AMERICAN PHARMACEUTICAL PARTNERS INC /DE/ - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-31781

American Pharmaceutical Partners, Inc.

(Exact name of registrant as specified in its charter)


Delaware		68-0389419
(State of Incorporation)		(I.R.S. Employer Identification No.)

1501 East Woodfield Road, Suite 300 East Schaumburg, IL		60173-5837
(Address of principal executive offices)		(Zip Code)

(847) 969-2700

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant is an accelerated filer (as determined by rule 12b-2 of the Exchange Act). Yes x No ¨

As of November 2, 2004, the registrant had 70,537,986 shares of $0.001 par value common stock outstanding.

American Pharmaceutical Partners, Inc.

INDEX


		Page
PART I. Financial Information

Item 1.	Financial Statements (Unaudited)

	Condensed consolidated balance sheets – September 30, 2004 and December 31, 2003	3

	Condensed consolidated statements of income – Three months ended September 30, 2004 and 2003; Nine months ended September 30, 2004 and 2003	4

	Condensed consolidated statements of cash flows – Nine months ended September 30, 2004 and 2003	5

	Notes to condensed consolidated financial statements – September 30, 2004	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27

Item 4.	Controls and Procedures	29

PART II. Other Information

Item 1.	Legal Proceedings	30

Item 6.	Exhibits	31

Signatures		32

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

American Pharmaceutical Partners, Inc.

Condensed Consolidated Balance Sheets


(in thousands, except share data)	September 30, 2004			December 31, 2003
	(Unaudited)			(Note 1)
Assets
Current assets:
Cash and cash equivalents	$	61,943		$	58,625
Accounts receivable, net		8,558			31,402
Inventories		143,903			110,384
Prepaid expenses and other current assets		8,341			7,340
Deferred income taxes		7,948			7,948

Total current assets		230,693			215,699
Property, plant and equipment, net		100,254			77,340
Investment in Drug Source Co., LLC		5,981			5,166
Product license rights and other non-current assets, net		5,172			3,027
Deferred financing costs, net		426			2,553

Total assets	$	342,526		$	303,785

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	20,866		$	26,560
Accrued expenses		30,013			29,120

Total current liabilities		50,879			55,680
Deferred income taxes		2,044			2,044

Total liabilities		52,923			57,724

Stockholders’ equity
Common stock - $.001 par value; 100,000,000 shares authorized, 77,168,083 and 76,514,964 shares issued in 2004 and 2003, respectively		77			77
Additional paid-in capital		209,853			201,009
Amounts due from American BioScience, Inc.		(21,693	)		(21,132	)
Deferred stock-based compensation		(1,016	)		(1,309	)
Retained earnings		158,377			123,550
Accumulated other comprehensive income		279			140
Less treasury stock at cost, 6,646,398 common shares in 2004 and 2003		(56,274	)		(56,274	)

Total stockholders’ equity		289,603			246,061

Total liabilities and stockholders’ equity	$	342,526		$	303,785

See notes to condensed consolidated financial statements.

American Pharmaceutical Partners, Inc.

Condensed Consolidated Statements of Income

(Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
	(in thousands, except per share data)
Net sales	$	95,614		$	90,354		$	282,456		$	262,115
Cost of sales		43,915			41,817			133,229			116,792

Gross profit		51,699			48,537			149,227			145,323
Operating expenses:
Research and development		7,406			4,987			21,346			16,130
Selling, general and administrative		21,693			13,256			65,583			37,389
Milestone payment		—			—			10,000			—
Stock-based compensation		175			256			650			989
Equity in net income of Drug Source Co., LLC		(753	)		(551	)		(1,991	)		(1,049	)

Total operating expenses		28,521			17,948			95,588			53,459

Income from operations		23,178			30,589			53,639			91,864
Interest income		439			420			1,284			1,315
Interest expense and other		142			(9	)		50			317
Loss on early extinguishment of credit facility		(1,986	)		—			(1,986	)		—

Income before income taxes		21,773			31,000			52,987			93,496
Provision for income taxes		7,960			12,710			18,160			38,333

Net income	$	13,813		$	18,290		$	34,827		$	55,163

Income per common share:
Basic	$	0.20		$	0.26		$	0.50		$	0.79

Diluted	$	0.19		$	0.25		$	0.48		$	0.76

Interest income includes interest earned from American BioScience, Inc. as follows:	$	271		$	298		$	833		$	923

See notes to condensed consolidated financial statements.

American Pharmaceutical Partners, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)


	Nine Months Ended September 30,
	2004			2003
	(in thousands)
Cash flows from operating activities:
Net income	$	34,827		$	55,163
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		6,183			6,360
Amortization		832			708
Stock-based compensation		650			989
Loss on early extinguishment of credit facility		1,986			—
Loss on disposal of property, plant and equipment		13			—
Deferred income taxes		—			(666	)
Equity in net income of Drug Source Company, LLC, net of dividends received		(815	)		(1,181	)
Income tax benefit on stock option exercises		2,923			4,462
Changes in operating assets and liabilities:
Accounts receivable, net		22,844			(1,281	)
Inventories		(33,519	)		(22,425	)
Prepaid expenses and other current assets		(1,001	)		(3,263	)
Accounts payable and accrued expenses		(3,606	)		18,787

Net cash provided by operating activities		31,317			57,653

Cash flows from investing activities:
Purchases of property, plant and equipment		(29,110	)		(17,539	)
Purchase of other non-current assets		(2,396	)		—

Net cash used in investing activities		(31,506	)		(17,539	)

Cash flows from financing activities:
Proceeds from the exercise of stock options		1,961			2,483
Proceeds from the sale of stock under employee retirement and stock purchase plans		2,408			1,048
Increase in amounts due from American BioScience, Inc.		(561	)		(357	)
Payment of deferred financing costs		(440	)		—
Purchase of treasury stock		—			(19,999	)

Net cash provided by (used in) financing activities		3,368			(16,825	)

Effect of foreign currency translation		139			116

Increase in cash and cash equivalents		3,318			23,405
Cash and cash equivalents at beginning of period		58,625			39,771

Cash and cash equivalents at end of period	$	61,943		$	63,176

See notes to condensed consolidated financial statements.

AMERICAN PHARMACEUTICAL PARTNERS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2004

(Unaudited)

(1) Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of American Pharmaceutical Partners, Inc. 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, 2004 are not necessarily indicative of the results that may be expected for the year ended December 31, 2004.

The balance sheet information at December 31, 2003 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 wholly owned subsidiary of American Pharmaceutical Partners holds a 50% interest in 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. Because our 50% interest in Drug Source Company does not provide financial or operational control of the entity, we account for our interest in Drug Source Company under the equity method. 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 condensed consolidated statements of income. Research and development expense includes raw material purchases from Drug Source Company of $0.3 million and $0.2 million for the nine months ended September 30, 2004 and 2003, respectively. Ending inventory included raw material purchases from Drug Source Company of $1.7 million at September 30, 2004 and $0.8 million at December 31, 2003.

For further information, refer to the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2003.

(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 quarters ended on September 30. Both of the three-month periods ended September 30, 2004 and 2003 included 13 weeks and each of the nine month periods ended September 30, 2004 and 2003 included 39 weeks.

