10QSB 1 d10qsb.txt FORM 10-QSB ================================================================================ 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 June 30, 2003 [_] 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 August 6, 2003, 34,139,537 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 - June 30, 2003 and December 31, 2002 ................................................ 3 Condensed Statements of Operations - For the three months and six months ended June 30, 2003 and 2002 and the period July 6, 1988 (inception) to June 30, 2003 ........................... 4 Condensed Statements of Cash Flows - For the six months ended June 30, 2003 and 2002 and the period July 6, 1988 (inception) to June 30, 2003 ........................... 5 Notes to Condensed Financial Statements ............................................... 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ...................................... 9 Item 3. Controls and Procedures ............................................................... 13 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds ............................................. 14 Item 4. Submission of Matters to a Vote of Security Holders ................................... 15 Item 6. Exhibits and Reports on Form 8-K ...................................................... 16 Signatures ............................................................................ 17
2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Balance Sheets
June 30, December 31, 2003 2002 ---------------------------- Assets (unaudited) Current assets: Cash and cash equivalents $ 2,443,524 $ 733,978 Contract receivable 605,196 - Other current assets 117,616 30,773 ---------------------------- Total current assets 3,166,336 764,751 Deposits 30,479 29,679 Equipment and leasehold improvements, net 101,016 80,928 ---------------------------- $ 3,297,831 $ 875,358 ============================ Liabilities and stockholders' equity Current liabilities: Accounts payable $ 239,215 $ 389,109 Accrued employee benefits 135,816 112,714 Other accrued expenses 31,003 49,530 Deferred rent 24,111 24,111 ---------------------------- Total current liabilities 430,145 575,464 Long-term portion deferred rent 12,056 24,111 Stockholders' equity: Convertible Preferred Stock, $.01 par value, 5,000,000 shares authorized, 87,096 and 76,120 shares issued and outstanding at June 30, 2003 and December 31, 2002, respectively; liquidation preference of $8,709,600 and $7,612,000 at June 30, 2003 and December 31, 2002, respectively 8,164,917 7,266,780 Common stock, $.01 par value, 120,000,000 shares authorized, 36,638,628 and 29,731,535 shares issued and outstanding at June 30, 2003 and December 31, 2002, respectively 366,398 297,327 Additional paid-in capital 40,273,374 36,618,235 Deficit accumulated during development stage (45,949,059) (43,906,559) ---------------------------- Total stockholders' equity 2,855,630 275,783 ---------------------------- $ 3,297,831 $ 875,358 ============================
See accompanying notes. 3 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Statements of Operations (unaudited)
For the period July 6, 1988 (inception) to Three months ended Six months ended June 30, June 30, June 30, 2003 2002 2003 2002 2003 ------------------------------------------------------------------------------- Revenues: Contract revenue $ 742,696 $ 943,764 $ 1,193,679 $ 1,413,342 $ 10,452,265 Interest income 9,263 2,016 10,847 3,636 1,257,794 Product and other income - - - 1,500 694,779 ---------------------------- ------------------------------ ------------- Total revenues 751,959 945,780 1,204,526 1,418,478 12,404,838 Expenses: Research and development 636,086 872,719 1,177,952 1,523,757 33,564,057 Selling, general and administrative 415,405 377,898 695,827 666,745 19,468,208 ---------------------------- ------------------------------ ------------- Total expenses 1,051,491 1,250,617 1,873,779 2,190,502 53,032,265 ---------------------------- ------------------------------ ------------- Net loss (299,532) (304,837) (669,253) (772,024) (40,627,427) Undeclared, imputed and/or paid dividends on preferred stock 137,082 69,220 1,510,925 137,678 7,583,496 ---------------------------- ------------------------------ ------------- Net loss applicable to common shareholders $ (436,614) $ (374,057) $ (2,180,178) $ (909,702) $ (48,210,923) =============================================================================== Basic and diluted net loss per common share $ (0.01) $ (0.01) $ (0.07) $ (0.04) ============================================================== Shares used in computing basic and diluted net loss per common share 34,037,634 27,000,455 31,926,744 25,566,557 ==============================================================
See accompanying notes. 4 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Statements of Cash Flows (unaudited)
