing and business development activities. We are pursuing a number of alternatives available to meet the continuing capital requirements of our operations, such as collaborative agreements and public and private financings. Further, we are continuing our reimbursed services to Spine Wave. We are currently engaged in discussions with potential financing sources and collaborative partners regarding funding in the form of equity investments, convertible debt financing, license fees, milestone payments and research and development payments. There can be no assurance that any of these fundings will be consummated in the timeframes needed for continuing operations or on terms favorable to us. If adequate funds are not available, we will be required to significantly curtail our operating plans and would likely have to sell or license out significant portions of our technology, and possibly cease operations. Item 3. Controls and Procedures (a) Disclosure Controls and Procedures. Based on their evaluation, as of the end of the period covered by this quarterly report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 ("Exchange Act")) are effective based on their evaluation of these controls and procedures required by paragraph (b) of Rules 13a-15 or 15d-15 under the Exchange Act. (b) Internal Control Over Financial Reporting. There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 under the Exchange Act that occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 15 PART II. OTHER INFORMATION Item 6. Exhibits 31.1 Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a- 14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Director of Finance (Principal Financial Officer) pursuant to Securities Exchange Act Rules 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer and Director of Finance (Principal Financial Officer) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 16 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PROTEIN POLYMER TECHNOLOGIES, INC. Date: November 15, 2004 By /s/ J. Thomas Parmeter ----------------------- J. Thomas Parmeter Chairman of the Board, Chief Executive Officer Date: November 15, 2004 By /s/ Janis Y. Neves ------------------- Janis Y. Neves Director of Finance, Controller and Corporate Secretary 17 EXHIBIT INDEX Exhibit Number Description ------ ----------- 31.1 Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a- 14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of Director of Finance (Principal Financial Officer) pursuant to Securities Exchange Act Rules 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of Chief Executive Officer and Director of Finance (Principal Financial Officer) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.