(3) Earnings Per Share Information

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


	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
	(in thousands except per share data)
Basic and dilutive numerator:
Net income applicable to common stock	$	13,813	$	18,290	$	34,827	$	55,163

Denominator:
Weighted-average common shares outstanding - basic		70,399		69,585		70,234		69,643
Net effect of dilutive securities:
Stock options and restricted stock awards		2,626		3,222		2,893		3,050

Weighted-average common shares outstanding - diluted		73,025		72,807		73,127		72,693

Income per common share - basic	$	0.20	$	0.26	$	0.50	$	0.79

Income per common share - diluted	$	0.19	$	0.25	$	0.48	$	0.76

Employee stock options for which the exercise price exceeded the average market price of our common stock were excluded from the computation of diluted income per common share as follows:



	Three Months Ended September 30,		Nine Months Ended September 30,
	2004	2003	2004	2003
	(in thousands except per share data)
Number of shares excluded	618	8	264	50
Range of exercise prices	$29.08 - $46.20	$32.89	$35.54 - $46.20	$23.10 - $32.89

(4) Transactions with American BioScience, Inc.

Product License and Manufacturing Agreements

We have secured the North American marketing and manufacturing rights for ABRAXANE^™ from American BioScience, Inc., which is responsible for conducting the clinical studies of and obtaining regulatory approval for ABRAXANE^™.

In November 2001, we signed a perpetual license agreement with American BioScience, Inc. under which we acquired the exclusive rights to market and sell ABRAXANE^™ in North America for indications relating to breast, lung, ovarian, prostate and other cancers. Under the agreement, we made an initial payment to American BioScience of $60.0 million and committed to future milestone payments contingent upon achievement of specified regulatory and sales objectives for licensed indications. American BioScience is responsible for conducting clinical studies in support of ABRAXANE^™ and for substantially all costs associated with the development and obtaining regulatory approval for ABRAXANE^™, except that we provided $2.0 million of ABRAXANE^™ for use in clinical trials, the cost of which we charged to research and development expense in 2001. We may receive revenue resulting from this agreement only after our launch of ABRAXANE^™ in North America, which will not occur until after FDA approval is obtained. Even though the FDA accepted American BioScience’s NDA filing for ABRAXANE^™ for metastatic breast cancer in May 2004, we cannot predict when the FDA will complete its review of the filing, or when or if the NDA will be approved. Any profit, as defined in the license agreement, resulting from American Pharmaceutical Partners’ sales of ABRAXANE^™ following approval would be shared equally between American BioScience and us, following the recapture of half of the pre-launch sales, marketing and pre-production costs we have incurred.

The terms of the license agreement were negotiated to reflect the value of the licensed product rights acquired, then in late-stage development, American BioScience’s remaining obligation to complete the NDA filing and the potential sales of the product under licensed clinical indications. The license agreement was a product of several months of extensive negotiation with American BioScience involving outside counsel, investment banks and a nationally recognized valuation firm. Based upon the analysis and recommendations of our advisors, we believe that the overall terms of the agreement were fair to us, including in comparison to similar licenses between unrelated parties. The agreement was unanimously approved by the disinterested members of our Board of Directors, with those directors who also have an affiliation with American BioScience recusing themselves from the vote. There are no restrictions on how American BioScience would use payments made under the license agreement and we understand such payments have been and will be used both to fund the development of ABRAXANE^™ in relation to our licensed product rights and for other purposes.

In December 2001, upon completion of our initial public offering, we recorded an initial payment due American BioScience of $60.0 million. In our financial statements, the license agreement was accounted for as an asset contributed by a principal shareholder using the shareholder’s historical cost basis which was zero, and the $60.0 million payment was accounted for as a distribution of stockholders’ equity. For income tax purposes, the payment was recorded as an asset and is being amortized over a 15-year period. Because there was no corresponding charge to income, the income tax benefit of this payment is being credited to stockholders’ equity as realized.

Future milestone payments which will be earned upon achievement of regulatory events enumerated in the license agreement prior to FDA approval for each licensed indication will be expensed as achieved, while regulatory milestone payments earned upon FDA approval of those indications will be capitalized and amortized over the expected life of the product. Any future sales-based milestone payments will be expensed in the period in which the sales milestone is achieved.

In May 2004, the FDA accepted, meaning that the FDA found the NDA complete on its face in all respects, American BioScience’s NDA filing for the first potential ABRAXANE^™ indication being studied, metastatic breast cancer. This FDA acceptance triggered a $10.0 million milestone payment to American BioScience which was paid and expensed in the second quarter of 2004. Additionally, upon FDA approval of the NDA for metastatic breast cancer, we will be required to pay American BioScience an additional $15.0 million which will be capitalized and amortized over the expected life of the product, subject to periodic review for impairment. Regulatory achievements related to other licensed indications under study, including lung, ovarian and prostate cancers, will trigger further milestone payments to American BioScience, but only after ABRAXANE^™ has received NDA approval related to the breast cancer indication. Such payments generally total $17.5 million per agreed indication. As with the indication of breast cancer, those payments earned prior to FDA approval for each indication will be expensed, while amounts earned upon FDA approval of those indications will be capitalized and amortized over the expected life of the product. We have the option not to make one or more of the milestone payments tied to certain indications under study if, following breast cancer approval, sales of the product do not meet specified levels.

Subsequent to FDA approval of ABRAXANE^™ and upon achievement of major annual one-time ABRAXANE^™ sales milestones, we would be required to make additional payments which, in the aggregate, could total $110.0 million should annual ABRAXANE^™ sales exceed $1.0 billion. The first sales milestone payment of $10.0 million would be triggered upon achievement of annual calendar year ABRAXANE^™ sales in excess of $200.0 million. Sales milestone payments will be expensed in the period in which the sales milestone is achieved.

related to product recalls and product liability claims generally will be split equally between American BioScience and us and expensed as incurred. Pursuant to an agreement that we have with American BioScience, certain costs of any unsaleable ramp-up inventory of ABRAXANE^™ that is manufactured in preparation for its projected launch will be shared equally between us and American BioScience.

In November 2001, along with the license agreement for ABRAXANE^™, we also entered into a manufacturing agreement with American BioScience under which we agreed to manufacture ABRAXANE^™ for American BioScience and its licensees for sales outside North America. Under this agreement, we have the exclusive right to manufacture ABRAXANE^™ for sales in North America for a period of three years and the non-exclusive right to manufacture ABRAXANE^™ for sales (a) outside North America and (b) in North America after expiration of the three year exclusivity period. We will charge American BioScience and its licensees a customary margin on our manufacturing costs based on whether the product will be used for clinical trials or commercial sale. The initial term of this agreement is ten years and may be extended for successive two-year terms by American BioScience.

Loans to American BioScience, Inc.

Prior to our licensing of ABRAXANE^™ in November 2001, we made loans to American BioScience, our majority shareholder, to support development of ABRAXANE^™. Subsequent to formalization of the license and manufacturing agreements on December 14, 2001, we received a demand promissory note, which replaced prior notes, from American BioScience for the outstanding loan balance (“Demand Note”). The Demand Note is capped at $23.0 million, and the terms of our September 2004 credit facility limit any increases in such amount. The Demand Note bears interest at a rate equal to the rate of interest on our credit facility, 4.25% at September 30, 2004. American BioScience is required to repay any amounts outstanding under the Demand Note by the earlier of November 20, 2006 or our cumulative payment of $75.0 million of profit on ABRAXANE^™ to American BioScience. As security for American BioScience’s obligations under the Demand Note, American BioScience pledged and granted to us a security interest in shares of our common stock held by American BioScience having a fair market value equal to 120% of the balance of the Demand Note.

We charge payments made on American BioScience’s behalf related to labor and other costs directly related to new product development, income taxes, interest and an agreed allocation of administrative costs to the American BioScience loan account. A summary of activity in the amounts due from American BioScience, which is classified as a reduction of stockholders equity in the accompanying condensed consolidated balance sheets, follows:


	September 30, 2004			December 31, 2003
	(in thousands)
Balance at beginning of year	$	21,132		$	22,567
Payments on behalf of American BioScience:
New product development		295			1,229
Interest charged to American BioScience		833			1,221
Other		38			85
Reductions in lieu of income tax liability		—			(2,252	)
Repayments by American Bioscience		(605	)		(1,718	)

	$	21,693		$	21,132

American BioScience

We are a majority owned subsidiary of American BioScience. American BioScience is a privately held biotechnology company focused on the discovery, development and delivery of next-generation therapeutic compounds including ABRAXANE^™ and a variety of biologically active molecules, already existing within the human biological system, for the treatment of life-threatening diseases. American BioScience’s employees, administration and research facilities are independent, separate and distinct from our operations. Except for our President, Chief Executive Officer and Chairman of our Board of Directors,

Patrick Soon-Shiong, M.D., no employee of American BioScience is also an employee of ours. Even though Dr. Soon-Shiong is also the president, chief financial officer and a director of American BioScience, we believe that compensation paid to Dr. Soon-Shiong by us is commensurate with his duties to us.

Under the license agreement, American BioScience is responsible for conducting clinical studies in support of ABRAXANE^™ and for substantially all costs associated with the development and obtaining regulatory approval for ABRAXANE^™, for each indication licensed to us. Other than the $2.0 million of ABRAXANE^™ that we provided American BioScience in 2001 for use in clinical trials, we have no further obligation under the license agreement for the development or regulatory approval of ABRAXANE^™. Due to the multiple ABRAXANE^™ indications which we license, American BioScience’s obligations under the license agreement will be ongoing and we cannot predict when American BioScience will be able to complete the development and regulatory approval of each of these indications.

American BioScience began research and development work on its nanoparticle drug delivery platform, including ABRAXANE^™, in 1994. Prior to execution of the license agreement, American BioScience had completed multiple pre-clinical animal studies, two Phase I human studies and two Phase II clinical studies. After execution of the license agreement, American BioScience completed a single Phase III clinical study in metastatic breast cancer as a basis for FDA approval and published the data from this Phase III study on December 5, 2003 at the San Antonio Breast Cancer Symposium. In June 2003, American BioScience began the ABRAXANE^™ NDA filing process with the pre-submission of the Pre-clinical and Chemistry, Manufacturing and Control sections of the NDA under the Fast Track designation granted ABRAXANE^™ by the FDA earlier in 2003, completing the entire filing on March 8, 2004. In May 2004, we announced that American BioScience’s NDA application for ABRAXANE^™ had been accepted for filing with standard review by the FDA, indicating that the FDA had determined that the application is sufficiently complete to permit a substantive review. The FDA action date is within 10 months of completion of the filing, or January 8, 2005. American BioScience has also conducted a Phase II clinical trial to explore a weekly dosing regimen of ABRAXANE^™ in metastatic breast cancer patients in which prior taxane therapy failed and Phase I and/or Phase II trials evaluating ABRAXANE^™ in non-small cell lung, head and neck, ovarian, melanoma and cervical cancers, the rights to which we have licensed. To date, American BioScence has initiated or is planning approximately 36 ABRAXANE^™ clinical trials in various settings, including those listed above, and prostate cancer.

(5) Inventories

Inventories consisted of the following:


	September 30, 2004		December 31, 2003
	(in thousands)
Finished goods	$	41,940	$	30,300
Work in process		19,218		15,948
Raw materials		82,745		64,136

	$	143,903	$	110,384

(6) Accrued Expenses

Accrued expenses consisted of the following:


	September 30, 2004		December 31, 2003
	(in thousands)
Sales and marketing	$	12,688	$	8,932
Payroll and employee benefits		7,737		7,785
Legal and insurance		3,839		6,383
Accrued income taxes		4,239		4,498
Other		1,510		1,522

	$	30,013	$	29,120

(7) Credit Facilities and Non-Recurring Charge

On September 2, 2004 we entered into a $100 million three-year unsecured revolving credit and letter of credit facility . The new credit facility may be extended to $150 million at our request.

The new credit facility replaced a $50 million senior secured revolving credit facility which was put in place in December 2001. As a result of our early termination of the prior credit facility, we recorded a non-recurring, non-cash pretax charge of approximately $2.0 million, or approximately $1.2 million net of applicable income tax, in the 2004 third quarter to write-off unamortized debt acquisition costs related to the prior facility. We had never drawn on the prior facility. Debt acquisition fees of approximately $0.4 million for the new facility will be amortized over its three year term.

Interest rates under the new credit facility vary depending on the type of loan made and our leverage ratio. The interest rate for Base Rate Loans and letters of credit is the greater of the prime rate charged by the lead bank, or the federal funds rate plus 0.5%, less an “Applicable Margin” ranging from minus 50 basis points to zero, depending on our leverage ratio. At September 30, 2004, the interest rate for Base Rate Loans under the credit facility was 4.25%. The credit facility limits the amount of and assesses a 0.125% fee on the face amount of outstanding letters of credit. With respect to the capital stock held by American BioScience, the credit facility prohibits us from declaring or paying any cash dividends or making any other such cash distributions. Additionally, the terms of our September 2004 credit facility limit the principal amount of the demand note received from American BioScience to $23 million, among various other covenants and restrictions. There was no outstanding balance or letters of credit under the new credit facility, and we were in compliance with all covenants, at September 30, 2004.

No interest expense was capitalized during the nine month period ended September 30, 2004.

(8) Stock Options and Restricted Stock

During the nine months ended September 30, 2004, options for the purchase of 733,850 shares of our common stock were granted at a weighted average exercise price of $34.96 and options for 406,920 shares were exercised at a weighted average exercise price of $4.59. Stock-based compensation charges were $0.2 million and $0.3 million for the three months ended September 30, 2004 and 2003, respectively, and $0.7 million and $1.0 million for the nine months ended September 30, 2004 and 2003, respectively.

The following table illustrates the pro forma effect on net income and income per common share had we applied the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2004			2003			2004			2003
	(in thousands, except per share data)
Net income, as reported	$	13,813		$	18,290		$	34,827		$	55,163
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		108			151			399			583
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects		(1,783	)		(1,002	)		(4,144	)		(2,434	)

Pro forma net income	$	12,138		$	17,439		$	31,082		$	53,312

Net income per common share:
Basic - as reported	$	0.20		$	0.26		$	0.50		$	0.79
Basic - pro forma	$	0.17		$	0.25		$	0.44		$	0.77

Diluted - as reported	$	0.19		$	0.25		$	0.48		$	0.76
Diluted - pro forma	$	0.17		$	0.24		$	0.43		$	0.73

(9) Treasury Stock

On April 24, 2003, our Board of Directors amended our stock repurchase program to authorize, from time-to-time, the repurchase of up to an additional $20.0 million of our common stock through open market purchases and/or privately negotiated transactions. No repurchases have been made under the April 24, 2003 authorization.

(10) Litigation

In October and November of 2003, several purported federal securities class action lawsuits were filed against us in the United States District Court for the Northern District of Illinois. All of the class action lawsuits were consolidated in March 2004 and an amended complaint against us, one of our officers, and American BioScience, Inc. was filed in the consolidated cases in May 2004, alleging violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, and rule 10b-5, principally relating to purportedly false and misleading statements made by us regarding ABRAXANE^™. Management believes that these claims are without merit and intends to vigorously defend against these claims.

Additionally, in December 2003 a purported shareholder derivative action was filed in the Circuit Court of Cook County, Illinois, Chancery Division against each member of our Board of Directors and one non-director executive officer. The Company is a nominal defendant in this lawsuit, which alleges claims relating to essentially the same purported misleading statements that are at issue in the pending securities class action lawsuits. In the securities class action lawsuits, the Company denies making any misleading statements. The derivative complaint also alleges claims relating to stock transactions by certain of the director and officer defendants. The Company believes that there are many defects in this complaint and intends to vigorously defend this action.

We are from time to time subject to claims and litigation arising in ordinary courses of business. These claims have included assertions that the 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 the us. In the opinion of management, the ultimate outcome of proceedings of which management is aware, will not have a material adverse effect on our consolidated financial position or results of operations.

(11) Net Sales by Product Line

Net sales by product line is as follows:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2004		2003		2004		2003
	(in thousands)
Critical care	$	41,391	$	44,566	$	125,656	$	126,956
Anti-infective		29,865		21,016		83,914		65,198
Oncology		24,267		23,511		69,274		66,641
Contract manufacturing		91		1,040		3,501		2,756
Other		—		221		111		564

	$	95,614	$	90,354	$	282,456	$	262,115

(12) 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. Through September 30, 2004, we had capitalized $16.5 million in construction in progress for license fees, development and other costs related to this project.

(13) Acquisition of Assets

On July 28, 2004, we acquired certain assets, including a 25,000 square foot manufacturing facility and certain injectable oncology product rights for a purchase price of approximately $11 million in cash, subject to adjustments, including for inventory. Located in Barbengo, Switzerland, the FDA approved facility uses Isolator Technology which is particularly suitable for the manufacture of oncolytic products, including daunorubicin, methotrexate, and leucovorin calcium, for our U.S. operations. We had previously been purchasing products from this facility for resale in the U.S. We anticipate, and it is our intention to, invest in both personnel and systems to enhance quality standards. Additionally, we acquired eight FDA approved ANDAs covering 15 product codes and one ANDA pending with the U.S. FDA. Also included in the transaction were a number of generic injectable oncology products currently marketed in Europe and South America and a number of Marketing Authorization Applications (MAAs) currently approved or pending with the European Agency for the Evaluation of Medicinal Products as well as other products under development. Initially, the acquired facility will continue to supply certain products to our U.S. operations and to sell existing products in Europe and South America to certain third parties. Acquired intangible assets will be amortized over their estimated useful lives, on average, approximately five to seven years.

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

Note Regarding Forward-Looking Statements

Statements contained in this Quarterly Report on 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:

•

the timing of and costs associated with the expected launch of ABRAXANE^™;

•

the timing of any approvals of any ongoing or future NDA applications for ABRAXANE^™;

•

the acceptance of and demand for our existing and new pharmaceutical products;

•

the impact of competitive products and pricing;

•

the ability to successfully manufacture products in an efficient, time-sensitive and cost effective manner;

•

the impact on our products and revenues of patents and other proprietary rights licensed or owned by us, our competitors and other third parties;

•

our ability, and that of our suppliers, to comply with laws, regulations, and standards, and the application and interpretation of those laws, regulations, and standards, that govern or affect the pharmaceutical industry, the non-compliance with which may delay or prevent the sale of our products;

•

the difficulty in predicting the timing or outcome of product development efforts and regulatory approvals;

•

the ability to successfully integrate the recent and potential future acquisitions;

•

evolution of the fee-for-service arrangements being adopted by our major wholesale customers;

•

the impact of recent legislative changes to the governmental reimbursement system.

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.

OVERVIEW

The overview section of Management’s Discussion and Analysis of Financial Conditions and Results of Operations (“MD&A”) is designed to provide the reader with summary level information on: our history, strategy, highlights of our third-quarter 2004 results and an update on our outlook for the remainder of 2004. Following this overview the third-quarter 2004 MD&A is organized as follows:

•

a discussion of our operating results,

•

a review of factors impacting our liquidity and cash flow,

•

a discussion of accounting policies and estimates critical to an understanding of the assumptions and judgments incorporated in our financial results, and

•

information on the license and manufacturing agreements relating to our proprietary oncology product candidate, ABRAXANE^™.

The MD&A should be read in conjunction with our 2003 Annual Report on Form 10-K, including “Item 1: Business”; “Item 6: Selected Financial Data”; and “Item 8: Financial Statements and Supplemental Data.”

Background

We commenced operations in 1996 and reincorporated in Delaware in 2001. We are a majority owned subsidiary of American BioScience, Inc., a California corporation, which at September 30, 2004 owned 47,984,160 shares, or 68.0%, of our outstanding common stock.

We are a specialty pharmaceutical company that develops, manufactures and markets injectable pharmaceutical products. We believe that we are the only independent U.S. public company with a primary focus on the injectable oncology, anti-infective and critical care markets, and we further believe that we offer one of the most comprehensive injectable product portfolios in the pharmaceutical industry. We manufacture products in each of the three basic forms in which injectable products are sold: liquid, powder and lyophilized, or freeze-dried.

We began in 1996 with an initial focus on U.S. marketing and distribution of generic pharmaceutical products manufactured by others. In June 1998, we acquired Fujisawa USA, Inc.’s generic injectable pharmaceutical business including manufacturing facilities in Melrose Park, Illinois and Grand Island, New York and our research and development facility in Melrose Park, Illinois. We also acquired additional assets in this transaction, including inventories, plant and equipment and abbreviated new drug applications that were approved by and pending with the FDA. We have derived substantially all of our revenue since the acquisition from the sale of products manufactured in the facilities acquired from Fujisawa.

In November 2001, we obtained the exclusive North American rights to manufacture and sell ABRAXANE^™, formerly known as ABI-007, a proprietary nanoparticle injectable oncology product that is a patented formulation of paclitaxel. Paclitaxel is the active ingredient in Taxol^®, one of the world’s top selling cancer drugs. A multi-center Phase III clinical trial of ABRAXANE^™ in the treatment of metastatic breast cancer, or breast cancer that has spread to other parts of the body, was completed in 2003 and American BioScience completed the submission of the New Drug Application (“NDA”) filing with the U.S. Food and Drug Administration (“FDA”) in March 2004. In May 2004, we announced that American BioScience’s NDA application for ABRAXANE^™ had been accepted for filing with standard review by the FDA, indicating that the FDA had determined that the application was sufficiently complete to permit a substantive review.

Strategy

Our goal is to expand upon our position as an industry leader in the development, manufacture, sale and distribution of injectable pharmaceutical products, with an intent of offering a broad portfolio of injectable products affecting every aspect of hospital care. Key elements of our strategy include:

•

Continue to focus on new, higher-margin injectable product opportunities, including: our proprietary oncology product candidate, ABRAXANE^™; generic opportunities as products approach patent expiry; low molecular weight heparins; and, as the FDA regulatory environment evolves, generic biological products.

•

Maintain and improve our current Good Manufacturing Practice (“cGMP”) product development and manufacturing capabilities and capacity to meet future market needs and evolving regulatory requirements.

•

Enhance our customer relationships with group purchasing organizations (“GPOs”), specialty distributors and end-user organizations by providing the service level, quality and relationships expected by our customers, further enhanced by our breadth of product offering and sole supplier position for needed products.

•

Make targeted acquisitions to enhance our product offerings, market presence and capabilities, both in the United States and globally.

•

Advance our strategic sourcing capabilities to obtain raw materials, intellectual property, technology and processes necessary to develop and manufacture both future and existing products.

2004 Highlights

•

To date in 2004, we have obtained 15 FDA approvals, including 14 Abbreviated New Drug Application (“ANDA”) approvals, one final approval for a product for which we had already received a tentative approval, and our first NDA approval, Tobramycin Powder. We currently have 14 ANDAs on file and under review at the FDA and over 50 additional products under development.

•

The ABRAXANE^™ NDA filing was completed on March 8, 2004 and on May 9, 2004, we announced that American BioScience’s NDA application for ABRAXANE^™ had been accepted for filing with standard review by the FDA, indicating that the FDA had determined that the application is sufficiently complete to permit a substantive review. The FDA action date is within 10 months of completion of the filing, or January 8, 2005. American BioScience has also conducted a Phase II clinical trial to explore a weekly dosing regimen of ABRAXANE^™ in metastatic breast cancer patients in which prior taxane therapy failed and Phase I and/or Phase II trials evaluating ABRAXANE^™ in non-small cell lung, head and neck, ovarian, melanoma and cervical cancers, the rights to which we have licensed. To date, American BioScence has initiated or is planning approximately 36 ABRAXANE^™ clinical trials in various settings, including those listed above, and prostate cancer.

•

approved or pending with the European Agency for the Evaluation of Medicinal Products as well as other products under development. Initially, the acquired facility will continue to supply certain product to our U.S. operations and to sell existing products in Europe and South America to certain third parties. Acquired intangible assets will be amortized over their estimated useful lives, on average, approximately five to seven years.

2004 Outlook

With respect to the remainder of 2004, we provide the following guidance:

•

With revenue growth year-to-date of 8% together with the recent approval of carboplatin, 2004 net sales are expected to increase approximately 15% over 2003;

•

Fiscal 2004 gross margin in the core business is expected to be in the low to mid 50% range;

•

The FDA accepted the ABRAXANE^™ NDA filing on May 8, 2004 and we are preparing for the potential launch of ABRAXANE^™. Expenses related to ABRAXANE^™, totaling $30.4 million in the first nine months of 2004, are expected to approximate $40 million for all of 2004. In addition, we paid and expensed a $10.0 million milestone payment in the 2004 second quarter triggered upon the FDA’s acceptance of the ABRAXANE^™ NDA filing, and expect to pay a $15.0 million milestone payment 30 days following FDA approval of the NDA. The FDA action date is within 10 months of completion of the NDA filing, or January 8, 2005. The FDA approval milestone would be capitalized and amortized over the estimated life of the product.

Even though the FDA accepted American BioScience’s NDA filing for ABRAXANE^™ for metastatic breast cancer in May 2004, we cannot predict when the FDA will complete its review of the filing or when or if the NDA will be approved. Any resulting profit, as defined in the license agreement, on North American sales of ABRAXANE^™ for licensed indications would be shared equally between American BioScience and us.

If regulatory approval of ABRAXANE^™ for metastatic breast cancer in the United States is not obtained or is substantially delayed, we do not believe there will be any material accumulated adverse impact on earnings or cash flow as marketing and pre-launch costs (excluding inventory) are being expensed as incurred and we would not be required to make any future payments for the achievement of regulatory milestones for any other indication. In addition, we anticipate that we would be able to recover a substantial portion of our investment in paclitaxel raw material inventory; however, we expect that we would have to write-off any commercial ABRAXANE^™ finished goods inventory, of which we currently have none. Pursuant to an agreement that we have with American BioScience, certain costs of any unsaleable ramp-up inventory of ABRAXANE^™ that is manufactured in preparation for its projected launch will be shared equally between us and American BioScience.

RESULTS OF OPERATIONS

Three Months Ended September 30, 2004 and September 30, 2003

The table below sets forth the results of our operations for the periods indicated, and forms the basis for the following discussion of our third quarter operating activities:


	Three Months Ended September 30,						Change Favorable (Unfavorable)
	2004			2003			$			%
	(in thousands, except per share data and percentages)
Consolidated statement of income data:
Net sales
Critical care	$	41,391		$	44,566		$	(3,175	)	(7	)%
Anti-infective		29,865			21,016			8,849		42	%
Oncology		24,267			23,511			756		3	%
Contract manufacturing and other		91			1,261			(1,170	)

Total net sales		95,614			90,354			5,260		6	%
Cost of sales		43,915			41,817			(2,098	)

Gross profit		51,699			48,537			3,162		7	%
Percent to net sales		54.1	%		53.7	%
Operating expenses:
Research and development costs		7,406			4,987			(2,419	)	(49	)%
Percent to net sales		7.7	%		5.5	%
Selling, general and administrative expenses		21,693			13,256			(8,437	)	(64	)%
Percent to net sales		22.7	%		14.7	%
Stock-based compensation		175			256			81		32	%
Equity in net income of Drug Source Co., LLC		(753	)		(551	)		202		37	%

Total operating expenses		28,521			17,948			(10,573	)	(59	)%

Percent to net sales		29.8	%		19.9	%
Operating income		23,178			30,589			(7,411	)	(24	)%
Percent to net sales		24.2	%		33.9	%
Interest income		439			420			19		5	%
Interest expense and other		142			(9	)		151
Loss on early extinguishment of credit facility		(1,986	)		—			(1,986	)

Income before income taxes		21,773			31,000			(9,227	)	(30	)%
Provision for income taxes		7,960			12,710			4,750

Net income	$	13,813		$	18,290		$	(4,477	)	(24	)%

Income per common share:
Basic	$	0.20		$	0.26
Diluted	$	0.19		$	0.25

Weighted-average common shares outstanding:
Basic		70,399			69,585
Diluted		73,025			72,807

Net Sales

Net sales for the 2004 third quarter increased $5.3 million, or 6%, over the prior year third quarter. Growth was driven primarily by strong demand for a range of our anti-infective products, including the newly launched Tobramycin Powder and increased penetration into the specialty oncology distribution channel for Pamidronate, one of our key products.

Gross Profit

As compared to the 2003 third quarter, gross profit increased $3.2 million, or 7%, due primarily to the increase in net sales. Gross profit represented 54.1% of sales in the 2004 quarter, comparable to the 53.7% of sales in the third quarter of 2003.

Research and development (“R&D”)

Third quarter 2004 R&D expense increased $2.4 million, or 49%, as compared to the 2003 third quarter due primarily to increased development activity on the generic side of the business and a $0.9 million increase in pre-production development work on ABRAXANE^™.

Selling, general and administrative (“SG&A”)

As compared to the 2003 third quarter, SG&A expense increased $8.4 million, or 64%, in the 2004 third quarter due primarily to a $7.1 million increase in sales and marketing costs in anticipation of approval and launch of ABRAXANE^™. The remaining increase was attributable to higher professional services, infrastructure and staffing requirements resulting from continued growth in the core generics business. Excluding the investment in ABRAXANE^™ pre-launch costs, SG&A expense for the core injectable business was 15.0% and 14.4% of sales in the 2004 and 2003 third quarters, respectively.

Other Expenses

Drug Source Company, LLC, is a 50% owned company, and is a selling agent of raw material to the pharmaceutical industry, including APP. Our investment in Drug Source Company is intended to both generate a return on our investment and to strengthen our strategic sourcing capabilities over time. Because our 50% ownership interest in Drug Source Company does not provide financial or operational control of Drug Source Company, we account for our interest in Drug Source Company under the equity method. As compared to the prior year quarter, our equity income in Drug Source Company increased $0.2 million, to $0.8 million, in the 2004 third quarter due primarily to the introduction of new products by Drug Source Company. Research and development expense included no raw material purchases from Drug Source Company in either the 2004 and 2003 third quarter. Ending inventory included raw material purchases from Drug Source Company of $1.7 million and $0.8 million at September 30, 2004 and December 31, 2003, respectively.