For the period July 6, 1988 Six months ended (inception) to June 30, June 30, 2003 2002 2003 ------------------------------------------------- Operating activities Net loss $ (669,253) $ (772,024) $(40,627,427) Adjustments to reconcile net loss to net cash used for operating activities: Stock issued for compensation and interest - - 472,676 Depreciation and amortization 34,088 87,534 2,392,472 Write-off of purchased technology - - 503,500 Changes in assets and liabilities: Contract receivable (605,196) - (605,196) Deposits (800) (800) (30,479) Other current assets (86,843) 23,533 (117,616) Accounts payable (149,894) 209,672 239,215 Accrued employee benefits 23,102 (7,963) 135,816 Other accrued expenses (18,526) (4,787) 31,005 Deferred revenue - (166,667) - Deferred rent (12,056) (12,056) 36,166 ------------------------------------------------- Net cash used for operating activities (1,485,378) (643,558) (37,569,868) Investing activities Purchase of technology - - (570,000) Purchase of equipment and improvements (54,175) (25,280) (2,051,461) Purchases of short-term investments - - (16,161,667) Sales of short-term investments - - 16,161,667 ------------------------------------------------- Net cash provided by (used for) investing activities $ (54,175) $ (25,280) $ (2,621,461)
See accompanying notes. 5 PROTEIN POLYMER TECHNOLOGIES, INC. (A Development Stage Company) Condensed Statements of Cash Flows (unaudited)
For the period July 6, 1988 Six months ended (inception) to June 30, June 30, 2003 2002 2003 ------------------------------------------- Financing activities Net proceeds from exercise of options and warrants, and sale of common stock $ 359,449 $ 1,001,834 $ 23,215,525 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 note payable - - 484,323 ------------------------------------------- Net cash provided by financing activities 3,249,099 1,001,834 42,634,853 ------------------------------------------- Net increase in cash and cash equivalents 1,709,546 332,996 2,443,524 Cash and cash equivalents at beginning of period 733,978 234,271 - ------------------------------------------- Cash and cash equivalents at end of period $ 2,443,524 $ 567,267 $ 2,443,524 =========================================== Supplemental disclosures of cash flow information Equipment purchased by capital leases - - $ 288,772 Interest paid - 723 146,775 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 1,921,513 643,750 5,277,813 Conversion of Series G preferred stock to common stock 15,000 570,000 585,000 Conversion of Series I preferred stock to common stock 55,000 - 55,000 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) June 30, 2003 1. Basis of Presentation The condensed financial statements of Protein Polymer Technologies, Inc. (the "Company") for the three months and the six months ended June 30, 2003 and 2002 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 June 30, 2003 and the results of operations for the three months and the six months ended June 30, 2003 and 2002. The results of operations for the six months ended June 30, 2003 are not necessarily indicative of the results to be expected for the year ended December 31, 2003. 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, 2002, filed with the Securities and Exchange Commission. 2. New Accounting Pronouncements In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," which amends SFAS 123, "Accounting for Stock-Based Compensation." SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirement of SFAS 123 to require more prominent and more frequent disclosures in financial statements about the effects of stock-based compensation, regardless of which accounting method is used to account for stock-based compensation. The transition guidance and annual disclosure provisions of SFAS 148 are effective for fiscal years ending after December 15, 2002. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15, 2002. The Company has adopted the disclosure requirements of SFAS 148 as described in Footnote 6. 3. 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 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. 4. Issuance of Preferred Stock On March 25 and May 12, 2003, we raised approximately $3.25 million from the sale of 32,550 shares of our Series I Convertible Preferred Stock ("Series I Stock") priced at $100 per share, with warrants to purchase an aggregate of 2,582,669 shares of common stock to a small group of institutional and accredited investors. Each share of Series I Stock is convertible at any time at the election of the holder into approximately 181 shares of common stock at a conversion price of $0.55 per share, subject to certain anti-dilution adjustments. In connection with this transaction, we recorded a non-cash "imputed dividend" expense of $1,373,247 in order to account for the difference between the fair market value of the common stock and the conversion price of the preferred stock into common stock. We intend to use the net proceeds for general corporate and working capital purposes. Each share of Series I Stock received two common stock warrants. One warrant is exercisable at any time for 27 shares of common stock at an exercise price of $0.88 per share, and expires 18 months after the close of the offering; the other warrant is exercisable at any time for 18 shares of common stock at an exercise price of $1.65 per share, and expires 48 months after the close of the offering. In connection with the issuance of the Series I Stock, additional warrants to purchase 819,543 shares of common stock at an exercise price of $0.65 per share, expiring 18 months after the close of the offering were issued, as well as 7 warrants to purchase 204,998 shares of common stock at an exercise price of $0.58 per share, warrants to purchase 27,340 shares of common stock at an exercise price of $0.68 per share, warrants to purchase 30,748 shares