##### Table of Contents




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UNITED
STATES


SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





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FORM 10-Q





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(MARK ONE)





x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934.





FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002,





OR





 ̈

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934.





For the transition period from ___________ to __________.





Commission file number: 0-20772





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QUESTCOR PHARMACEUTICALS, INC.


(Exact name of Registrant as specified in its
charter)





CALIFORNIA

33-0476164(State or other jurisdiction

(I.R.S.Employerof incorporation or organization)

Identification No.)





3260 Whipple Road


Union City, CA 94587-1217


(Address of Principal Executive Offices)





REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 400-0700





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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 prior 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  ̈





At May 8, 2002 there were 38,451,554 shares of the Registrants common stock, no par value per share, outstanding.





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QUESTCOR PHARMACEUTICALS, INC.





FORM 10-Q





TABLE OF CONTENTS





PagePART I.    FINANCIAL INFORMATIONItem 1

Financial Statements and Notes (Unaudited)

3Consolidated Balance SheetsMarch 31, 2002 and December 31, 2001

3Consolidated Statements of Operationsfor the three months ended March 31, 2002and 2001

4Consolidated Statements of Cash Flowsfor the three months ended March 31, 2002 and 2001

5Notes to Consolidated Financial Statements

6Item 2

Managements Discussion and Analysis of Financial Condition and Results of Operations

9Item 3

Quantitative and Qualitative Disclosures about Market Risk

13PART II.    OTHER INFORMATIONItem 1

Legal Proceedings

14Item 2

Changes in Securities and Use of Proceeds

14Item 3

Defaults upon Senior Securities

14Item 4

Submission of Matters to a Vote of Security Holders

14Item 5

Other Information

14Item 6

Exhibits and Reports

14Signatures

15




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##### Table of Contents




ITEM 1.    
FINANCIAL STATEMENTS





QUESTCOR PHARMACEUTICALS, INC.





CONSOLIDATED BALANCE SHEETS


(IN THOUSANDS)





March 31, 2002


December 31, 2001(Unaudited)


(Note 1)ASSETSCurrent assets:Cash and cash equivalents (which included a compensating balance of $5,000 at December 31, 2001)

$
10,063


$
10,183Short-term investments


296



388Accounts receivable, net of allowance for doubtful accounts of $86 at March 31, 2002 and $78 at December 31, 2001



958



672Inventories


32



96Prepaid expenses and other current assets


1,215



377Total current assets


12,564



11,716Property and equipment, net


575



602Purchased technology and goodwill, net


1,378



1,638Deposits and other assets


1,152



1,116Total assets

$
15,669


$
15,072LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)Current liabilities:Accounts payable

$
1,184


$
1,095Accrued compensation


401



575Unissued common stock






960Other accrued liabilities


1,522



1,070Note payable to bank






5,000Short-term debt and current portion of long-term debt


1,367



368Current portion of capital lease obligations


45



57Total current liabilities


4,519



9,125Convertible debentures, (face amount of $4,000), net of deemed discount of $1,443


2,557



Long-term debt


39



121Other non-current liabilities


1,054



1,045CommitmentsPreferred stock, subject to redemption


5,081



5,081Stockholders equity (deficit):Common stock


77,156



74,018Deferred compensation


(16
)


(20
)Accumulated deficit


(74,515
)


(74,183
)Accumulated other comprehensive income (loss)


(206
)


(115
)Total stockholders equity (deficit)


2,419



(300
)Total liabilities and stockholders equity

$
15,669


$
15,072





See accompanying notes.




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QUESTCOR PHARMACEUTICALS, INC.