Interest income consists primarily of interest earned on the intercompany note from American BioScience and interest earned on invested cash, and was comparable between the 2004 and 2003 third quarters. Interest expense and other consists primarily of miscellaneous interest expense and other financing costs. The third-quarter 2004 credit resulted primarily from foreign exchange gains on our intercompany trading account with our wholly owned Canadian subsidiary, Pharmaceutical Partners of Canada.

Loss on early extinguishment of credit facility

In the third quarter of 2004 we recorded a non-recurring, non-cash pretax charge of $2.0 million, or $1.2 million net of applicable income tax, to write-off unamortized debt acquisition costs related to the early extinguishment of our prior five-year credit facility.

Provision for income taxes

Our effective income tax rate in the 2004 third quarter was 36.6% as compared to 41.0% in the comparable prior year quarter. The decline was due to a lower effective state income tax rate, favorable experience as a standalone tax entity and resolution of tax matters.

Nine months Ended September 30, 2004 and September 30, 2003

The table below sets forth the results of our operations for the periods indicated, and forms the basis for the following discussion of our year-to-date operating activities:


	Nine Months Ended September 30,						Change Favorable (Unfavorable)
	2004			2003			$			%
	(in thousands, except per share data and percentages)
Consolidated statement of income data:
Net sales
Critical care	$	125,656		$	126,956		$	(1,300	)	(1	)%
Anti-infective		83,914			65,198			18,716		29	%
Oncology		69,274			66,641			2,633		4	%
Contract manufacturing and other		3,612			3,320			292

Total net sales		282,456			262,115			20,341		8	%
Cost of sales		133,229			116,792			(16,437	)

Gross profit		149,227			145,323			3,904		3	%
Percent to net sales		52.8	%		55.4	%
Operating expenses:
Research and development costs		21,346			16,130			(5,216	)	(32	)%
Percent to net sales		7.6	%		6.2	%
Selling, general and administrative expenses		65,583			37,389			(28,194	)	(75	)%
Percent to net sales		23.2	%		14.3	%
Milestone payment		10,000			—			(10,000	)
Stock-based compensation		650			989			339		34	%
Equity in net income of Drug Source Co., LLC		(1,991	)		(1,049	)		942		90	%

Total operating expenses		95,588			53,459			(42,129	)	(79	)%

Operating income		53,639			91,864			(38,225	)	(42	)%

Interest income		1,284			1,315			(31	)	(2	)%
Interest expense and other		50			317			(267	)
Loss on early extinguishment of credit facility		(1,986	)		—			(1,986	)

Income before income taxes		52,987			93,496			(40,509	)	(43	)%
Provision for income taxes		18,160			38,333			20,173

Net income	$	34,827		$	55,163		$	(20,336	)	(37	)%

Income per common share:
Basic	$	0.50		$	0.79
Diluted	$	0.48		$	0.76

Weighted-average common shares outstanding:
Basic		70,234			69,643
Diluted		73,127			72,693

Net Sales

Net sales increased $20.3 million, or 8%, in the first nine months of 2004 as compared to the same prior year period. The 2004 increase resulted primarily from recent product launches, unit sales growth for certain key oncolytic products and strong demand for anti-infective products, partially offset by the impact of price declines which occurred during late 2003 on certain products.

Gross Profit

As compared to the first nine months of 2003, gross profit increased $3.9 million, or 3%, in the first nine months of 2004 , representing 52.8% of sales in the 2004 period as compared to 55.4% of sales in the first nine months of 2003. Gross profit margins declined primarily due to the impact of price declines, principally in late 2003 on key products launched in 2002 and the cost and sales impact of an extended seasonal plant shut-down in the 2004 first quarter.

R&D

R&D expense increased by $5.2 million, or 32%, in the first nine months of 2004 as compared to the 2003 period due principally to a $4.5 million increase in ABRAXANE^™ pre-production costs, and increased development activity, and the timing of such activity, on the generic side of the business.

SG&A

As compared to the first nine months of 2003, SG&A expense increased $28.2 million, or 75%, in the 2004 period due to $22.8 million in ABRAXANE^™ sales and marketing pre-launch costs, as well as increased risk management costs and staffing requirements resulting from growth in the core injectable business. Excluding the investment in ABRAXANE^™ pre-launch costs, SG&A for the core injectable business were 15.1% and 14.0% of sales in the first nine months of 2004 and 2003, respectively.

Other Expenses

In the second quarter of 2004, we expensed and paid a $10.0 million milestone payment to American BioScience triggered by the FDA’s May 8, 2004 acceptance of the ABRAXANE^™ NDA filing.

Stock-based compensation expense declined by $0.3 million as compared to the first nine months of 2003 due primarily to the lower stock price at period end, and the accelerated amortization schedule used to expense pre-IPO grants. Stock-based compensation expense results primarily from the issuance, prior to our initial public offering, of stock based compensation for which the exercise price was less than the estimated fair value of common stock on the grant date.

As compared to the first nine months of 2003, equity income in Drug Source Company increased $0.9 million, to $2.0 million, in the 2004 period due primarily to the introduction of new products by Drug Source Company. Research and development expense includes raw material purchases from Drug Source Company of $0.3 million and $0.2 million in the year-to-date 2004 and 2003 periods, respectively.

Interest income consists primarily of interest earned on the intercompany note from American BioScience and interest earned on invested cash and was comparable between the 2004 and 2003 periods. Interest expense and other consists primarily of miscellaneous interest expense and other financing costs. The credits in both 2004 and 2003 resulted primarily from foreign exchange gains on our intercompany trading account with our wholly owned Canadian subsidiary, Pharmaceutical Partners of Canada.

Loss on early extinguishment of credit facility

In the third quarter of 2004 we recorded a non-recurring, non-cash pretax charge of approximately $2.0 million, or approximately $1.2 million net of applicable income tax, to write-off unamortized debt acquisition costs related to the early extinguishment of our prior five-year credit facility.

Provision for income taxes

Our 2004 provision for income taxes included the benefit of a $1.7 million one-time investment tax credit finalized in the second quarter. Absent this one-time benefit, our effective income tax rate in the 2004 first nine months was 37.5% as compared to 41.0% in the comparable prior period with the decline due to a lower effective state income tax rate, favorable experience as a standalone tax entity and resolution of tax matters.

LIQUIDITY AND CAPITAL RESOURCES

Overview

The following table summarizes key elements of our financial position and sources and (uses) of cash and cash equivalents for the periods identified:


	September 30, 2004			December 31, 2003
	(in thousands)
Summary Financial Position:
Cash and cash equivalents	$	61,943		$	58,625

Working capital	$	179,814		$	160,019

Total assets	$	342,526		$	303,785

Total stockholders’ equity	$	289,603		$	246,061


	Nine Months Ended September 30,
	2004			2003
	(in thousands)
Summary of Sources and (Uses) of Cash and Cash Equivalents:
Operating activities	$	31,317		$	57,653

Investing activities	$	(31,506	)	$	(17,539	)

Financing activities	$	3,368		$	(16,825	)

We believe that our current cash and short-term investments, cash generated from operations, funds available under our revolving line of credit and the ability to issue debt or equity securities under our shelf registration will be sufficient to finance our operations, including pre-launch activity relating to ABRAXANE^™, product development and capital expenditures for at least the next 12 months and foreseeable future. In the event we engage in future acquisitions or other extraordinary corporate events we may have to raise additional capital through additional borrowings or the issuance of debt or equity securities pursuant to our shelf registration or otherwise.