of common stock at an exercise price of $0.92 per share and warrants to purchase 20,500 shares of common stock at an exercise price of $1.73 per share, each expiring 5 years after the close of the offering. No underwriters were engaged by us in connection with such issuance and, accordingly, no underwriting discounts were paid. The offering is exempt from registration under Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), and met the requirements of Rule 506 of Regulation D promulgated under the Securities Act. 5. Exercise and Exchange of Warrants In June 2003, certain holders of warrants exercised their warrants to purchase common stock, these warrants were due to expire in August 2003. The exercise prices of such warrants were $0.40 and $0.10 per share. As an incentive to exercise the warrant early the Company 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 $353,500. The newly issued warrants will expire on the last day of September 2003. 6. Accounting for Stock-Based Compensation As allowed by Statement No. 123, Accounting for Stock-Based Compensation, we account for stock compensation arrangements with employees using the intrinsic value method under the provisions of the Accounting Principles Board's Opinion No. 25, Accounting for Stock Issued to Employees. Deferred stock-based compensation is amortized over the vesting period, which is generally three to five years, utilizing the accelerated method prescribed in FASB Interpretation No. 28. Pro Forma stock compensation in accordance with Statement No. 123 is amortized using the straight-line method over the vesting period. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of Statement No. 123:
For the three months For the six months Ended June 30, Ended June 30, 2003 2002 2003 2002 ---- ---- ---- ---- Net loss: As reported (436,614) (374,057) (2,180,178) $ (909,702) Total stock-based employee compensation expense determined under fair value based methods for all options, net of related tax effects (53,869) (7,768) (76,663) (18,794) Pro forma net loss $(490,483) (381,825) (2,256,841) $ (928,496) Basic and diluted net loss per share: As reported 0.01 0.01 0.07 0.04 Pro forma 0.01 0.01 0.08 0.04
7. Liquidity We believe our existing available cash and cash equivalents as of June 30, 2003, plus contractual amounts receivable, is sufficient to meet our anticipated capital requirements until April 2004. Substantial additional capital resources will be required to fund continuing 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. 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 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 June 30, 2003 had an accumulated deficit of $(45,949,000). 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 urethral tissue for the treatment of female stress incontinence and in dermal tissue for cosmetic and reconstructive procedures, and tissue adhesive formulations for the repair of spinal discs damaged due of injury or aging. 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. 9 Spine Wave In April 2001, we entered into agreements with Spine Wave, Inc. ("Spine Wave"), 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. 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. The shares of founding common stock are subject to a vesting schedule consisting of three triggers corresponding to Spine Wave's progress in commercializing products using the licensed technology. Unvested shares of founding common stock are subject to repurchase by Spine Wave at the original purchase price. One-third of the shares of founding common stock vest on or after each trigger. 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 year ended December 31, 2002 and for the period ended June 30, 2003 we recognized $2,427,000 and $1,194,000, 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 also priced at $0.50 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 June 30, 2003, the first of the three performance goals had been met. 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. In accordance with the agreement, we will receive a royalty on net product sales generated by Femcare, and we have the right to manufacture commercial product for Femcare. The agreement terminates on the greater of 20 years or upon which the last of the licensed patents expire. 10 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 product for the treatment of female stress urinary incontinence is in pilot human clinical testing. We project beginning pivotal clinical testing during 2004. 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 2006. Commercial manufacturing process development and completion of the clinical trials are estimated to cost approximately $10 million. Femcare, Ltd., our licensee for this product in Europe and Australia, has advised us that commercialization of the product in Europe potentially can occur at least one year in advance of U.S. commercialization. Our tissue augmentation product for use in cosmetic and reconstructive surgery applications is in pilot human clinical testing. We project beginning pivotal clinical testing during 2004. 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 late 2005. 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. 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 in pre-clinical testing. 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 and commercialization. 