CONSOLIDATED STATEMENTS OF OPERATIONS


(UNAUDITED)


(IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)





Three Months EndedMarch 31, 2002


March 31, 2001Revenues:Net product sales

$
3,806


$
701Contract research and grant revenue


45



225Technology revenue






90Royalty revenue


3



Total revenues


3,854



1,016Operating costs and expenses:Cost of product sales


576



361Sales and marketing


1,332



644General and administrative


1,332



744Research and development


461



747Non-cash stock based compensation


267



15Depreciation and amortization


344



559Total operating costs and expenses


4,312



3,070Loss from operations


(458
)


(2,054
)Non-cash amortization of deemed discount on convertible debentures


(44
)


Interest income, net


27



27Other income, net


71



Rental income, net


72



155Net loss

$
(332
)

$
(1,872
)Basic and diluted net loss per common share

$
(0.01
)

$
(0.07
)Weighted average shares of common stock outstanding


37,843



25,371








See accompanying notes.




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##### Table of Contents




QUESTCOR PHARMACEUTICALS, INC.





CONSOLIDATED STATEMENTS OF CASH FLOWS


(UNAUDITED)





INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS


(IN THOUSANDS)





Three Months EndedMarch 31, 2002


March 31, 2001OPERATING ACTIVITIESNet loss

$
(332
)

$
(1,872
)Adjustments to reconcile net loss to net cash used in operating activities:Compensation expense related to stock options


267



(4
)Amortization of deemed discount on convertible debentures


44



Depreciation and amortization


344



559Deferred rent expense


10



Gain on the sale of equipment


(2
)


Changes in operating assets and liabilities:Accounts receivable


(286
)


(344
)Inventories


64



31Prepaid expenses and other current assets


(838
)


(284
)Accounts payable


89



562Accrued compensation and employee benefits


(174
)


187Accrued development costs






(23
)Other accrued liabilities


453



(479
)Net cash flows used in operating activities


(361
)


(1,667
)INVESTING ACTIVITIESProceeds from the maturity of short-term investments, net






499Purchase of property and equipment


(67
)


(6
)Increase in other liabilities






8Sale of property and equipment


13



Decrease in other assets


44



72Net cash flows (used in) provided by investing activities


(10
)


573FINANCING ACTIVITIESIssuance of common stock, net


348



42Issuance of convertible debentures


4,000



Short-term borrowings


1,019



Repayment of note payable to bank


(5,000
)


Repayment of long-term debt


(102
)


(70
)Repayments of capital lease obligations


(14
)


(34
)Net cash flows provided by (used in) financing activities


251



(62
)Decrease in cash and cash equivalents


(120
)


(1,156
)Cash and cash equivalents at beginning of period


10,183



6,818Cash and cash equivalents at end of period

$
10,063


$
5,662SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:Cash paid for interest

$
33


$
117





See accompanying notes.




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##### Table of Contents




QUESTCOR PHARMACEUTICALS, INC.





NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





1.    BASIS OF PRESENTATION





Questcor Pharmaceuticals, Inc. (the Company) was
incorporated in California in 1990. The Company is an integrated specialty pharmaceutical company focused on the acquisition and marketing of acute care and critical care hospital/specialty pharmaceutical and related healthcare products. The Company
currently markets five products in the U.S.: HP Acthar ® Gel (Acthar), an injectable drug that helps
patients with infantile spasm, or West Syndrome; Ethamolin ® , an injectable drug used to treat enlarged weakened blood
vessels at the entrance to the stomach that have recently bled, known as esophageal varices; Glofil  -125 and Inulin
in Sodium Chloride, which are both injectable agents that assess the kidney function by measuring glomerular filtration rate, or kidney function; and VSL#3  , a patented probiotic marketed as a dietary supplement, to promote normal gastrointestinal (GI) function. Probiotics are living organisms in food and dietary supplements, which, upon
ingestion in certain numbers, improve the health of the host beyond their inherent basic nutrition. Additionally, the Company earns royalties from their strategic partner, Crinos Industria Farmacobiologica S.p.A. (Crinos), on sales in
Italy of Pramidin ® , an intranasal form of metoclopramide for the treatment of various gastrointestinal disorders.





The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with generally
accepted accounting principles and applicable Securities and Exchange Commission regulations for interim financial information. These financial statements do not include all of the information and footnotes required by generally accepted accounting
principles for complete financial statements. The unaudited financial statements should be read in conjunction with the audited financial statements and related footnotes included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2001, as filed on March 19, 2002 with the Securities and Exchange Commission. In the opinion of the Companys management, all adjustments (consisting of normal recurring adjustments) considered necessary for fair presentation of
interim financial information have been included. Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. Certain amounts in the prior
quarters financial statements have been reclassified to conform with the current quarters presentation. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated.