Capital Requirements

Our capital requirements depend on numerous factors, including:

•

working capital requirements and sales and marketing costs required to fund the ABRAXANE^™ commercialization effort;

•

the need for manufacturing expansion and improvement and information technology requirements;

•

the requirements of our recent, and of any potential future, acquisitions, asset purchases or equity investments;

•

the amount of cash generated by operations;

•

the possible repurchase of up to an additional $20.0 million of our common stock as authorized by our Board of Directors on April 24, 2003.

We presently anticipate that our 2004 capital expenditure requirements will approximate $35 - $40 million.

Adequate funds for these and other purposes may not be available when needed or on terms acceptable to us, and we may need to raise capital that may not be available on terms favorable or acceptable to us, if at all. Any additional equity financing may be dilutive to stockholders, and debt financing, if available, may include restrictive covenants. If we cannot raise money when needed, we may have to reduce or slow ABRAXANE^™ pre-launch activities, reduce capital expenditures or scale back development of new products.

Sources of Financing

In addition to available cash on hand and cash flow from operations, we have additional financing available under our new $100 million credit facility established in September 2004, and up to $150 million potentially available under a universal shelf registration statement filed in September 2003, which are further described below:

•

Our credit facility consists of an unsecured, three-year, $100 million revolving line of credit which can be increased to $150 million at our request . There were no balances outstanding under our credit facility and we were in compliance with all covenants at September 30, 2004. Compared to our prior credit facility, our new credit facility is larger, more flexible and provides us with enhanced financial capacity to support continued growth of our base and proprietary businesses at a lower cost of capital, with fewer restrictive covenants.

•

On September 5, 2003, we filed a universal shelf registration statement on Form S-3, which was declared effective by the Securities and Exchange Commission on September 22, 2003. Under the shelf registration statement, we may from time to time, offer and sell up to $150 million of our common stock (which may include some or all of the our 6,646,398 treasury shares), debt securities, common stock warrants and/or debt warrants at prices and on terms to be determined at the time of the offering of such securities. If and when we offer and sell these securities, we anticipate using the resulting proceeds for general corporate purposes including efforts related to the commercialization of ABRAXANE^™. The terms of any offering under the universal shelf registration would be determined at the time of the offering. We cannot assure you that any offering under the universal shelf will be available to us on terms acceptable or favorable to us. Additionally, American BioScience may, from time to time, sell up to 3,000,000 shares of our common stock under the shelf registration. We would not receive any proceeds from the sale of shares of our common stock by American BioScience. As of the date of this filing, no securities have been offered under the shelf registration and we currently do not have any plans to offer securities pursuant to this shelf registration.

Sources and Uses of Cash

Operating Activities

Cash flow from operating activities is our primary source of liquidity. Net cash provided by operating activities was $31.3 million in the first nine months of 2004 as compared to $57.7 million in the same period last year. The decrease in cash provided by operating activities was due primarily to: a $26.5 million increase in ABRAXANE^™ sales, marketing and development expense; the $10.0 million milestone payment triggered upon the FDA’s May 2004 acceptance of the ABRAXANE^™ NDA filing; and a $33.5 million increase in inventory. The higher 2004 inventory levels resulted from increased anti-infective inventory requirements, increased raw material and work-in-process inventory relating to ABRAXANE^™ and inventory for pending and recently launched products. We had $34.4 million and $27.6 million of paclitaxel raw material inventory on hand at September 30, 2004 and December 31, 2003, respectively. These 2004 uses of cash from operating activities were partially offset by a $22.8 million decrease in accounts receivable due primarily to the impact of timing issues related to cash payments versus chargebacks processed in the third quarter of 2004.

Investing Activities

Our investing activities consist principally of capital expenditures necessary to expand and maintain our manufacturing capabilities and infrastructure and, to a lesser extent, outlays necessary to acquire various product or intellectual property rights. Net cash used in investing activities totaled $31.5 million and $17.5 million in the first nine months of 2004 and 2003, respectively. The 2004 increase resulted from the purchase of certain assets, including a manufacturing facility in Switzerland and certain injectable oncology rights in the 2004 second quarter for approximately $11 million in cash, and a higher level of capital expenditures supporting additional or improved manufacturing capacity and information technology initiatives.

Financing Activities

Financing activities generally include cash flows from the issuance or repurchase of our common stock, proceeds from the exercise of employee stock options and transactions with American BioScience, our parent company. Net cash provided by financing activities totaled $3.4 million in the first nine months of 2004 as compared to $16.8 million used in the same period in 2003. First nine months 2004 financing activities included $4.4 million in cash proceeds from the exercise of employee stock options and sale of stock through the employee stock purchase program. Financing activities in the 2003 first nine months included the repurchase of 1,596,081 shares of our common stock on the open market for $20.0 million pursuant to the stock repurchase program.

Stock Repurchase Program

On April 24, 2003, our Board of Directors amended our stock repurchase program to authorize the repurchase, from time to time, of up to an additional $20.0 million of our common stock through open market purchases and/or privately negotiated transactions. No repurchases have been made under the April 24, 2003 authorization. During the 2003 first quarter, pursuant to a December 10, 2002 authorization by our Board of Directors, we repurchased 1,596,081 of our shares for $20.0 million. In aggregate, the 6,646,398 common shares held as treasury stock at December 31, 2003 have a cost basis of $8.47 per share.

ABRAXANE^™ LICENSE AND MANUFACTURING AGREEMENT

American BioScience would use payments made under the license agreement and we understand such payments have been and will be used both to fund the development of ABRAXANE^™ in relation to our licensed product rights and for other purposes.

On May 9, 2004 we announced that the FDA had accepted, meaning that the FDA found the NDA complete on its face in all respects, American BioScience’s NDA filing for the first potential ABRAXANE^™ indication being studied, metastatic breast cancer. This FDA acceptance triggered a $10.0 million milestone payment to American BioScience which was expensed and paid in the second quarter of 2004. Additionally, upon FDA approval of the NDA for metastatic breast cancer, we will be required to pay American BioScience an additional $15.0 million which will be capitalized and amortized over the expected life of the product, subject to periodic review for impairment. Regulatory achievements related to other licensed indications under study, including lung, ovarian and prostate cancers, will trigger further milestone payments to American BioScience, but only after ABRAXANE^™ has received NDA approval related to the breast cancer indication. Such payments generally total $17.5 million per agreed indication. As with the indication of breast cancer, those payments earned prior to FDA approval for each indication will be expensed, while amounts earned upon FDA approval of those indications will be capitalized and amortized over the expected life of the product. We have the option not to make one or more of the milestone payments tied to certain indications under study if, following breast cancer approval, sales of the product do not meet specified levels.

Under the license agreement, any profit on ABRAXANE^™ sales in North America would be shared equally between American BioScience and us. The license agreement defines profit as ABRAXANE^™ net sales less cost of goods sold, selling expenses (including pre-launch production and other expenses which we will continue to expense as incurred, but which will be accumulated and charged against first profit under the agreement) and an allocation of related general and administrative expenses. We will expense American BioScience’s share of any profit earned in our statements of income. Any costs and expenses related to product recalls and product liability claims generally will be split equally between American BioScience and us and expensed as incurred. Pursuant to an agreement that we have with American BioScience, certain costs of any unsaleable ramp-up inventory of ABRAXANE^™ that is manufactured in preparation for its projected launch will be shared equally between us and American BioScience.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates in our condensed consolidated financial statements are discussed below. Actual results could vary from those estimates.

Revenue recognition

We recognize revenue from the sale of a product when that product is shipped to a customer, acceptance terms are fulfilled and no significant contractual obligations remain. We sell a majority of our products to wholesalers, who generally sell our products to hospitals or alternative healthcare facilities at contractual prices previously agreed upon between us and group purchasing organizations, or GPOs, on behalf of end users such as hospitals. GPOs enter into collective purchasing contracts with pharmaceutical suppliers for products in an effort to secure favorable drug pricing on behalf of their members. We invoice wholesalers at our wholesale list price. Net sales represent our wholesale list price offset by wholesaler chargebacks, further adjusted for estimated discounts and contractual allowances, including GPO fees. Wholesaler chargebacks represent the difference between the wholesale list price and the estimated contractual sales price, based upon our historical experience ratings.

The most significant estimates that affect net sales are wholesaler chargebacks, sales credits and cash discounts. The wholesaler chargeback calculation is computed as described in the following paragraph. The allowances for doubtful accounts, cash discounts and sales credits are estimated monthly by applying historical percentages (based on credits issued for each category), which are reassessed periodically, to the product sales for the month.

Chargebacks

The majority of our products are distributed through independent pharmaceutical wholesalers. In accordance with industry practice, sales to wholesalers are initially transacted at wholesale list price. The wholesalers then generally sell to an end user, normally a hospital, alternative healthcare facility, or an independent pharmacy, at a lower price previously contractually established between the end user (directly or through a GPO) and us.

When we initially record a sale to a wholesaler, the sale and resulting receivable are recorded at our list price. However, experience indicates that most of these selling prices will eventually be reduced to a lower, end-user contract price. Therefore, at the time of the sale, a contra asset is recorded for, and revenue is reduced by, the difference between the list price and the estimated average end-user contract price. This is calculated by product code, taking the expected number of outstanding wholesale units sold that will ultimately be sold under end-user contracts multiplied by the anticipated, weighted-average contract price. Thus, a contra asset is established, reducing the initial wholesaler receivable by the difference between the initial list price and the estimated, ultimate end-user selling price. In addition, cash advance credits are also periodically issued to wholesalers as a standard trade practice and an estimated reserve for such discounts is established at the time of sale. When the wholesaler ultimately sells the product to the end user at the end-user contract price, the wholesaler charges us (a “chargeback”) for the difference between the list price and the end-user contract price and such chargeback is offset against our initial estimated contra asset.

Expense recognition

Cost of sales represents the costs of the products which we have sold and consists of labor, raw materials, components, packaging, quality assurance and quality control, shipping and manufacturing overhead costs and the cost of finished products purchased from third parties. Our inventories are valued at the lower of cost or market as determined under the first-in, first-out (“FIFO”) method.

Research and development costs are expensed as incurred or consumed and consist primarily of salaries and other personnel-related expenses, as well as depreciation of equipment, allocable facility, raw material and production expenses, and contract and consulting fees. We have invested and will continue to invest in research and development to expand our new product offerings and grow our business.

Selling, general and administrative expenses consist primarily of salaries, commissions and other personnel-related expenses, as well as costs for travel, trade shows and conventions, promotional material and catalogs, advertising and promotion, facilities, risk management and professional fees. We believe that our selling, general and administrative expenses will continue to increase inline with the growth of our core generic and proprietary business.

Stock-based compensation

Stock-based compensation related to research and development costs and selling, general and administrative expenses are presented separately in our consolidated statements of operations. Stock-based compensation represents the difference between the exercise price of options granted and the deemed fair value of our common stock on the grant date in accordance with Accounting Principles Board Opinion No. 25 Accounting for Stock Issued to Employees and its related interpretations. We recognize stock-based compensation over the option vesting period, typically four years, primarily on an accelerated basis using the graded vesting method in accordance with Financial Accounting Standards Board Interpretation No. 28 Accounting for Stock Appreciation Rights and Other Variable Stock Option Plans.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our activities. Some of the securities that we invest in may have interest rate risk. This means that a change in prevailing interest rates may cause the fair value of the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the prevailing rate and the prevailing rate later rises, the fair value of the principal amount of our investment will probably decline.

To minimize this risk, we intend to maintain an investment portfolio of cash equivalents and short-term investments consisting of high credit quality securities, including commercial paper, government and non-government debt securities and money market funds. We do not use derivative financial instruments. The average maturity of the debt securities in which we invest has been less than 90 days and the maximum maturity has been three months. Because our investments are diversified and are of a short-term nature, a hypothetical one or two percentage point change in interest rates would not have a material effect on our consolidated financial statements.

We have operated primarily in the United States and the majority of our activities outside the United States to date have been conducted in U.S. dollars. Our only other significant foreign currency transactions are generally transacted in Canadian dollars, and we do not believe we have a material exposure to foreign currency risk because of the relative stability of the Canadian dollar in relation to the U.S. dollar. A 10% adverse change in currency exchange rates of the Canadian versus the U.S. dollar would not have a material effect on our consolidated results of operations, financial position, or cash flows. Accordingly, we have not had any material exposure to foreign currency exchange rate fluctuations.

During the third quarter of 2004, we acquired a facility in Switzerland which manufactures and markets products for our U.S. operations and in Europe and South America. As a result of this transaction, we will have increased transactional and translational exposure to fluctuations in foreign currency exchange rates, primarily with respect to European currencies. We do not currently expect the transactional foreign

exchange risk to be significant in the near term and we would expect over the longer term to potentially mitigate transactional exposure to foreign currency risk by entering into forward currency hedging contracts. We will also have exposure related to the translation of financial statements from the local currency of foreign operations into U.S. dollars, our functional and reporting currency. We do not expect the potential gain or loss due to foreign currency translation, assuming a 10% aggregate increase or decrease in the respective currencies, to be material to our financial statements in the near term. We do not anticipate hedging our translational exposure.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

We have carried out an evaluation, under the supervision and with the participation of management, including our chief executive officer and our chief financial officer of the effectiveness of our internal disclosure controls and procedures as of the end of the period covered by this report. Based on their evaluation, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and are functioning effectively to provide reasonable assurance that we can meet our disclosure obligations. Consistent with the SEC’s recommendations to public companies, we have formed a disclosure committee consisting of key personnel designed to review the accuracy and completeness of all disclosures made by us.

(b) Changes in internal controls.

There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their most recent evaluation.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

ITEM 6. EXHIBITS

10.26(1)

Credit Agreement dated September 2, 2004 among American Pharmaceutical Partners, Inc., Fifth Third Bank, Wachovia Bank, and various lenders.

31.1

Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a), as required by Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a), as required by 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 added by Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as added by Section 906 of the Sarbanes-Oxley Act of 2002.

(1)	Incorporated by reference to Exhibit 10.26 to Registrant’s Form 8-K filed with the Securities and Exchange Commission on September 9, 2004.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


AMERICAN PHARMACEUTICAL PARTNERS, INC.

By:		/s/ PATRICK SOON-SHIONG
		Patrick Soon-Shiong, M.D.
		Chief Executive Officer and President
		(Principal Executive Officer)

By:		/s/ NICOLE S. WILLIAMS
		Nicole S. Williams
		Executive Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)

Date: November 9, 2004

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