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 June 30, 2003 and for the period of project inception to date are approximately $743,000 and $4,071,000 respectively. 11 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 $743,000 in contract and licensing revenue for the three months ended June 30, 2003 as compared to $944,000 for the three months ended June 30, 2002. For the six month period ended June 30, 2003, we recognized $1,194,000 in contract and licensing income as compared to $1,413,000 for the same period in 2002. The contract and licensing revenue for the three months ended June 30, 2003 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 whereas contract and licensing revenue for the same period in 2002 also included $83,000 and $167,000 respectively in amortized revenue from a $1 million up-front license payment (being recognized ratably over a period of three years) from Femcare for the commercial rights to our incontinence product in Europe and Australia. The amortization of the $1 million dollar payment terminated on December 31, 2002. The decrease in contract revenue in 2003 is due to the reduction in preclinical testing of the injectable spinal disc nucleus product in preparation for Spine Wave filing an Investigational Device exemption with the Food and Drug Administration requesting permission to initiate human clinical trials. Interest income was $9,000 and $11,000 respectively for the three months and six months ended June 30, 2003 versus $2,000 and $4,000 respectively for the same periods in 2002. Research and development expenses for the three and six-month periods ended June 30, 2003 were $636,000 and $1,178,000 respectively, as compared to $873,000 and $1,524,000 for the same periods in 2002. The decrease in research and development expenditures for the three and six month periods in 2003 primarily reflects reduced pre-clinical costs associated with the development of the spinal disc nucleus replacement product. 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 six month periods ended June 30, 2003 were $415,000 and $696,000 respectively as compared to $378,000 and $667,000 respectively for the same periods in 2002. 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 June 30, 2003, we recorded a net loss applicable to common shareholders of $437,000 or $0.01 per share, as compared to a loss of $374,000, or $0.01 per share for the same period in 2002. For the six months ended June 30, 2003, we recorded a net loss applicable to common shareholders of $2,180,000 or $0.07 per share, as compared to a loss of $910,000, or $0.04 per share for the same period in 2002. Included in the net loss per share for the six months ended June 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 which raised approximately $3.25 million less expenses (see Note 4 to the Financial Statements). The net loss and the net loss per share also included in each of the three month and the six-month periods of 2003 and 2002 $68,000 and $137,000 for undeclared dividends related to our preferred stock. Excluding the effect of the imputed dividends, the net loss applicable to common shareholders would have been $807,000 ($.03 per share) for the six months ended June 30, 2003. 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 initiation of new tissue adhesive product development activities. Our financial 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. 12 Liquidity and Capital Resources As of June 30, 2003, we had cash, cash equivalents and short-term investments totaling $2,444,000 as compared to $734,000 at December 31, 2002. As of June 30, 2003, we had working capital of $2,736,000, compared to a working capital of $189,000 at December 31, 2002. We do not have any off balance sheet financing activities and do not have any special purpose entities. We had no long-term capital lease obligations as of June 30, 2003 or December 31, 2002. For the three month period ended June 30, 2003, our cash expenditures for capital equipment and leasehold improvements totaled $(54,175), compared with $(25,280) for the same period in the prior year. To the extent capital is available, we anticipate that these expenditures will be increased in 2003 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 equivalents and short-term investments as of June 30, 2003, in combination with continuing contractual commitments will be sufficient to meet our anticipated capital requirements until April of 2004. Substantial additional capital resources will be required to fund continuing expenditures related to our research, development, manufacturing and business development activities. In addition we are pursuing a number of alternatives available to meet the continuing capital requirements of our operations, such as collaborative agreements and public or private financings. Further, we are continuing our reimbursed services to Spine Wave. We are currently in preliminary discussions with potential financing sources and collaborative partners, and funding in the form of equity investments, license fees, milestone payments or research and development payments could be generated. 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) Evaluation of 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) Changes in 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. 