2.    CASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS





The Company considers highly liquid investments with maturities from the date of purchase of three months or less to be
cash equivalents. At March 31, 2002, the Company had cash, cash equivalents and short-term investments of $10,359,000. Following is a summary of cash, cash equivalents and short-term investments based on quoted market prices for these investments:





March 31, 2002


December 31, 2001Money market funds

$
8,682


$
4,943Certificates of deposit






5,000Corporate equity investments


296



3888,978



10,331Less amounts classified as cash equivalents


(8,682
)


(9,943
)Short-term investments

$
296


$
388





At March 31, 2002, the equity investment had a cost of $500,000 and an unrealized
loss of $204,000. At December 31, 2001 the equity investment had a cost of $500,000 and an unrealized loss of $112,000.




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##### Table of Contents




3.    INVENTORIES





Inventories are stated at the lower of cost (first-in, first-out method) or market and are comprised of finished goods of $112,000 and $152,000 net of an allowance for obsolete
inventories of $80,000 and $56,000 at March 31, 2002 and 2001, respectively.





4.    PURCHASED TECHNOLOGY AND GOODWILL





In July 2001, the FASB issued Statement No. 141, Business Combinations (SFAS 141) and Statement No. 142,
Goodwill and Other Intangible Assets (SFAS 142). SFAS 141 establishes new standards for accounting and reporting for business combinations and will require that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 and also specifies the criteria for the recognition of intangible assets separately from goodwill. SFAS 142 establishes new standards for goodwill, including the elimination of goodwill amortization to be replaced with
methods of periodically evaluating goodwill for impairment. The Companys adoption of SFAS 142 as of January 1, 2002 did not have a material impact on its financial statements. Goodwill and other indefinite lived intangible assets no
longer subject to amortization amounted to $479,000 at March 31, 2002. The remaining net balance of $899,000 relates to purchased technology and will be amortized over the estimated sales life of the associated product (seven years).





5.    NOTE PAYABLE





In December 1998, RiboGene, Inc. (RiboGene), a company that Questcor merged with in 1999, borrowed $5.0 million pursuant to a long-term note payable to a bank. The note required monthly interest only payments at prime plus 1.0%.
In November 2000, the $5.0 million long-term note payable was converted into $5.0 million cash secured facility. The minimum $5.0 million compensatory balance, which was invested in certificates of deposit, is included in cash and cash equivalents
at December 31, 2001. The note was paid in full on January 18, 2002.





6.    LINE OF CREDIT





On January 2, 2002, the Company entered into a revolving accounts receivable line of credit with an asset based lending division of a bank. Under the
Agreement, the Company can borrow up to the lesser of 80% of the eligible accounts receivable balance or $3,000,000. Interest accrues on outstanding advances at an annual rate equal to prime rate plus four and one-half percent. The term of the line
is one year. As of March 31, 2002, borrowings under the line of credit were $900,000.





7.    CONVERTIBLE DEBENTURES





On March 15, 2002, the Company issued $4.0 million of 8% convertible debentures to an institutional investor, and Defiante
Farmaceutica Unipessoal L.D.A. (Defiante), a wholly-owned subsidiary of Sigma-Tau Finanzaria S.p.A (Sigma-Tau). The Company will pay interest on the debentures at a rate of 8% per annum on a quarterly basis. The debentures
are convertible into shares of the Companys common stock at a fixed conversion price of $1.58 per share (subject to adjustment for stock splits and reclassifications). The debentures mature on March 15, 2005.





