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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

(Mark One)

Commission file number 0-31781

American Pharmaceutical Partners, Inc.
(Exact name of registrant as specified in its charter)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

As of November 8, 2002, the registrant had 46,850,750 shares of $0.001 par value Common Stock outstanding.

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American Pharmaceutical Partners, Inc.

INDEX

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PART I.   FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

American Pharmaceutical Partners, Inc.
Condensed Consolidated Balance Sheets

See notes to condensed consolidated financial statements.

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American Pharmaceutical Partners, Inc.
Condensed Consolidated Statements of Income
(Unaudited)

See notes to condensed consolidated financial statements.

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American Pharmaceutical Partners, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)

See notes to condensed consolidated financial statements.

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AMERICAN PHARMACEUTICAL PARTNERS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2002
(Unaudited)

(1)   Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these financial statements do not include all of the information and notes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002.

The balance sheet information at December 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and notes required by generally accepted accounting principles for complete financial statements.

A subsidiary of ours owns a 50% share of Drug Source Company, LLC. Drug Source Company is a joint venture with three other partners established in June 2000 to purchase raw materials for resale to pharmaceutical companies, including us. Our equity in the net income of Drug Source Company, net of intercompany profit on purchases of inventory, is classified in operating expenses in the accompanying consolidated statements of income. Research and development costs include purchases from Drug Source Company for $676,000 and $16,000 for the three months ended September 30, 2002 and 2001, respectively and $1,723,000 and $615,000 for the nine months ended September 30, 2002 and 2001, respectively. Inventory includes purchases from Drug Source Company of $221,000 for the three and nine months ended September 30, 2002. There were no inventory purchases from Drug Source Company for the three- and nine-month periods ended September 30, 2001.   

For further information, refer to the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K/A for the year ended December 31, 2001.

(2)   Quarterly Periods

We use a 52-week, 53-week fiscal year that ends on the Saturday nearest to December 31. For quarterly reporting purposes, the quarterly periods end on the Saturday nearest to the end of the quarter. For clarity of presentation, comparative periods are presented as if the quarter ended on September 30. Both of the three-month periods ended September 30, 2002 and 2001 contained 13 weeks, and both of the nine-month periods ended September 30, 2002 and 2001 contained 39 weeks.  

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(3)   Earnings Per Share Information

The following tables set forth the computation of basic and diluted earnings per share for the periods indicated:

The assumed conversion of the Series A convertible preferred stock, which was outstanding during the three and nine month periods ended September 30, 2001, was anti-dilutive.

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(4)   Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No.141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets (SFAS No. 141 and SFAS No. 142).  Under the new rules, effective January 1, 2002, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests in accordance with the Statements.  Other intangible assets continue to be amortized over their useful lives. The effect of adopting SFAS No. 141 and SFAS No. 142 had no impact on our statements of income or financial position. We do not have any goodwill recorded in our consolidated balance sheets.

(5)   Transactions with American BioScience, Inc.

     Loans to American BioScience, Inc.

A summary of activity in the note receivable from American BioScience, Inc. account for the nine months ended September 30, 2002, which is classified as a deduction from stockholders’ equity in the accompanying condensed consolidated balance sheet, is as follows:

Payments on behalf of American BioScience’s new product development activities include our administrative salary and benefit allocations, charges for our employees’ services and supplies related to American BioScience’s products in development. Subsequent to September 30, 2002, $1,132,000 has been repaid by American BioScience.

On December 14, 2001, we received a demand promissory note for the balance outstanding from American BioScience (Demand Note). The Demand Note bears interest at a rate equal to the rate of interest on our credit facility (6.0% at September 30, 2002).

In connection with the execution of the Demand Note, as security for payment of the obligations under the Demand Note, we entered into a pledge agreement with American BioScience under which American BioScience pledged and granted us a security interest in shares of our common stock held by it having a fair market value equal to 120% of the balance of the Demand Note.