13 PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds On March 25 and May 12, 2003, we raised approximately $3.25 million from the sale of 32,550 shares of our Series I Convertible Preferred Stock ("Series I Stock") priced at $100 per share, with warrants to purchase an aggregate of 2,582,669 shares of common stock to a small group of institutional and accredited investors. Each share of Series I Stock is convertible at any time at the election of the holder into approximately 181 shares of common stock at a conversion price of $0.55 per share, subject to certain anti-dilution adjustments. In connection with this transaction, we recorded a non-cash "imputed dividend" expense of $1,373,000 in order to account for the difference between the fair market value of the common stock and the conversion price of the preferred stock into common stock. We intend to use the net proceeds for general corporate and working capital purposes. Each share of Series I Stock received two common stock warrants. One warrant is exercisable at any time for 27 shares of common stock at an exercise price of $0.88 per share, and expires 18 months after the close of the offering; the other warrant is exercisable at any time for 18 shares of common stock at an exercise price of $1.65 per share, and expires 48 months after the close of the offering. In connection with the issuance of the Series I Stock, additional warrants to purchase 819,543 shares of common stock at an exercise price of $0.65 per share, expiring 18 months after the close of the offering were issued, as well as warrants to purchase 204,998 shares of common stock at an exercise price of $0.58 per share, warrants to purchase 27,340 shares of common stock at an exercise price of $0.68 per share, warrants to purchase 30,748 shares of common stock at an exercise price of $0.92 per share and warrants to purchase 20,500 shares of common stock at an exercise price of $1.73 per share, each expiring 5 years after the close of the offering. No underwriters were engaged by us in connection with such issuance and, accordingly, no underwriting discounts were paid. The offering is exempt from registration under Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), and met the requirements of Rule 506 of Regulation D promulgated under the Securities Act. The registration statement covering resales of the shares of common stock underlying the Series I Stock and the warrants became effective on June 6, 2003. 14 Item 4. Submission of Matters to a Vote of Security Holders The annual meeting of stockholders was held on April 25, 2003. Proposals I, II, III, IV and V were approved. The results are as follows: Proposal I The following directors were elected at the meeting to serve a one-year term as directors: Authority For Withheld J. Thomas Parmeter 24,189,520 0 George R. Walker 24,189,520 0 Philip J. Davis 24,189,520 0 Edward J. Hartnett 24,189,520 0 Phillip M. Berman 24,189,520 0 Kerry L. Kuhn 24,189,520 0 Edward G. Cape 24,189,520 0 Proposal II Approval of the Amendment to the Certificate of Incorporation to increase the number of authorized shares of Common Stock: Broker For Against Abstained Non-Vote ------------------------------ --------- ----------- ---------- 24,188,320 1,200 0 0 Proposal III Approval of the Amendment to the 2002 Stock Option Plan to increase the number of shares of Common Stock reserved for issuance under the Plan from 1,500,000 to 9,000,000: Broker For Against Abstained Non-Vote ------------------------------ --------- ----------- ---------- 18,257,103 235,668 7,400 5,689,349 Proposal IV Approval of the Amendment to the 1996 Non-employee Directors Stock Option Plan to increase the number of shares of common stock reserved for issuance under the Plan from 250,000 to 1,750,000: Broker For Against Abstained Non-Vote ------------------------------ --------- ----------- ---------- 18,242,803 226,868 30,500 5,689,349 Proposal V Ratification of appointment of Peterson & Co. as the Company's independent auditors for fiscal year 2003: Broker For Against Abstained Non-Vote ------------------------------ --------- ----------- ---------- 24,189,520 0 0 0 15 Item 6. Exhibits and Reports on Form 8-K a. Exhibits 10.1 Amended and Restated Securities Purchase Agreement related to the sale of Series I Preferred Stock dated as of May 12, 2003. 10.2 Form of $0.55 warrant issued in connection with the exchange of warrants. 31.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, 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 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of 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. b. Reports on Form 8-K None. 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: August 14, 2003 By /s/ J. Thomas Parmeter ---------------------- J. Thomas Parmeter Chairman of the Board, Chief Executive Officer, President Date: August 14, 2003 By /s/ Janis Y. Neves ------------------ Janis Y. Neves Director of Finance, Controller and Assistant Secretary 17 EXHIBIT INDEX Exhibit Number Description 10.1 Amended and Restated Securities Purchase Agreement related to the sale of Series I Preferred Stock dated as of May 12, 2003. 10.2 Form of $0.55 warrant issued in connection with the exchange of warrants. 31.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, 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 18 U.S.C. Section 1350, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of 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. 18