The Company may redeem the debentures for cash prior to maturity after March 15, 2003, provided the average of the closing sale price of the
Companys common stock for the twenty (20) consecutive trading days prior to the delivery of the optional prepayment notice to the holders of the debentures is equal to or greater than $3.16 per share, and the Company has satisfied certain
equity conditions. At the end of the term of the debentures, under certain circumstances, the Company may redeem any outstanding debentures for stock. The Company may redeem the institutional investors debentures for stock at maturity,
provided the total aggregate number of shares of the Companys common stock issued to them (including shares issuable upon conversion of




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their debenture and shares issuable upon exercise of their warrant) does not exceed 7,645,219 shares (representing 19.999% of the total number of issued and outstanding shares of the
Companys common stock as of March 15, 2002). The Company may redeem Defiantes debenture for stock at maturity, provided the market price of the Companys common stock at the time of redemption is greater than $1.50 per share
(representing the five day average closing sale price of the Companys common stock immediately prior to March 15, 2002).





The Company issued warrants to the institutional investor, Defiante and the placement agent to acquire an aggregate of 1,618,987 shares of common stock at an exercise price of $1.70 per share. The warrants expire on March 15, 2006. The
warrants issued to the institutional investor and Defiante were assigned a value of $843,000. The warrants issued to the placement agent were assigned a value of $82,000. The warrants were valued using the Black-Scholes method with the following
assumptions: a risk-free interest rate of 5%; an expiration date of March 15, 2006; volatility of 0.72; and a dividend yield of 0%. In connection with the issuance of the debentures and warrants, the Company recorded $641,000 related to the
beneficial conversion feature on the convertible debentures. The total amount of the deemed discount on the convertible debentures as a result of the warrant issuance and the beneficial conversion feature amounts to $1,484,000. The beneficial
conversion feature and warrant value will be amortized over the term of the debentures.





8.    NET LOSS PER SHARE





Under SFAS No. 128, Earnings Per Share, basic and diluted loss per share is based on net loss for the relevant period,
divided by the weighted average number of common shares outstanding during the period. Diluted earnings per share gives effect to all potential dilutive common shares outstanding during the period such as options, warrants, convertible preferred
stock, and contingently issuable shares. Diluted net loss per share has not been presented separately as, due to the Companys net loss position, it is anti-dilutive. Had the Company been in a net income position at March 31, 2002, shares used
in calculating diluted earnings per share would have included the dilutive effect of an additional 8,012,905 stock options, 2,155,715 convertible preferred shares, 2,531,646 convertible debentures, placement unit options for 986,898 shares and
4,804,172 warrants.





9.    STOCK OPTIONS AND WARRANTS





As permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), the Company has elected to account for
stock options and purchase rights granted to employees using the intrinsic value method and, accordingly, does not recognize compensation expense for options and purchase rights granted to employees with exercise prices which are not less than the
fair value of the underlying common stock.





For equity awards to non-employees, including lenders and lessors, the Company
applies the Black-Scholes method to determine the fair value of such instruments. The options and warrants granted to non-employees are re-measured as they vest and the resulting value is recognized as expense over the period of services received or
the term of the related financing. On March 22, 2002, the Board of Directors elected to accelerate the vesting for all options issued to non-employees. As a result, the Company recorded a non-cash charge of $112,000, which is included in
Non-cash stock based compensation on the Consolidated Statement of Operations. Non-cash stock based compensation of $267,000 relates to the following operating expenses for the three months ended March 31, 2002 and 2001:





THREE MONTHS ENDEDMARCH 31, 2002

MARCH 31, 2001Sales and marketing

$
44

$
General and administrative


199


12Research and development


24


3$
267

$
15




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ITEM 2.

MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS





Except for the historical information contained herein, the following discussion
contains forward-looking statements that involve risks and uncertainties, including statements regarding the period of time during which our existing capital resources and income from various sources will be adequate to satisfy our capital
requirements. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this section, as well as those discussed in our
annual report on form 10-K for the fiscal year ended December 31, 2001, including Item 1 Business of Questcor, and including without limitation Risk Factors, as well as factors discussed in any documents incorporated by
reference herein or therein.





