Avid Bioservices, Inc. - Quarter Report: 2004 July (Form 10-Q)

ITEM 1.          FINANCIAL STATEMENTS

PEREGRINE PHARMACEUTICALS, INC.

PEREGRINE PHARMACEUTICALS, INC.

See accompanying notes to condensed consolidated financial statements

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PEREGRINE PHARMACEUTICALS, INC.

See accompanying notes to condensed consolidated financial statements

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PEREGRINE PHARMACEUTICALS, INC.

See accompanying notes to condensed consolidated financial statements

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8.              SEGMENT REPORTING

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                This Form 10-Q contains forward-looking statements based on our current expectations. In some cases, you can identify these statements by terminology such as “may”, “should”, “plans”, “believe”, “will”, “anticipate”, “estimate”, “expect”, or “intend”, including their opposites or similar phrases or expressions. You should be aware that these statements are projections or estimates as to future events and are subject to a number of factors that may tend to influence the accuracy of the statements. These forward-looking statements should not be regarded as a representation by the Company or any other person that the events or plans of the Company will be achieved. Actual results may differ materially from these forward looking statements.

                To gain a better understanding of the  risk factors that may tend to influence the accuracy of our forward looking statements, we recommend that you read the risk factors identified in the Company’s Annual Report on Form 10-K for the year ended April 30, 2004. Although we believe that the risks described in the 10-K represent all material risks currently applicable to us, additional risks and uncertainties not presently known to us or that are currently not believed to be important to us may also affect our actual future results and could harm our business, financial condition and results of operations.

Company Overview

                Peregrine Pharmaceuticals, Inc., located in Tustin, California, is a biopharmaceutical company primarily engaged in the research, development, manufacture and commercialization of cancer therapeutics and cancer diagnostics through a series of proprietary platform technologies using monoclonal antibodies. The Company was originally incorporated in California in June 1981 and was reincorporated in the state of Delaware on September 25, 1996. We are organized into two reportable operating segments: (i) Peregrine, the parent company, is engaged in the research and development of novel therapeutics and (ii) Avid Bioservices, Inc., (“Avid”) our wholly-owned subsidiary, is engaged in providing contract manufacturing and development of biologics for biopharmaceutical and biotechnology companies.

                We are primarily focused on developing therapeutic agents that affect blood vessels and blood flow in cancer and other diseases. Our vascular research programs fall under several different proprietary platforms including Anti-Phospholipid Therapy (“APT”), Vascular Targeting Agents (“VTAs”), anti-Angiogenesis and Vasopermeation Enhancement Agents (“VEAs”). Peregrine’s first APT agent is scheduled to enter into clinical trials during calendar year 2004. These therapeutic agents may have applications in the treatment of cancer and other diseases such as viral infections, diabetes, arthritis, skin disorders and eye diseases.

                Our most clinically advanced therapeutic program is based on a targeting platform outside vascular biology. This technology platform is known as Tumor Necrosis Therapy (“TNT”) and targets dead or dying tumor cells that are common to the majority of different tumor types and deliver therapeutic agents that kill nearby living tumor cells.

                In January 2002, we commenced operations of our wholly-owned subsidiary, Avid Bioservices, Inc., which was formed from the facilities and expertise of Peregrine. Avid produces monoclonal antibodies and recombinant proteins for Peregrine and other biotechnology companies to support Phase I through Phase III clinical trials in stirred tank bioreactors. In order to expand our current capacity and to meet our needs and the needs of our customers, we have ordered a 1,000 liter bioreactor we anticipate will be installed and operational before the end of calendar year 2004. The 1,000 liter bioreactor will augment our functioning 22.5 liter, 100 liter and 300 liter bioreactors.

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Results of Operations

                The following table compares the statement of operations for the three month periods ended July 31, 2004 and July 31, 2003. This table provides you with an overview of the changes in the condensed consolidated statement of operations for the comparative periods, which changes are further discussed below.

                 Results of operations for the interim periods covered by this quarterly report on Form 10-Q may not necessarily be indicative of results of operations for the full fiscal year.

                 Total Revenues.  The increase in revenues of $132,000 during the three months ended July 31, 2004 compared to the same period in the prior year was due to an increase in contract manufacturing revenue of $132,000 associated with an increase in the number of active projects compared to the same three month period in the prior year. During the quarter ended July 31, 2004, we actively worked on six different antibodies compared to four antibodies in the prior year quarter for unrelated entities. We also expect contract manufacturing revenue to increase during the remainder of the current fiscal year based on the anticipated completion of projects under our current contract manufacturing agreements and the anticipated demand for Avid’s services. In addition, we will more than double Avid’s production capacity during the current fiscal year through the addition of a 1,000 liter bioreactor. Although Avid currently has a number of active projects and outstanding project proposals with various potential customers, we cannot estimate nor can we determine the likelihood that we will be successful in completing these ongoing projects or converting any of these proposals into definitive agreements during the remainder of fiscal year 2005.

                 Cost of Contract Manufacturing.  The increase in cost of contract manufacturing of $130,000 during the three months ended July 31, 2004 compared to the same period in the prior year was primarily related to the current three month increase in contract manufacturing revenue. We expect cost of contract manufacturing to increase during the current fiscal year based on the anticipated completion of projects under our current contract manufacturing agreements.

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                 Research and Development Expenses.  The increase in research and development expenses of $698,000 during the three months ended July 31, 2004 compared to the same period in the prior year was primarily due to an increase in (i) Tarvacin™ pre-clinical development expenses including technology license fees and toxicology studies, (ii) sponsored research fees and (iii) payroll and related expenses. During the quarter ended July 31, 2004, Tarvacin™ pre-clinical program expenses increased $539,000 to $570,000 compared to $31,000 in the same prior year primarily due to increased toxicology and other non-clinical studies being conducted over the current three month period. Sponsored research fees increased $109,000 to $265,000 in the current three month period compared to $156,000 in the same period in the prior year primarily due to increased funding under a sponsored research agreement to support additional research studies associated with our VEA technology. In addition, payroll and related expenses associated with clinical operations and research and development increased $180,000 to $478,000 during the quarter ended July 31, 2004 compared to $298,000 in same period in the prior year primarily due to the increase in active research programs including our planned Phase I study using Tarvacin™.

                 These increases in research and development expenses were offset by a decrease in manufacturing expenses. During the three months ended July 31, 2004, manufacturing expenses decreased $156,000 to $507,000 compared to $663,000 in the same period in the prior year primarily due to a decrease in our use of Avid’s manufacturing facility during the current quarter combined with an increase customer related projects.

                 We expect research and development expenses to increase over the near term primarily under the following ongoing research and development programs:

                 Due to the number of ongoing research programs, if we fail to obtain additional funding during fiscal year 2005, we may be forced to scale back our product development efforts or our operations in a manner that will ensure we can pay our obligations as they come due in the ordinary course of business through at least April 30, 2005.

                 The following represents the research and development expenses (“R&D Expenses”) we have incurred by each major platform technology under development:

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                 From inception to April 30, 1998, we expensed $20,898,000 on research and development of our product candidates, with the costs primarily being closely split between the TNT and Oncolym technologies. In addition to the above costs, we expensed an aggregate of $32,004,000 for the acquisition of our TNT and VTA technologies, which were acquired during fiscal years 1995 and 1997, respectively.

                 Looking beyond the current fiscal year, it is extremely difficult for us to reasonably estimate all future research and development costs associated with each of our technologies due to the number of unknowns and uncertainties associated with pre-clinical and clinical trial development. These unknown variables and uncertainties include, but are not limited to:

                 We or our potential partners will need to do additional development and clinical testing prior to seeking any regulatory approval for commercialization of our product candidates as all of our products are in discovery, pre-clinical or clinical development. Testing, manufacturing, commercialization, advertising, promotion, exporting and marketing, among other things, of our proposed products are subject to extensive regulation by governmental authorities in the United States and other countries. The testing and approval process requires substantial time, effort and financial resources, and we cannot guarantee that any approval will be granted on a timely basis, if at all. Companies in the pharmaceutical and biotechnology industries have suffered significant setbacks in conducting advanced human clinical trials, even after obtaining promising results in earlier trials. Furthermore, the United States Food and Drug Administration may suspend clinical trials at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk. Even if regulatory approval of a product is granted, such approval may entail limitations on the indicated uses for which it may be marketed. Accordingly, we or our potential partners may experience difficulties and delays in obtaining necessary governmental clearances and approvals to market our products, and we or our potential partners may not be able to obtain all necessary governmental clearances and approvals to market our products.

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                  Selling, General and Administrative Expenses.  Selling, general and administrative expenses consist primarily of compensation expense, director fees, facility, travel, legal and accounting fees, insurance, and other expenses relating to our general management, finance, administrative and business development activities. The decrease in selling, general and administrative expenses of $52,000 during the three months ended July 31, 2004 compared to the same period in the prior year is primarily due to a decrease in director fees offset by an increase in legal fees and stock-based compensation expense. During the quarter ended July 31, 2004, director fees decreased $199,000 to $57,000 compared to $256,000 in the same prior year period primarily due to a one-time aggregate director fee of $180,000 incurred during the prior year quarter ended July 31, 2003 associated with our director’s increased oversight responsibilities mandated by the Sarbanes-Oxley Act of 2002. Prior to fiscal year 2004, directors did not receive any cash compensation other than the reimbursement of expenses. This decrease in director fees was offset by an increase in legal fees, which increased $53,000 to $72,000 during the quarter ended July 31, 2004, compared to $19,000 in the same prior year period primarily due to an increase in general corporate activity. In addition, during the three months ended July 31, 2003, stock-based compensation expense increased $79,000 to $82,000 compared to $3,000 in the same prior year period primarily due to an increase in amortization expenses associated with the fair value of stock options granted to non-employee consultants performing business development activities. The options were valued using the Black-Scholes valuation model and are being amortized over the estimated period of service or related vesting period.

                 Interest and Other Expense.  The decrease in interest and other expense of $1,359,000 during the three months ended July 31, 2004 compared to the same three month period in the prior year was primarily due to a $1,340,000 decrease in non-cash interest expense associated with the amortization of the convertible debt discount and debt issuance costs. We did not incur any interest expense associated with convertible debt discount and debt issuance costs during the quarter ended July 31, 2004 as all outstanding convertible debt was converted into common stock and the associated discount and issuance costs were fully amortized in the prior fiscal year.

Critical Accounting Policies

                 The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results we report in our condensed consolidated financial statements. We evaluate our estimates and judgments on an on-going basis. We base our estimates on historical experience and on assumptions that we believe to be reasonable under the circumstances. Our experience and assumptions form the basis for our judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may vary from what we anticipate and different assumptions or estimates about the future could change our reported results. We believe the following accounting policies are the most critical to us, in that they are important to the portrayal of our financial statements and they require our most difficult, subjective or complex judgments in the preparation of our condensed consolidated financial statements: 

                 Revenue Recognition.  We currently derive revenues primarily from licensing agreements associated with Peregrine’s technologies under development and from contract manufacturing services provided by Avid. We recognize revenues pursuant to Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as well as the recently issued Staff Accounting Bulletin No. 104, Revenue Recognition. These bulletins draw on existing accounting rules and provides specific guidance on how those accounting rules should be applied. Revenue is generally realized or realizable and earned when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the seller’s price to the buyer is fixed or determinable, and ( iv) collectibility is reasonably assured.

                 Revenues associated with licensing agreements primarily consist of nonrefundable up-front license fees and milestones payments. Revenues under licensing agreements are recognized based on the performance requirements of the agreement. Nonrefundable up-front license fees received under license agreements, whereby continued performance or future obligations are considered inconsequential to the relevant licensed technology, are generally recognized as revenue upon delivery of the technology. Milestone payments are generally recognized as revenue upon completion of the milestone assuming there are no other continuing obligations. Nonrefundable up-front license fees, whereby we have an ongoing involvement or performance obligation, are generally recorded as deferred revenue and generally recognized as revenue over the term of the performance obligation or relevant agreement. Under some license agreements, the obligation period may not be contractually defined. Under these circumstances, we must exercise judgment in estimating the period of time over which certain deliverables will be provided to enable the licensee to practice the license.

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                 Contract manufacturing revenues are generally recognized once the service has been provided and/or upon shipment of the product to the customer. We also record a provision for estimated contract losses, if any, in the period in which they are determined.

                 In July 2000, the Emerging Issues Task Force (“EITF”) released Issue 99-19 (“EITF 99-19”), Reporting Revenue Gross as a Principal versus Net as an Agent. EITF 99-19 summarized the EITF’s views on when revenue should be recorded at the gross amount billed to a customer because it has earned revenue from the sale of goods or services, or the net amount retained (the amount billed to the customer less the amount paid to a supplier) because it has earned a fee or commission. In addition, the EITF released Issue 00-10 (“EITF 00-10”), Accounting for Shipping and Handling Fees and Costs, and Issue 01-14 (“EITF 01-14”), Income Statement Characterization of Reimbursements Received for “Out-of-Pocket” Expenses Incurred. EITF 00-10 summarized the EITF’s views on how the seller of goods should classify in the income statement amounts billed to a customer for shipping and handling and the costs associated with shipping and handling. EITF 01-14 summarized the EITF’s views on when the reimbursement of out-of-pocket expenses should be characterized as revenue or as a reduction of expenses incurred. Our revenue recognition policies are in compliance with EITF 99-19, EITF 00-10 and EITF 01-14 whereby we record revenue for the gross amount billed to customers (the cost of raw materials, supplies, and shipping, plus the related handling mark-up fee) and record the cost of the amounts billed as cost of sales as we act as a principal in these transactions.

                 Allowance for Doubtful Receivables.  We continually monitor our allowance for all receivables. A considerable amount of judgment is required in assessing the ultimate realization of these receivables and we estimate an allowance for doubtful accounts based on factors that appear reasonable under the circumstances.

Liquidity and Capital Resources

                 Our cash and cash equivalents totaled $11,956,000 at July 31, 2004. We have expended substantial funds on the development of our product candidates and for clinical trials and we have incurred negative cash flows from operations for the majority of our years since inception. Since inception, we have generally financed our operations primarily through the sale of our common stock and issuance of convertible debt, which has been supplemented with payments received from various licensing collaborations and through the revenues generated by Avid. We expect negative cash flows from operations to continue until we are able to generate sufficient revenue from the contract manufacturing services provided by Avid and/or from the licensing of Peregrine’s products under development.

                 Revenues earned by Avid during the quarter ended July 31, 2004 amounted to $485,000. We expect that Avid will continue to generate revenues which should lower cash flows used in operations, although we expect those near term revenues will be insufficient to fully cover cash flows used in operations. As such, we will continue to need to raise additional capital to provide for our operations, including the anticipated development and clinical trial costs of Tarvacin™ and Cotara®, the anticipated development costs associated with Anti-Phospholipid Therapy, Vasopermeation Enhancement Agents (“VEA’s”) and Vascular Targeting Agents (“VTA’s”), and the potential expansion of Avid’s manufacturing capabilities. If we fail to obtain additional funding during the remainder of the current fiscal year, we may be forced to scale back our product development efforts or our operations in a manner that will ensure we can pay our obligations as they come due in the ordinary course of business.

                 We plan to raise additional capital through the registered offer and sale of shares of our common stock from our current shelf registration statement on Form S-3, File No. 333-109982. As of August 31, 2004, we had approximately 8,757,000 shares available for possible future transactions under the shelf registration statement. However, given uncertain market conditions and the volatility of our stock price, we may not be able to sell our securities in public offerings or private placements at prices and on terms that are favorable to us, if at all.

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                 In addition to equity financing, we are always actively exploring various other sources of cash by utilizing our many assets. We believe we have a broad intellectual property portfolio that allows us to develop products in-house while at the same time we can out-license certain areas of the technology we cannot focus on developing internally. In addition, for the products that we do develop internally, we may seek a licensing or development partner after we have generated clinical proof of efficacy, which we believe will generate the most value to the Company. We are also seeking to out-license or partner products we do not have sufficient financial resources to develop internally, such as the registration trial using Cotara® for the treatment of brain cancer, which final stage trial would require significant financial resources to complete. Such licensing or partnering arrangements may require us to relinquish our rights to our technologies, products or marketing territories, or to grant licenses on terms that are not favorable to us. We also have the facilities of Avid that we may utilize for non-dilutive financing. During the past fiscal year, we have had discussions with several parties interested in either partnering or acquiring Avid. Provided that the right opportunity and financial terms are presented to us and further provided that the manufacturing needs of our customers and Peregrine are not jeopardized, we would be open to a possible strategic transaction related to Avid.

                 There can be no assurances that we will be successful in raising additional funds on terms acceptable to us, or at all, or that sufficient additional capital will be raised to complete the research, development, and clinical testing of our product candidates beyond fiscal year 2005.

                 Significant components of the changes in cash flows from operating, investing and financing activities for the three months ended July 31, 2004 are as follows:

                 Cash Used In Operating Activities.  During the quarter ended July 31, 2004, cash used in operating activities increased $634,000 to $2,827,000 compared to $2,193,000 for the three months ended July 31, 2003. This increase was primarily due to a $629,000 increase in net cash used in operating activities before considering the changes in operating assets and liabilities calculated as follows:

                This increase in net cash used in operating activities before changes in operating assets and liabilities of $629,000 was primarily due to an increase in research and development activities associated with Tarvacin™ pre-clinical program expenses and the increase in active research programs including our planned Phase I study using Tarvacin™.

                Cash Used In Investing Activities.  Net cash used in investing activities increased $69,000 to $158,000 for the three months ended July 31, 2004 compared to $89,000 for the three months ended July 31, 2003 primarily due to installment payments made on a 1,000-liter bioreactor to be installed during calendar year 2004 offset by a decrease in property acquisitions.

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                Cash Provided By Financing Activities.  Net cash provided by financing activities decreased $7,410,000 to $57,000 for the three months ended July 31, 2004 compared to net cash provided of $7,467,000 for the three months ended July 31, 2003 due to a decrease in financing activities during the current quarter. During the three months ended July 31, 2004, we received net proceeds of $57,000 from the exercise of options compared to the three months ended July 31, 2003, which we received net proceeds of $7,467,000 from the sale of our common stock and the exercise of options and warrants.

Commitments

                 At July 31, 2004, we had no material capital commitments, other than the balances owed for the 1,000-liter bioreactor and related facility improvements ordered by Avid in the amount of $146,000. In addition, we have significant obligations under license agreements that are contingent on clinical trial development milestones.

Risk Factors of Our Company

                 The biotechnology industry includes many risks and challenges. Our challenges may include, but are not limited to: uncertainties associated with completing pre-clinical and clinical trials for our technologies; the significant costs to develop our products as all of our products are currently in development, pre-clinical studies or clinical trials and no revenue has been generated from commercial product sales; obtaining additional financing to support our operations and the development of our products; obtaining regulatory approval for our technologies; complying with governmental regulations applicable to our business; obtaining the raw materials necessary in the development of such compounds; consummating collaborative arrangements with corporate partners for product development; achieving milestones under collaborative arrangements with corporate partners; developing the capacity to manufacture, market and sell our products, either directly or indirectly with collaborative partners; developing market demand for and acceptance of such products; competing effectively with other pharmaceutical and biotechnological products; attracting and retaining key personnel; protecting proprietary rights; accurately forecasting operating and capital expenditures, other capital commitments, or clinical trial costs and general economic conditions. A more detailed discussion regarding our industry and business risk factors can be found in our Annual Report on Form 10-K for the year ended April 30, 2004, as filed with the Securities and Exchange Commission on July 14, 2004.