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     VivoRx, Inc. Settlement

As of September 30, 2002, we are jointly and severally liable for the remaining $12,000,000 settlement payment to VivoRx, Inc. due February 2003, which American Bioscience has agreed to make, as more fully described in Note 14. We expect that American BioScience will have sufficient liquid assets to make this remaining payment to VivoRx. In 2001, American BioScience agreed that if it fails to timely make any of the settlement payments due to VivoRx, American BioScience will surrender to us that number of shares of our common stock having a fair market value equal to 120% of the unpaid amount. As American BioScience makes the payment to VivoRx, the liability to VivoRx reflected in our consolidated balance sheet will be eliminated and a corresponding capital contribution will be recorded net of related deferred income taxes. In February 2002, American BioScience made the scheduled $12,000,000 payment due in February 2002 with the resulting capital contribution to us of $7,320,000, net of related deferred income taxes.

     Product License Agreement

In November 2001, we entered into a license agreement with American BioScience under which we acquired the exclusive rights to market and sell ABI-007 in North America, and which provided for initial license payments of $60,000,000 in January 2002. This license is perpetual. American BioScience also entered into a manufacturing agreement with us that grants us exclusive manufacturing rights for a three-year period. American BioScience is responsible for substantially all costs associated with the development of ABI-007, except that we agreed to provide up to $2,000,000 of ABI-007 for use in clinical trials. The cost of the clinical product was charged to research and development expense in the year ended December 31, 2001. We are also required to make milestone payments of up to (a) $60,000,000 for indications related to breast, ovarian and lung cancers and (b) $32,500,000 for indications relating to prostate cancer and other indications as agreed upon between American BioScience and us. We also may be required to make additional milestone payments of up to an aggregate of $110,000,000 based upon the achievement of particular annual sales levels. Profits from any sales of ABI-007 will be shared equally with American BioScience after deducting costs of goods sold, selling expenses and other appropriate deductions. All costs and expenses related to product recalls and product liability claims generally will be split equally between American BioScience and us.

The initial license payment has been accounted for as a distribution of our stockholders’ equity to American BioScience. As of December 31, 2001, the entire $60,000,000 had been accrued as a distribution payable to American BioScience. The $60,000,000 was paid to American BioScience in January 2002. The income tax benefits related to this payment will be credited to the stockholders’ equity as realized.

(6)   Inventories

Inventories consist of the following:

Inventory increases were attributable to new product introductions, product mix, increased sales, as well as an overall general increase in months of supply.

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(7)   Accrued Liabilities

Accrued liabilities consist of the following:

(8)   Credit Facility

In December 2001, we entered into a credit facility providing for a $25,000,000 term loan and a $50,000,000 revolving line of credit. This credit facility replaced a former facility with another lender. Proceeds of our initial public offering were used to pay off all outstanding amounts under the revolving line of credit and retire the term loan. The revolving line of credit can be increased to $75,000,000 at our request.  In connection with our repurchase of shares of our common stock from one of our stockholders on July 29, 2002, we amended our revolving credit facility to temporarily reduce our available credit to $30,000,000 until the six-month anniversary of that repurchase, or January 29, 2003. This credit facility expires December 14, 2006.

The credit facility’s interest rate for the revolving line is equal to the sum of an adjustable margin rate (1.25% for the nine months ended September 30, 2002) plus the greater of the prime rate or the federal funds rate plus 0.5%. We also have the option of converting revolving line loans to the eurocurrency rate, as defined.

There were no outstanding balances under the revolving lines of credit at September 30, 2002. Loans under the credit facility are collateralized by substantially all of our assets. Under the credit facility, we are prohibited from paying dividends and are subject to various covenants and restrictions. At September 30, 2002, we were in compliance with all covenants.   

The credit facility limits the aggregate undrawn amount of all letters of credit and assesses fees on the face amount of commercial and standby letters of credit. A fee is assessed at 3.75% of the face amount of commercial and standby letters of credit. The letters of credit are payable on demand. There were no amounts outstanding under letters of credit at September 30, 2002.

(9)   Exercise of Over-allotment Option

On January 10, 2002, the underwriters for our initial public offering in December 2001 exercised in full their option to purchase an additional 1,350,000 shares of our common stock at the initial public offering price of $16.00 per share in order to cover over-allotments. As a result of this exercise, we received net proceeds of $20,088,000, after underwriting discounts and commissions of $1,512,000.

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(10)  Shares Earned by Premier Purchasing Partners, L.P.