Overview





We are an integrated specialty pharmaceutical company focused on the acquisition and marketing of acute care and critical care hospital/specialty pharmaceutical and related healthcare products. We currently market
five products in the U.S.: HP Acthar ® Gel (Acthar), an injectable drug that helps patients with infantile
spasm, or West Syndrome; Ethamolin ® , an injectable drug used to treat enlarged weakened blood vessels at the entrance
to the stomach that have recently bled, known as esophageal varices; Glofil  -125 and Inulin in Sodium Chloride,
which are both injectable agents that assess the kidney function by measuring glomerular filtration rate, or kidney function; and VSL#3  , a patented probiotic marketed as a dietary supplement, to promote normal gastrointestinal function. Probiotics are living organisms in food and dietary supplements, which, upon ingestion in certain numbers, improve the
health of the host beyond their inherent basic nutrition. Additionally, we earn royalties from our strategic partner, Crinos Industria Farmacobiologica S.p.A. (Crinos), on sales in Italy of Pramidin ® , an intranasal form of metoclopramide for the treatment of various gastrointestinal disorders.





For the quarter ended March 31, 2002, our research and development programs included the following products: Emitasol  for delayed onset emesis, (the vomiting associated with cancer chemotherapy patients), Hypnostat  for sleep disorders, Panistat  for panic disorders, the Glial Excitotoxin Release Inhibitors (GERI) compounds as cytoprotective agents and Ceresine  for Congenital Lactic Acidosis (CLA). The development of Hypnostat  and Panistat  will be controlled by Fabre-Kramer. The future development of
Emitasol  , the GERI compounds and Ceresine  will be dependent in part on our ability to enter into partnership arrangements or secure additional sources of capital to fund our development efforts. As we rely on current and future
strategic partners to develop and fund the remaining projects, we are unable to project estimated completion dates. We have limited control, if any, over these programs due to our reliance on partners for their development. Accordingly, our ability
to disclose historical and future costs associated with these projects is limited.





We have sustained an accumulated deficit of
$74.5 million from inception through March 31, 2002. Based on our internal forecast and projections, we believe that our cash on hand and the cash to be generated through the expected sale of our products will be sufficient to fund operations
through December 31, 2002. While it is our goal to reach cash flow breakeven before the end of 2002, if we are unable to achieve the revenue forecast for 2002 or if our expenses and costs associated with running our operations exceed our estimates,
we may not reach cash flow breakeven before the end of 2002, if ever, and we may incur significant operating losses over the next several years. Results of operations may vary significantly from quarter to quarter depending on, among other factors,
the results of our sales efforts, the availability of raw materials and finished goods from our sole-source manufacturers, the timing of certain expenses, the establishment of strategic alliances and corporate partnering and the receipt of milestone
payments. (See Liquidity and Capital Resources.)





Critical Accounting Policies





Our management discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses,
and related




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disclosures. On an on-going basis, we evaluate our estimates, including those related to sales allowances, bad debts, inventories, investments and intangible assets. We base our estimates on
historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent
from other sources. Actual results may differ from these estimates.





We believe the following critical accounting policies
affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.





Sales Allowances





We record estimated sales allowances against product revenues for expected returns,
chargebacks and cash discounts for prompt payment. We estimate product returns based on historical return experience, the shelf life of our products (ranging from 45 days to 3 years) and compliance with our returned goods policy. If historical
return experience differs from estimated future returns, or if a new product has return experience different than our estimate, this could negatively impact our revenue.





Intangible Assets





We have intangible assets
related to goodwill and other acquired intangibles. The determination of related estimated useful lives and whether or not these assets are impaired involves significant judgment. Changes in strategy and/or market conditions could significantly
impact these judgments and require adjustments to recorded asset balances. We review intangible assets, as well as other long-lived assets, for impairment whenever events or circumstances indicate that the carrying amount may not be fully
recoverable. As discussed in the notes to the consolidated financial statements, $479,000 of goodwill and other indefinite lived intangible assets are no longer subject to amortization at March 31, 2002.





Results of Operations





For the quarter ended
March 31, 2002, we incurred a net loss of $332,000 or $0.01 per share, as compared to a net loss of $1,872,000, or $0.07 per share for the quarter ended March 31, 2001, a reduction of $1,540,000 or 82%.





For the quarter ended March 31, 2002, net product sales increased $3,105,000 or 443% to $3,806,000 from $701,000 for the quarter ended March 31, 2001.
The increase in product revenues was due primarily to sales of Acthar ® , which was introduced in the third quarter of
2001. The increase in product revenues was also due to the shipment of backorders outstanding at December 31, 2001 amounting to $334,000 for Acthar ® and $408,000 for Ethamolin ® . Without these backorders, product revenues would
have been $3,064,000, an increase of $2,363,000 or 337% over the quarter ended March 31, 2001.





Contract research and grant
revenue decreased $180,000 or 80% for the quarter ended March 31, 2002 from $225,000 for the comparable quarter ended March 31, 2001. This decrease was a result of lower reimbursement under the Small Business Innovation Research (SBIR)
grant due to less activity taking place with the GERI compound research projects in the quarter ended March 31, 2002, as compared to the quarter ended March 31, 2001.





For the quarter ended March 31, 2002, we did not recognize any technology revenue. During the quarter ended March 31, 2001, we recognized $90,000 in technology revenue related to a
one-time payment under our license agreement with Tularik, Inc. Royalty revenue for the quarter ended March 31, 2002 was $3,000, a 100% increase as compared to the quarter ended March 31, 2001. Royalty revenue represents sales of
Pramidin ® in Italy, under our license agreement with Crinos Industria Farmacobiologic SpA.




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Total revenues for the quarter ended March 31, 2002 increased $2,838,000 or 279% to $3,854,000
from total revenues of $1,016,000 for the comparable quarter ended March 31, 2001.





Cost of product sales increased 60% to
$576,000 during the quarter ended March 31, 2002 from $361,000 in the comparable quarter ended March 31, 2001. This increase was due to greater material costs as a result of the higher product sales for the quarter. However, cost of product sales as
a percentage of net product sales decreased to 15% for the quarter ended March 31, 2002 from 51% for the quarter ended March 31, 2001, primarily due to a change in product mix for the quarter ended March 31, 2002 as compared to the quarter ended
March 31, 2001.





Sales and marketing expenses for the quarter ended March 31, 2002 were $1,332,000, which represents an increase
of $688,000 or 107% as compared to $644,000 for the comparable quarter ended March 31, 2001. The increase is primarily due to salary and other costs associated with the expansion of our sales and marketing departments, and increased marketing costs
to support our newer products, Acthar ® and VSL#3  .





General and administrative
expenses for the quarter ended March 31, 2002 were $1,332,000, which represents an increase of $588,000 or 79%, compared to $744,000 in the quarter ended March 31, 2001. The increase was primarily related to increased legal fees associated with
potential product acquisitions, professional services costs and other administrative expenses.





Research and development
expenses for the quarter ended March 31, 2002 were $461,000, which represents a decrease of $286,000 or 38%, as compared to $747,000 for the quarter ended March 31, 2001. Since the completion of our merger with RiboGene in 1999, we have reduced our
focus on research and development of non-marketed products and reduced our headcount accordingly. The decrease was related to lower salary and related expenses related to our research and development activities. Should we elect to undertake any
development work, we expect to fund future clinical trials and additional research and development from our anticipated revenues. Should our revenue projections differ from actual results we would expect our research and development costs to
increase or decrease accordingly.





Non-cash amortization of deemed discount on convertible debentures for the quarter ended
March 31, 2002 was $44,000 due to the current quarters amortization of deemed discount related to the convertible debentures.





Interest income, net was unchanged for the quarter ended March 31, 2002, as compared the comparable quarter ended March 31, 2001.





Other income, net increased by $71,000 or 100% for the quarter ended March 31, 2002 primarily due to the receipt of profits arising from short swing stock trades executed by one of our 10% shareholders.





Rental income, net decreased to $72,000 during the quarter ended March 31, 2002, from $155,000 in the comparable quarter ended March 31,
2001, due to a one-time sublease termination fee of $130,000 by the former sublessor of our Carlsbad facility in the quarter ended March 31, 2001, offset by increased sublease income in the current period as a result of the complete sublease of our
Hayward facility commencing in July 2001.





Liquidity and Capital Resources





We have principally funded our activities to date through various issuances of equity securities, which, through March 31, 2002, have raised total net proceeds of $45.9 million, and to a
lesser extent through product sales.





At March 31, 2002, we had cash, cash equivalents and short-term investments of $10,359,000
compared to $10,571,000 at December 31, 2001 (including a compensating balance of $5,000,000). At March 31, 2002, working capital was $8,045,000 compared to $2,591,000 at December 31, 2001. The increase in working capital was principally due to the
issuance of $4,000,000 convertible debentures coupled with increased product sales for




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the period. Currently we use cash earnings as a measure of our performance. Cash earnings/(burn) is defined as net loss excluding certain non-cash charges (depreciation and amortization, non-cash
amortization of deemed discount on convertible debentures, and non-cash stock based compensation.) Cash earnings for the quarter ended March 31, 2002 were $323,000, an improvement of $1,621,000 as compared to cash burn of $1,298,000 for the quarter
ended March 31, 2001.





As a result of the merger with RiboGene, we assumed $5 million of long-term debt financing with a bank.
The note required us to make monthly interest payments, at prime plus 1% (5.75% at December 31, 2001), with the principal payment due at the end of the three-year term (December 2001). The note had a 90-day extension period, and the notes term
was extended to March 2002. We paid the note in full on January 18, 2002.





On January 2, 2002, we entered into a revolving
accounts receivable line of credit. Under the agreement, we can borrow up to the lesser of 80% of our eligible accounts receivable balance or $3,000,000. Interest accrues on outstanding advances at an annual rate equal to prime rate plus four and
one-half percent. The term of the agreement is one year. As of March 31, 2002, we had a balance of $900,000 under the line of credit, which has been subsequently paid.





We lease four buildings with lease terms expiring between 2004 and 2012. Annual rent payments for all of our facilities in 2002 are estimated to be $1,449,000. We utilize the Union City
facility as our headquarters and the Carlsbad facility as our warehousing and distribution center. Annual rent payments for 2002 for these facilities are $660,000. We have subleased laboratory space and laboratory equipment in Hayward, California
for a term of six years and anticipate that we will receive $949,000 in 2002 as sublease income to be used to pay the annual rental expense of $651,000 in 2002. The Lees Summit facility was closed in May 2001 and this facility is currently
available for sublease. Lease payments under the facility in Lees Summit, Missouri are $138,000 for 2002. Additionally, we have other contractual obligations as of December 31, 2001 as shown in the table below:





Payments Due by PeriodContractual Obligations

Total

1 Year or Less

Greater Than 1 to 3 Years

4 to 5 Years

After 5 Years(In thousands)Notes Payable

$
5,489

$
5,368

$
121

$


$
Capital Lease Obligations


58


57


1





Operating Leases


14,819


1,449


3,046


2,760


7,564Total Contractual Cash Obligations

$
20,366

$
6,874

$
3,168

$
2,760

$
7,564





We also hold 83,333 shares of Rigel Pharmaceuticals, Inc. (NASD: RIGL) common
stock that we received in conjunction with the agreement to sell Rigel exclusive rights to certain of our proprietary antiviral drug research technology. As of April 16, 2002, the shares had a market value of $399,000. It is our intention to sell
these securities when it is practical.





On March 15, 2002, we issued $4.0 million of 8% convertible debentures to an
institutional investor, and Defiante Farmaceutica Unipessoal L.D.A. (Defiante), a wholly-owned subsidiary of Sigma-Tau Finanzaria S.p.A (Sigma-Tau). We will pay interest on the debentures at a rate of 8% per annum on a
quarterly basis. The debentures are convertible into shares of our common stock at a fixed conversion price of $1.58 per share (subject to adjustment for stock splits and reclassifications). The debentures mature on March 15, 2005.





We may redeem the debentures for cash prior to maturity after March 15, 2003, provided the average of the closing sale price of our common
stock for the twenty (20) consecutive trading days prior to the delivery of the optional prepayment notice to the holders of the debentures is equal to or greater than $3.16 per share, and we have satisfied certain equity conditions. At the end of
the term of the debentures, under certain circumstances we may redeem any outstanding debentures for stock. We may redeem the institutional investors debenture for




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stock at maturity, provided the total aggregate number of shares of our common stock issued to them (including shares issuable upon conversion of their debenture and shares issuable upon exercise
of their warrant) does not exceed 7,645,219 shares (representing 19.999% of the total number of issued and outstanding shares of our common stock as of March 15, 2002). We may redeem Defiantes debenture for stock at maturity, provided the
market price of our common stock at the time of redemption is greater than $1.50 per share (representing the five day average closing sale price of our common stock immediately prior to March 15, 2002).





We issued warrants to the institutional investor, Defiante and the placement agent to acquire an aggregate of 1,618,987 shares of common stock at an
exercise price of $1.70 per share. The warrants expire on March 15, 2006. The warrants issued to the institutional investor and Defiante were assigned a value of $843,000. The warrants issued to the placement agent were assigned a value of $82,000.
The warrants were valued using the Black-Scholes method with the following assumptions: a risk-free interest rate of 5%; an expiration date of March 15, 2006; volatility of 0.72; and a dividend yield of 0%. In connection with the issuance of the
debentures and warrants, we recorded $641,000 related to the beneficial conversion feature on the convertible debentures. The total amount of the deemed discount on the convertible debentures as a result of the warrant issuance and the beneficial
conversion feature amounts to $1,484,000. The beneficial conversion feature and warrant value will be amortized over the term of the debentures.





Based on our internal forecast and projections, we believe that our cash on hand and the cash to be generated through the expected sale of our products will be sufficient to fund operations through December 31, 2002.
While it is our goal to reach cash flow breakeven before the end of 2002, if we are unable to achieve the revenue forecast for 2002 or if our expenses and costs associated with running our operations exceed our estimates, we may not reach cash flow
breakeven before the end of 2002, if ever, and we may incur significant operating losses over the next several years. Our future funding requirements will depend on many factors, including: the timing and extent of product sales, our ability to
receive product timely from our contract manufacturers, any expansion or acceleration of our development programs; the acquisition and licensing of products, technologies or compounds, if any; the results of preclinical studies and clinical trials
conducted by us or our collaborative partners or licensees, if any; our ability to manage growth; competing technological and market developments; costs involved in filing, prosecuting, defending and enforcing patent and intellectual property
claims; the receipt of licensing or milestone fees from current or future collaborative and license agreements, if established; the timing of regulatory approvals; and other factors.





We may seek additional funds through public or private equity financings or from other sources. Should this occur, there can be no assurance that additional funds can be obtained on
desirable terms or at all. We may seek to raise additional capital whenever conditions in the financial markets are favorable, even if we do not have an immediate need for additional cash at that time.





ITEM 3.    
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Our exposure to market risk at March 31, 2002 has not changed materially from
December 31, 2001, and reference is made to the more detailed disclosures of market risk included in our 2001 Form 10-K as filed with the Securities and Exchange Commission on March 19, 2002.




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PART II.    OTHER INFORMATION





ITEM 1.    
LEGAL PROCEEDINGS





Not applicable





ITEM 2.    
CHANGES IN SECURITIES AND USE OF PROCEEDS





Not applicable





ITEM 3.    
DEFAULTS UPON SENIOR SECURITIES





Not applicable





ITEM 4.    
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS





Not Applicable





ITEM 5.    
OTHER INFORMATION





Not applicable





ITEM 6.    
EXHIBITS AND REPORTS ON FORM 8-K





(a)  Exhibits





None





(b)  Reports on Form 8-K





None




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SIGNATURES





Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.





PHARMACEUTICALS, INC.Date: May 10, 2002



By:

/s/    CHARLES J. CASAMENTOCharles J. Casamento Chairman, President &
CEODate: May 10, 2002



By:

/s/    TIMOTHY E. MORRISTimothy E. Morris Vice President, Finance & Administration And Chief Financial Officer (Principal Financial and Accounting Officer)




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