Pursuant to an agreement that expired March 31, 2001, Premier Purchasing Partners, L.P. (Premier) earned, at no cost, shares of our common stock based upon the level of our sales to Premier’s partners. During the nine months ended September 30, 2001, the shares earned by Premier had a fair value of $1,754,000 and were classified as a reduction of net sales in the accompanying condensed consolidated statements of income.

(11)  Stock Options

During the nine months ended September 30, 2002, 217,300 options were granted at an average exercise price of $12.69 and 411,067 options were exercised at an average exercise price of $3.26. Stock based compensation charges were $2,005,000 and $1,748,000 for the nine months ended September 30, 2002 and 2001, respectively.

(12)  Treasury Stock

On July 29, 2002, we repurchased all shares of our common stock held by Premier Purchasing Partners, totaling 2,914,593 shares for $29,758,000 in cash. In addition, on August 28, 2002, we repurchased 452,284 shares of our common stock owned by Biotechnology Development Fund, L.P. for $6,000,000 in cash pursuant to a stock repurchase program adopted by our Board of Directors on July 26, 2002. These repurchases were funded through our internal cash resources and the shares are being retained as treasury stock.

(13)  Employee Stock Purchase Plan

On July 31, 2002, 421 participants in our employee stock purchase plan elected to purchase 37,598 shares of our common stock at $10.20 per share. The purchase price of the stock was established at the inception of the plan to be 85% of the lower of the fair market value per share of our common stock on the date the offer period begins or the exercise date. In our initial purchase period, the offer period began on December 14, 2001 and ended on July 31, 2002, the exercise date. 

(14)  Litigation

VivoRx, Inc. and VivoRx Diabetes, Inc.

During 1999, VivoRx brought an action against us, our chairman and chief executive officer and American BioScience relating to the development of the businesses of American BioScience and us while our chairman and chief executive officer was also serving as the chief executive officer and chairman of VivoRx.  This action was settled in February 2001 with American BioScience obtaining clear title and ownership to its intellectual property, including the intellectual property underlying American BioScience’s ABI-007 product candidate. Under the settlement, we are jointly and severally liable with American BioScience to pay VivoRx the remaining obligation under the settlement agreement of $12,000,000 in February 2003, of which American BioScience has agreed to pay. The respective boards of directors for American BioScience and us, in consultation with litigation counsel, passed resolutions allocating $3,400,000 of the total settlement obligation of $34,000,000 to us and the remaining $30,600,000 to American BioScience. We paid our allocated portion of the settlement obligation in February 2001. The allocation of the settlement was primarily based upon American BioScience obtaining clear title and ownership to its intellectual property, including the intellectual property underlying American BioScience’s ABI-007 product candidate, and, accordingly, being the primary beneficiary of the settlement.

Notwithstanding the agreed upon allocation of the settlement obligation between American BioScience and us, we recorded the entire present value of $30,354,000 of the litigation settlement with VivoRx as an expense for the year ended December 31, 2000.

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 Other

We are from time to time subject to claims and litigation arising in ordinary courses of business. These claims have included assertions that our products infringe existing patents and also claims that the use of our products has caused personal injuries. We intend to defend vigorously any such litigation that may arise under all defenses that would be available to us. In the opinion of management, the ultimate outcome of such proceedings of which management is currently aware will not have a material adverse effect on our consolidated financial position or results of operation.

(15)  Net Sales by Product Line

Net sales by product line is as follows:

(16)  Enterprise Resource Planning System

In March 2002, we entered into various licensing and support agreements for the implementation of a new enterprise resource planning (ERP) business system application. During the nine months ended September 30, 2002, we have capitalized $4,998,000 for license fees, hardware and other costs for this project.

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Note Regarding Forward-Looking Statements

Statements contained in this Form 10-Q, which are not historical facts, are forward-looking statements, as the term is defined in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements, whether expressed or implied, are subject to risks and uncertainties which can cause actual results to differ materially from those currently anticipated, due to a number of factors, which include, but are not limited to:

Forward-looking statements also include the assumptions underlying or relating to any of the foregoing or other such statements.  When used in this report, the words “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “continue,” and similar expressions are generally intended to identify forward-looking statements.

Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements.

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Results of Operations

The following table sets forth the results of our operations for the periods indicated as a percentage of net sales: