10-Q 1 doc1.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20459 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED SEPTEMBER 30, 2001 COMMISSION FILE NUMBER 000-22347 --------- ASCENT PEDIATRICS, INC. ----------------------- (Exact name of registrant as specified in its charter) Delaware 04-3047405 -------- ---------- (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number) 187 Ballardvale Street, Suite B125, Wilmington, MA 01887 -------------------------------------------------------- ----- (Address of principle executive offices) (Zip Code) Registrant's telephone number, including area code (978) 658-2500 -------------- None ---- (Former name, former address, and former fiscal year if changed since last report) 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 number of shares outstanding of the registrant's Common Stock: As of November 12, 2001, there were 17,056,817 depositary shares outstanding, each depositary share representing one share of common stock, $0.00004 par value per share. ASCENT PEDIATRICS, INC. TABLE OF CONTENTS

Page 1 Part I. Financial Information Item 1 - Unaudited Condensed Financial Statements ASCENT PEDIATRICS, INC. UNAUDITED CONDENSED BALANCE SHEETS

See accompanying notes to unaudited condensed financial statements. Page 2 ASCENT PEDIATRICS, INC. UNAUDITED CONDENSED STATEMENTS OF OPERATIONS

See accompanying notes to unaudited condensed financial statements. Page 3 ASCENT PEDIATRICS, INC. UNAUDITED CONDENSED STATEMENTS OF CASH FLOWS

See accompanying notes to unaudited condensed financial statements. Page 4 ASCENT PEDIATRICS, INC. NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS 1. NATURE OF BUSINESS Ascent Pediatrics, Inc. ("Ascent" or the "Company"), formerly Ascent Pharmaceuticals, Inc., incorporated in Delaware on March 16, 1989, is currently focused on marketing products exclusively to the pediatric market. Since its inception, until July 9, 1997, Ascent had operated as a development stage enterprise devoting substantially all of its efforts to establishing a new business. Ascent introduced its first two products, Feverall acetaminophen suppositories and Pediamist nasal saline spray, to the market in the second half of 1997. Ascent introduced Primsol(R) trimethoprim solution, a prescription antibiotic, to the market in February 2000 and Orapred(R) syrup, a liquid steroid for the treatment of inflammation, including inflammation resulting from respiratory conditions, to the market in January 2001. On October 1, 2001, Ascent entered into a definitive merger agreement with Medicis Pharmaceutical Corporation ("Medicis") and a wholly-owned subsidiary of Medicis, under which Ascent would merge with the subsidiary of Medicis and become a wholly-owned subsidiary of Medicis. The Company's board of directors has unanimously recommended the transaction to its stockholders. The closing of the transaction is contingent upon approval by Ascent stockholders and customary closing conditions. Under a separate agreement, entities affiliated with FS Private Investments have agreed to vote shares, which, as of October 1, 2001, represented 53.9% of our outstanding shares, in favor of the transaction. Under the terms of the merger agreement, Medicis will pay approximately $60 million, less certain retention payments and transaction fees and expenses, upon the closing of the transaction for the outstanding capital stock and retirement of indebtedness of Ascent and has agreed to pay to the holders of Ascent's common equity up to an additional $10 million per year for each of the first five years following closing based upon reaching certain sales threshold milestones on the Ascent products (as defined under the merger agreement). The Company has scheduled a special meeting of our stockholders to consider and vote on the proposal to adopt and approve the merger agreement, and the transactions contemplated by the merger agreement, for Thursday, November 15, 2001 and the Company expects the merger to close on such date. Ascent has incurred net losses since its inception. If the merger with Medicis does not occur on November 15, 2001, Ascent expects to incur additional operating losses in the future as Ascent seeks to maintain its sales and marketing organization and promotion of Orapred and Primsol to the market. Ascent expects to close the merger on November 15, 2001. In December 1999, Ascent modified its strategy until such time as Ascent determines that its financial condition has adequately improved. Specifically, Ascent is focused on marketing Orapred and Primsol and on seeking appropriate co-promotional opportunities. Ascent has suspended all product development activities until such time, if ever, as Ascent's financial condition has adequately improved. Page 5 Ascent is subject to a number of risks similar to other companies in the industry, including the need to obtain additional financing, rapid technological change, uncertainty of market acceptance of products, uncertainty of regulatory approval, limited sales and marketing experience, competition from substitute products and larger companies, customers' reliance on third-party reimbursement, compliance with government regulations, protection of proprietary technology, dependence on third-party manufacturers, distributors, collaborators and limited suppliers, product liability, and dependence on key individuals. As of September 30, 2001, FS Private Investments, formerly ING Furman Selz Investments LLC, beneficially owns approximately 67% of our securities, including depositary shares issuable upon conversion of outstanding convertible notes and warrants. Accordingly, FS Private Investments, by virtue of its majority ownership of our securities, has the power, acting alone, to elect a majority of Ascent's board of directors over a three year period and has the ability to determine the outcome of any corporate actions requiring stockholder approval, including, without limitation, the proposed merger with Medicis, regardless of how Ascent's other stockholders may vote. FS Private Investments' interests could conflict with the interests of Ascent's other stockholders. For instance, in the event of a merger involving Ascent, the first $28.95 million, plus accumulated interest, in proceeds will be paid to FS Private Investments as repayment of currently outstanding debt, $13.0 million in proceeds will be paid to FS Private Investments as repayment of Series H preferred stock ($12.0 million of which was outstanding as of September 30, 2001), plus additional payments required under the terms of certain outstanding securities. 2. BASIS OF PRESENTATION The accompanying interim financial statements are unaudited and have been prepared by Ascent in accordance with generally accepted accounting principles for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The interim financial statements include, in the opinion of management, all adjustments (consisting of normal and recurring adjustments) that are necessary for a fair presentation of the results for the interim periods ended September 30, 2001 and 2000. The results for the interim periods presented are not necessarily indicative of results to be expected in the full fiscal year or any future periods. Certain prior period items have been reclassified to conform with current period presentation. These financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2000 included in Ascent's Annual Report on Form 10-K as filed with the Securities and Exchange Commission. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Revenue Recognition Product revenue is recognized upon evidence of an arrangement, when the related fee is fixed or determinable and collection of the fee is reasonably assured. Recognition of revenues for any product that is subject to a right of return is deferred until such time that the right of return lapses, generally when Ascent's customers fulfill prescriptions for the consumer. Co-promotion revenue is recognized as earned based upon the performance requirements of the respective agreement. Ascent launched Primsol solution during February 2000 and Orapred syrup during January 2001. Ascent is deferring the recognition of revenue from the sale of both products until such time that the right of return lapses. Through September 30, 2001, Ascent has deferred $531,083 in Primsol revenue and $1,708,045 in Orapred revenue. Page 6 Net Loss Per Common Share Basic net income (loss) per common share is computed based on the weighted average number of common and common equivalent shares outstanding during the period. Diluted net income (loss) per common share gives effect to all dilutive potential common shares outstanding during the period. The computation of diluted earnings per share does not assume the issuance of common shares that have an antidilutive effect on net income (loss) per common share. Options and warrants outstanding to purchase an aggregate of 6,359,882 and 1,440,113 depositary shares as of September 30, 2001 and 2000, respectively, were not included in the computation of diluted net loss per common share because Ascent is in a loss position, and the inclusion of such shares would be antidilutive. Similarly, options, warrants and convertible debt outstanding to purchase or convert into an aggregate of 8,568,703 and 11,153,922 depositary shares as of September 30, 2001 and 2000, respectively, were not included in the computation of diluted net loss per common share because the options, warrants and convertible debt have exercise or conversion prices greater than the per share market price at September 30, 2001 or 2000, as the case may be, of the depositary shares and would be antidilutive under the treasury stock method. Recent Accounting Pronouncements In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations", which is effective January 1, 2003. SFAS No. 143 addresses the financial accounting and reporting for obligations and retirement costs related to the retirement of tangible long-lived assets. The Company does not expect that the adoption of SFAS No. 143 will have a material impact on its financial statements. In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business combinations be accounted for under the purchase method only and that certain acquired intangible assets in a business combination be recognized as assets apart from goodwill. SFAS No. 142 requires that ratable amortization of goodwill be replaced with periodic tests of the goodwill's impairment and that intangible assets other than goodwill be amortized over their useful lives. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The provisions of SFAS No. 142 will be effective for fiscal years beginning after December 15, 2001, and will thus be adopted by Ascent, as required, in fiscal year 2002. Ascent does not believe that the adoption of SFAS No.141 and SFAS No. 142 will have any effect on its financial statements. Page 7 In August 2001, the FASB issued SFAS No. 144 , "Accounting for the Impairment or Disposal of Long-Lived Assets", which is effective January 1, 2002. SFAS No. 144 supersedes SFAS No. 121, " Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and the accounting and reporting provisions relating to the disposal of a segment of a business of Accounting Principles Board Opinion No. 30. Ascent does not expect that the adoption of SFAS No. 144 will have a material impact on its financial statements. 4. INVENTORIES Inventories are stated at the lower of cost or market using the first in, first out (FIFO) method and consist of the following:

Page 8 5. ACCRUED EXPENSES Accrued expenses consisted of the following:

6. FS PRIVATE INVESTMENTS LOAN ARRANGEMENTS $4.0 Million Credit Facility. On July 1, 1999, Ascent entered into an arrangement with certain funds affiliated with FS Private Investments under which such funds agreed to loan Ascent up to $4.0 million. Pursuant to this agreement, Ascent issued to the funds affiliated with FS Private Investments 7.5% convertible subordinated notes in the aggregate principal amount of $4.0 million and warrants to purchase an aggregate of 600,000 depositary shares at an exercise price of $3.00 per share, which, as described below, was subsequently decreased to $0.05 per share, and which expire on July 1, 2006. As of February 2000, Ascent had borrowed the entire $4.0 million under this credit facility. Of the $4.0 million convertible subordinated notes issued and sold, $3,605,700 was allocated to the relative fair value of the convertible subordinated notes (classified as debt) and $394,300 was allocated to the relative fair value of the warrants (classified as additional paid-in-capital). Accordingly, the 7.5% convertible subordinated notes will be accreted from $3,605,700 to the maturity amount of $4,000,000 as interest expense over the term of the convertible subordinated notes. The notes mature on July 1, 2004 and are convertible into depositary shares at a conversion price of $3.00 per share. Interest on these notes is due and payable quarterly, in arrears, on the last day of each calendar quarter, and the outstanding principal on the notes is payable in full on July 1, 2004. In connection with this arrangement, a second representative of FS Private Investments was added to Ascent's board of directors. $10.0 Million Credit Facility. On October 15, 1999, Ascent entered into an arrangement with certain funds affiliated with FS Private Investments under which such funds agreed to loan Ascent up to an additional $10.0 million. Pursuant to this agreement, Ascent issued to the funds affiliated with FS Private Investments 7.5% convertible subordinated notes in the aggregate principal amount of $10.0 million and warrants to purchase an aggregate of 5,000,000 depositary shares at an original exercise price of $3.00 per share, which, as described below, was subsequently decreased to $0.05 per share, and which expire on October 15, 2006. As part of the right to draw down the $10.0 million, Ascent issued to the funds affiliated with FS Private Investments 1,000,000 warrants which were valued at $513,500 (classified as debt issue costs). As of December 31, 2000, Ascent had borrowed the entire $10.0 million under this credit facility. Of the $10.0 million of convertible subordinated notes issued and sold, $8,540,187 was allocated to the relative fair value of the convertible subordinated notes (classified as debt), and $1,459,813 was allocated to the relative fair value of the warrants (classified as additional paid-in-capital). Accordingly, the 7.5% convertible subordinated notes will be accreted from $8,540,187 to the maturity amount of $10.0 million as interest expense over the term of the convertible subordinated notes. The notes mature on July 1, 2004 and are convertible into Ascent depositary shares at a conversion price of $3.00 per share. Interest on these notes is due and payable quarterly, in arrears, on the last day of each calendar quarter, and the outstanding principal on the notes is payable in full on July 1, 2004. Page 9 $10.25 Million Credit Facility. On December 29, 2000, Ascent entered into a loan agreement with FS Ascent Investments LLC ("FS Investments"), which is affiliated with FS Private Investments, and a fifth amendment to the Series G securities purchase agreement. Pursuant to the loan agreement and the fifth amendment, Ascent will receive up to $10.25 million in financing from FS Investments. The financing is comprised of $6.25 million of 7.5% secured notes (of which the entire $6.25 million has been advanced to Ascent as of September 30, 2001) and $4.0 million of Series H preferred stock ($2,001,000 of which has been advanced as of September 30, 2001). Under the terms of the notes, Ascent will pay interest quarterly and repay the outstanding principal of the notes on June 30, 2001, unless extended to no later than December 31, 2001 at Ascent's election, or earlier upon a change in control (as defined in the loan agreement) of Ascent or certain other conditions. Ascent has currently elected to extend the maturity date until November 30, 2001. The notes are secured by Ascent's Primsol product line, including intellectual property rights of Ascent pertaining to Primsol, pursuant to a security agreement, dated as of December 29, 2000, by and between Ascent and FS Investments. The $6.25 million advanced to Ascent under the loan agreement was obtained by FS Investments from Alpharma USPD under a loan agreement between FS Investments and Alpharma USPD. Under the terms of the Series H preferred stock, Ascent will be entitled to, and the holders of the Series H preferred stock will be entitled to cause Ascent to redeem the Series H preferred stock for a price equal to the liquidation amount ($1,000 per share) of the Series H preferred stock, plus $10.0 million. The $10.0 million redemption price was recorded as a current liability and as debt issue costs as an asset on the balance sheet and was amortized to interest expense over the original six month term of the loan agreement with FS Investments. In connection with the financing, Ascent agreed to issue warrants to FS Investments to purchase up to 10,950,000 depositary shares of Ascent at an exercise price of $.05 per share (of which warrants to purchase 6,950,000 depositary shares have been issued as of September 30, 2001(1,950,000 of which were exercised as of September 30, 2001)) and reduced the exercise price of previously issued outstanding warrants to purchase a total of 5,600,000 depositary shares issued under the Series G securities purchase agreement from $3.00 to $0.05 per share, all of which warrants, as discussed below, were exercised as of March 23, 2001. The warrants issued to FS Investments to purchase 6,950,000 depositary shares (1,950,000 of which were exercised as of September 30, 2001) expire on December 29, 2007. The fair value of these warrants was recorded as a contribution to additional paid in capital of $4,219,884. The incremental value of the repriced 5,600,000 warrants was recorded as a contribution to additional paid in capital of $599,476 and as debt issue costs as an asset on the balance sheet to be amortized to interest expense over the original six month term of the loan agreement with FS Investments. The warrants, issuable for an aggregate of 9,000,000 depositary shares are issued in increments upon the extension of the due date of the principal of the note from June 30, 2001 to no later than December 31, 2001, as discussed above. The due date on the notes can be extended by Ascent until December 31, 2001 in monthly increments with the first three extensions each requiring the issuance of warrants exercisable for an aggregate of 1,000,000 depositary shares, and with each of the fourth, fifth and sixth extensions requiring the issuance of warrants exercisable for an aggregate of 2,000,000 depositary shares. On June 29, 2001, Ascent issued warrants to purchase 1,000,000 depositary shares to FS Investments to extend the due date from June 30, 2001 to July 31, 2001. The fair value of these warrants was recorded as a contribution to additional paid in capital of $469,135 and as interest expense in the quarter ended September 30, 2001. On July 30, 2001, Ascent issued warrants to purchase 1,000,000 depositary shares to FS Investments to extend the due date from July 31, 2001 to August 31, 2001. The fair value of these warrants was recorded as a contribution to additional paid in capital of $439,121 and as interest expense in the quarter ended September 30, 2001. On August 30, 2001, Ascent issued warrants to purchase 1,000,000 depositary shares to FS Investments to extend the due date from August 31, 2001 to September 30, 2001. The fair value of these warrants was recorded as a contribution to additional paid in capital of $640,463 and as interest expense in the quarter ended September 30, 2001. On September 29, 2001, Ascent issued warrants to purchase 2,000,000 depositary shares to FS Investments to extend the due date from September 30, 2001 to October 31, 2001. The fair value of these warrants was recorded as a contribution to additional paid in capital of $982,146 and was capitalized as debt issue costs on the balance sheet. The value of these warrants will be amortized as interest expense in the quarter ended December 31, 2001. The Series H preferred stock is entitled to cumulative annual dividends payable on December 31, 2001 at the rate of 7.5% of the liquidation preference (as defined in the loan agreement dated as of December 29, 2000 between Ascent and FS Investments LLC). As of September 30, 2001, cumulative dividends payable are $8,812. The Series H preferred stock is redeemable at the redemption price at any time after the due date or the occurrence of a change in control (each as defined in such loan agreement) of Ascent at the option of the holders of the Series H preferred stock holding at least 80% of the shares of such stock then outstanding. Ascent may redeem all of the Series H preferred stock at the redemption price at any time. The holders of Series H preferred stock generally do not have any voting rights. Page 10 On March 23, 2001, the funds affiliated with FS Private Investments exercised all of their then outstanding warrants (including the repriced warrants exercisable for an aggregate of 5,600,000 depositary shares discussed above), on a cashless basis, which resulted in the issuance of 7,211,528 depositary shares. 7. SUBSEQUENT EVENTS On October 1, 2001, Ascent announced with Medicis that they, and a wholly owned subsidiary of Medicis, had entered into a definitive merger agreement under which Ascent would merge with the subsidiary of Medicis and become a wholly-owned subsidiary of Medicis. Our board of directors has unanimously recommended the transaction to our stockholders. The closing of the transaction is contingent upon approval by Ascent stockholders and customary closing conditions. Under a separate agreement, entities affiliated with FS Private Investments have agreed to vote shares, which, as of October 1, 2001, represented 53.9% of our outstanding shares, in favor of the transaction. Under the terms of the merger agreement, Medicis will pay approximately $60 million, less certain retention payments and transaction fees and expenses, upon the closing of the transaction for the outstanding capital stock and retirement of indebtedness of Ascent and has agreed to pay to the holders of Ascent's common equity up to an additional $10 million per year for each of the first five years following closing based upon reaching certain sales threshold milestones on the Ascent products (as defined under the merger agreement). Ascent has scheduled a special meeting of our stockholders to consider and vote on the proposal to adopt and approve the merger agreement, and the transactions contemplated by the merger agreement, for Thursday, November 15, 2001 and the Company expects the merger to close on such date. In connection with the merger, Ascent will incur approximately $6,431,000 in related costs, which includes (i) a $3.0 million transaction fee to entities affiliated with FS Private Investments, (ii) a total of $1.675 million to be paid at closing as retention payments to Ascent's executive officers and certain other of Ascent's employees, (iii) a total of $300,000 to be paid at closing to two of Ascent's directors, and (iv) transaction costs incurred by Ascent, to the extent that such costs exceed $1.2 million. On November 9, 2001 Ascent received notice that Triumph-Connecticut Limited Partnership and related parties had brought a civil action against the Company on such date in the Superior Court, Suffolk County in the Commonwealth of Massachusetts. In the action, the Triumph group claims that the execution by the Company of the merger agreement and the anticipated consummation of the merger contemplated by the merger agreement without the consent of the Triumph group or the payment to the Triumph group of a specified amount breaches the terms of a securities purchase agreement entered into in January 1997 between the Company and the Triumph group, the terms of warrants issued by the Company to the Triumph group, an implied covenant of good faith and fair dealing and chapter 93A of the Massachusetts general laws. The Triumph group is seeking damages in an amount not less than $18.6 million, plus multiple damages under chapter 93A. The Company believes that the claims of the Triumph group are without merit and intends to vigorously contest and defend the suit by the Triumph group. On October 9, 2001 Ascent drew down $1 million from FS Ascent Investments LLC under the $10.25 million credit facility in exchange for issuing 1,000 shares of Series H preferred stock. On October 30, 2001 Ascent issued warrants to purchase 2,000,000 depositary shares to FS Ascent Investments LLC to extend the due date on the $6.25 million of 7.5% secured notes from October 31, 2001 to November 30, 2001. The fair value of these warrants was recorded as a contribution to additional paid in capital of $1,139,862 on October 30, 2001 (the date of issuance). It will be recorded as interest expense in the quarter ended December 31, 2001. Page 11 ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL We are engaged in the marketing of pharmaceuticals for use in the treatment of common pediatric illnesses. We introduced our first two products, Feverall acetaminophen suppositories and Pediamist nasal saline spray, to the market in the second half of 1997. We introduced Primsol trimethoprim solution, a prescription antibiotic, to the market in February 2000 and Orapred syrup, a liquid steroid for the treatment of inflammation, including inflammation resulting from respiratory conditions, to the market in January 2001. On December 29, 2000, we sold the Feverall product line in an asset sale to Alpharma USPD in exchange for the cancellation by Alpharma USPD of $12.0 million owed to Alpharma USPD by us under the loan agreement between the two parties, although we have maintained the right to repurchase the product line through December 2001 at the same price. We leverage our marketing and sales capabilities, including our sales force, by seeking to enter into arrangements to promote third party pharmaceutical products to pediatricians. Since July 1997, when we established a sales force, we have entered into co-promotion agreements under which we promoted the combination corticosteroid/antibiotic, Pediotic(R), Omnicef(R) (cefdinir) oral suspension and capsules, and Duricef(R) (cefadroxil mono hydrate) oral suspension. All of these agreements have either expired or been terminated. We have incurred net losses since our inception. If the merger with Medicis does not occur on November 15, 2001, we expect to incur additional operating losses into 2002 as we seek to maintain our sales and marketing organization and promotion of Orapred and Primsol to the market. We expect the merger to close on November 15, 2001.We expect cumulative losses to increase over this period. We have incurred a deficit from inception through September 30, 2001 of $104,534,000. In December 1999, we modified our strategy until such time as we determine that our financial condition has adequately improved. Specifically, we are focused on marketing Orapred and Primsol and on seeking appropriate co-promotional opportunities. We have suspended all product development activities until such time, if ever, as our financial condition has adequately improved. Page 12 RESULTS OF OPERATIONS THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED WITH THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 REVENUE: Ascent had total net revenue of $2,819,000 and $6,117,000 for the three and nine months ended September 30, 2001, respectively, compared with total net revenue of $846,000 and $3,063,000 for the three and nine months ended September 30, 2000, respectively. The increase in net revenue of $1,973,000 for the three months ended September 30, 2001, was primarily attributable to $2,670,000 in Orapred syrup revenue. This was offset by a decrease in Primsol revenue of $31,000 over fiscal year 2000, the absence of Feverall revenue of $581,000 due to the sale of the Feverall product line in December 2000 to Alpharma USPD and the absence of co-promotional revenue of $88,000 due to the termination of the Omnicef(R) agreement in January 2000. The increase in net revenue of $3,054,000 for the nine months ended September 30, 2001, was primarily attributable to $5,512,000 in Orapred syrup revenue and an increase in Primsol revenue of $316,000 over fiscal year 2000. This was offset by the absence of Feverall revenue of $1,703,000 due to the sale of the Feverall product line in December 2000 to Alpharma USPD and the absence of co-promotional revenue of $1,069,000 due to the termination of the Omnicef(R) agreement in January 2000. COST OF PRODUCT SALES: Cost of product sales was $548,000 and $1,222,000 for the three and nine months ended September 30, 2001, respectively, compared with cost of product sales of $350,000 and $969,000 for the three and nine months ended September 30, 2000, respectively. The increase in cost of product sales of $198,000 for the three months ended September 30, 2001, was primarily the result of an increase of $294,000 in manufacturing and testing costs associated with the production of Orapred syrup and Primsol solution. This was offset by decreases of $153,000 in manufacturing costs and $83,000 in amortization expense related to the termination of the Feverall manufacturing agreement due to the sale of the Feverall product line. The increase in cost of product sales of $253,000 for the nine months ended September 30, 2001, was primarily the result of an increase of $766,000 in manufacturing and testing costs associated with the production of Orapred syrup and Primsol solution. This was offset by a decreases of $449,000 in manufacturing costs and $250,000 in amortization expense related to the termination of the Feverall manufacturing agreement due to the sale of the Feverall product line. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES: Ascent incurred selling, general and administrative expenses of $4,427,000 and $11,781,000 for the three and nine months ended September 30, 2001, respectively, compared with $3,088,000 and $9,422,000 for the three and nine months ended September 30, 2000, respectively, representing increases of $1,339,000 and $2,359,000, respectively. Selling and marketing expenses were $2,968,000 and $9,031,000 for the three and nine months ended September 30, 2001, respectively, compared with expenses of $2,538,000 and $7,744,000 for the three and nine months ended September 30, 2000, respectively. The increase in selling and marketing expenses of $430,000 for the three months ended September 30, 2001, was primarily the result of $446,000 in advertising and promotion expenses for Orapred syrup and an increase of $48,000 in sample accountability expenses due to increased requirements under the Prescription Drug Medical Act ("PDMA"). This was offset by a decrease of $156,000 in advertising and promotion expenses for Primsol solution. The increase in selling and marketing expenses of $1,287,000 for the nine months ended September 30, 2001, was primarily the result of (i) $1,744,000 for the launch of Orapred syrup, which included a national sales meeting, samples and selling materials, direct mail, media, and trade promotions, (ii) an increase of $125,000 in sample accountability expenses due to increased PDMA requirements, and (iii) an increase of $77,000 in trade show expense due to an increased presence at trade shows in 2001. This was offset by (i) a decrease of $169,000 in personnel expenses due to reduced headcount, (ii) a decrease of $437,000 in advertising and promotion expenses for Primsol solution and (iii) the decrease of $47,000 in telesales expenses in a marketing program. Page 13 General and administrative expenses were $1,459,000 and $2,750,000 for the three and nine months ended September 30, 2001, respectively, compared with expenses of $550,000 and $1,678,000 for the three and nine months ended September 30, 2000, respectively. The increase of $909,000 for the three months ended September 30, 2001, was primarily attributable to increases of $758,000 due to expenses related to the proposed merger between Ascent and Medicis and $155,000 in recruiting expenses due to the expansion of the sales force. These increases were offset by a decrease of $81,000 in amortization expense for trademarks and goodwill due to the sale of the Feverall product line to Alpharma USPD. The increase of $1,072,000 for the nine months ended September 30, 2001, was primarily attributable to increases of (i) $758,000 due to expenses related to the proposed merger between Ascent and Medicis, (ii) $241,000 due to changes in Ascent's bonus plan, (iii) $75,000 in consulting expenses due to agreements with members of Ascent's board of directors, and (iv) $138,000 in recruiting expenses due to the expansion of the sales force. These increases were offset by a decrease of $244,000 in amortization expense for trademarks and goodwill due to the sale of the Feverall product line to Alpharma USPD. RESEARCH AND DEVELOPMENT: Ascent incurred research and development expenses of $269,000 and $845,000 for the three and nine months ended September 30, 2001, respectively, compared with expenses of $651,000 and $1,926,000 for the three and nine months ended September 30, 2000, respectively. The decrease of $382,000 for the three months ended September 30, 2001, primarily reflects the incurrence in fiscal 2000 and not fiscal 2001 of (i) $103,000 for the Orapred product's research and development program due to timing differences in expenses in anticipation of the FDA's response on Ascent's Abbreviated New Drug Application, (ii) $121,000 in FDA user fees, and (iii) $136,000 in personnel expenses due to reduced headcount. The decrease of $1,081,000 for the nine months ended September 30, 2001, primarily reflects the incurrence in fiscal 2000 and not fiscal 2001 of (i) $92,000 for the Pediavent product research and development program that was terminated in December 1999, but which had certain outstanding obligations in fiscal 2000, (ii) $131,000 for the Orapred product's research and development program due to timing differences in expenses in anticipation of the FDA's response on Ascent's Abbreviated New Drug Application, (iii) $148,000 in manufacturing and testing expenses related to the production of Primsol solution batches in anticipation of receiving FDA market approval, (iv) $121,000 in FDA user fees, and (v) $530,000 in personnel expenses due to reduced headcount. INTEREST: Ascent had interest income of $4,000 and $26,000 for the three and nine months ended September 30, 2001, respectively, compared with interest income of $21,000 and $48,000 for the three and nine months ended September 30, 2000, respectively, representing decreases of $17,000 and $22,000, respectively. Ascent had interest expense of $2,303,000 and $16,227,000 for the three and nine months ended September 30, 2001, respectively, compared with interest expense of $802,000 and $2,133,000 for the three and nine months ended September 30, 2000, respectively. The increase of $1,501,000 for the three months ended September 30, 2001, was primarily attributable to interest expense due to the additional $6.25 million of subordinated notes issued and outstanding during the third quarter of 2001 compared to the third quarter of 2000. The increase of $14,094,000 for the nine months ended September 30, 2001, was primarily attributable to the amortization of the $10.0 million Series H redemption price, as well as $3,518,000 in interest expense due to (i) the additional $6.25 million of subordinated notes issued and outstanding at September 30, 2001 compared to September 30, 2000, and (ii) the additional 3,000,000 warrants expensed during the quarter ended September 30, 2001. Page 14 LIQUIDITY AND CAPITAL RESOURCES Since its inception, Ascent has financed its operations primarily from private sales of preferred stock, with net proceeds of $35.6 million, the private sale of subordinated secured notes and related common stock and depositary share purchase warrants, with net proceeds of $46.8 million, and, in 1997, an initial public offering of shares of common stock, with net proceeds of $17.5 million. As of September 30, 2001, Ascent had $36,000 in cash and cash equivalents, a decrease of $225,000 from $261,000 as of December 31, 2000. As of November 1, 2001, Ascent has borrowed $9.25 million from FS Ascent Investments LLC under its $10.25 million credit facility described below. Ascent currently does not have access to sufficient cash to fund operations and repay debt and interest on such debt through December 31, 2001. If the merger with Medicis does not occur on November 15, 2001, Ascent will need additional funds in December 2001 beyond the $1 million available under the $10.25 million credit facility to fund operations and to repay outstanding debt, including interest payments. Ascent expects the merger to close on November 15, 2001. Ascent used $8.1 million of cash in operations for the nine months ended September 30, 2001 compared to $10.7 million for the nine months ended September 30, 2000. Net cash used in operations for the nine months ended September 30, 2001 was primarily attributable to a $23.9 million net loss generated during the period, an increase in accounts receivable of $877,000 and a decrease in interest payable of $278,000. This was offset in part by non-cash interest expense of $14.6 million and increases in deferred revenue of $1.5 million and accounts payable of $723,000. Ascent's investing activities resulted in net cash used of $286,000 for the nine months ended September 30, 2001 compared to $247,000 for the nine months ended September 30, 2000. Ascent's capital expenditures consist primarily of purchases of property and equipment, including computer equipment and software. Ascent expects that its capital expenditures will remain steady in the future. Cash provided by financing activities was $8.2 million for the nine months ended September 30, 2001 compared to $10.8 million for the nine months ended September 30, 2000. The principal source of financing for the nine months ended September 30, 2001 was the FS Ascent Investments credit facility discussed below, which yielded net proceeds of $8.25 million. Outstanding Indebtedness to FS Private Investments and Other Entities As of September 30, 2001, Ascent had notes outstanding in the aggregate original principal amount of $28.95 million under its financing arrangements with the former holders of Series G preferred stock and funds affiliated with FS Private Investments. The notes currently outstanding are as follows: - 8% seven-year subordinated notes issued on June 1, 1998 to the holders of Series G preferred stock pursuant to the May 1998 securities purchase agreement, of which $1.7 million of principal amount was outstanding as of September 30, 2001. The principal is shown on the balance sheet net of the fair market value allocated to the warrants associated with the notes. These notes mature in June 2005. - 8% seven-year convertible subordinated notes issued on July 23, 1999 to the holders of Series G preferred stock pursuant to the second amendment to the May 1998 securities purchase agreement, as amended, upon the conversion of the Series G preferred stock, of which $7.0 million of principal amount was outstanding as of September 30, 2001. The principal is shown on the balance sheet net of the fair market value allocated to the warrants associated with the notes. These notes mature in June 2005. - 7.5% convertible subordinated notes in the principal amount of up to $4.0 million issued on July 1, 1999 to funds affiliated with FS Private Investments pursuant to the third amendment to the May 1998 securities purchase agreement, as amended, of which $4.0 million of principal amount was outstanding as of September 30, 2001. The principal is shown on the balance sheet net of the fair market value allocated to the warrants associated with the notes. These notes mature in July 2004. Page 15 - 7.5% convertible subordinated notes in the principal amount of up to $10.0 million issued on October 15, 1999 to funds affiliated with FS Private Investments pursuant to the fourth amendment to the May 1998 securities purchase agreement, as amended, of which $10.0 million of principal amount was outstanding as of September 30, 2001. The principal is shown on the balance sheet net of the fair market value allocated to the warrants associated with the notes. These notes mature in July 2004. - 7.5% subordinated notes in the principal amount of up to $6.25 million issued on January 2, 2001 to FS Ascent Investments of which $6.25 million of the principal amount was outstanding as of September 30, 2001. These notes were originally due in June 2001. We have currently elected to extend the due date until November 30, 2001. If the merger with Medicis does not take place on November 15, 2001, we have the right to extend the due date to December 31, 2001. Ascent expects the merger to close on November 15, 2001. Ascent's financing arrangements, including the material terms of the foregoing notes, are described in more detail below. Series G Financing. On May 13, 1998, Ascent entered into a Series G Securities Purchase Agreement with funds affiliated with FS Private Investments and BancBoston Ventures, Inc. In accordance with this agreement, on June 1, 1998, Ascent issued and sold to these funds an aggregate of 7,000 shares of Series G convertible exchangeable preferred stock, $9.0 million of 8% seven-year subordinated notes and seven-year warrants to purchase an aggregate of 2,116,958 shares of Ascent common stock at a per share exercise price of $4.75 per share (which, as discussed below, was subsequently decreased), for an aggregate purchase price of $16.0 million. Of the $9.0 million of subordinated secured notes issued and sold by Ascent, $8,652,515 was allocated to the relative fair value of the subordinated notes and $347,485 was allocated to the relative fair value of the warrants. Accordingly, the 8% subordinated notes will be accreted from $8,652,515 to the maturity amount of $9,000,000 as interest expense over the term of the notes. The $347,485 allocated to the warrants was included in additional paid-in-capital. Ascent used a portion of the net proceeds, after fees and expense, of $14.7 million to repay $5.3 million in existing indebtedness and used the balance for working capital. As a result of the early repayment of subordinated notes, Ascent accelerated the unaccreted portion of the discount amounting to $842,000. In addition, $325,000 of unamortized debt issue costs were written off. In connection with Ascent's strategic alliance with Alpharma USPD and Alpharma, Inc., which, as discussed below, was subsequently terminated, Ascent entered into a second amendment to the May 1998 securities purchase agreement in July 1999. The second amendment provided for, among other things, (a) Ascent's agreement to exercise its right to exchange all outstanding shares of Series G preferred stock for convertible subordinated notes in accordance with the terms of the Series G preferred stock, (b) the reduction in the exercise price of warrants to purchase an aggregate of 2,116,958 shares of Ascent common stock from $4.75 per share to $3.00 per share and the agreement of the Series G purchasers to exercise these warrants, (c) the issuance and sale to the Series G purchasers of an aggregate of 300,000 shares of Ascent common stock at a price of $3.00 per share and (d) the cancellation of approximately $7.25 million of principal under the subordinated notes held by the Series G purchasers to pay the exercise price of the warrants and the purchase price of the additional 300,000 shares. Page 16 The subordinated notes and convertible notes bear interest at a rate of 8% per annum, payable semiannually in June and December of each year, commencing December 1998. Ascent deferred forty percent of the interest due on the subordinated notes and fifty percent of the dividend interest due on the convertible notes in each of December 1998, June 1999, December 1999 and June 2000 for a period of three years. In the event of a change in control or unaffiliated merger of Ascent, Ascent could redeem the convertible notes issued upon exchange of the Series G preferred stock at a price equal to the liquidation preference plus accrued and unpaid dividends, although Ascent would be required to issue new common stock purchase warrants in connection with such redemption (which right has been waived, as discussed below). In the event of a change of control or unaffiliated merger of Ascent, the holders of the convertible notes and the subordinated notes could require Ascent to redeem these notes at a price equal to the unpaid principal plus accrued and unpaid interest on such notes. In connection with the Series G financing, a representative of FS Private Investments was added to Ascent's board of directors. $4.0 Million Credit Facility. On July 1, 1999, Ascent entered into an arrangement with certain funds affiliated with FS Private Investments under which such funds agreed to loan Ascent up to $4.0 million. Pursuant to this agreement, Ascent issued 7.5% convertible subordinated notes in the aggregate principal amount of $4.0 million and warrants to purchase an aggregate of 600,000 depositary shares at an exercise price of $3.00 per share, which, as described below, was subsequently decreased to $0.05 per share, and which expire on July 1, 2006, to the funds affiliated with FS Private Investments. As of February 2000, Ascent had borrowed the entire $4.0 million under this credit facility. Of the $4.0 million convertible subordinated notes issued and sold, $3,605,700 was allocated to the relative fair value of the convertible subordinated notes (classified as debt) and $394,300 was allocated to the relative fair value of the warrants (classified as additional paid-in-capital). Accordingly, the 7.5% convertible subordinated notes will be accreted from $3,605,700 to the maturity amount of $4,000,000 as interest expense over the term of the convertible subordinated notes. The notes mature on July 1, 2004 and are convertible into depositary shares at a conversion price of $3.00 per share. Interest on these notes is due and payable quarterly, in arrears, on the last day of each calendar quarter, and the outstanding principal on the notes is payable in full on July 1, 2004. In connection with this arrangement, a second representative of FS Private Investments was added to Ascent's board of directors. $10.0 Million Credit Facility. On October 15, 1999, Ascent entered into an arrangement with certain funds affiliated with FS Private Investments under which such funds agreed to loan Ascent up to an additional $10.0 million. Pursuant to this agreement, Ascent issued to the funds affiliated with FS Private Investments 7.5% convertible subordinated notes in the aggregate principal amount of $10.0 million and warrants to purchase an aggregate of 5,000,000 depositary shares at an original exercise price of $3.00 per share, which, as described below, was subsequently decreased to $0.05 per share, and which expire on October 15, 2006. As part of the right to draw down the $10.0 million, Ascent issued to the funds affiliated with FS Private Investments 1,000,000 warrants which were valued at $513,500 (classified as debt issue costs). As of December 31, 2000, Ascent had borrowed the entire $10.0 million under this credit facility. Of the $10.0 million of convertible subordinated notes issued and sold, $8,540,187 was allocated to the relative fair value of the convertible subordinated notes (classified as debt), and $1,459,813 was allocated to the relative fair value of the warrants (classified as additional paid-in-capital). Accordingly, the 7.5% convertible subordinated notes will be accreted from $8,540,187 to the maturity amount of $10.0 million as interest expense over the term of the convertible subordinated notes. The notes mature on July 1, 2004 and are convertible into Ascent depositary shares at a conversion price of $3.00 per share. Interest on these notes is due and payable quarterly, in arrears, on the last day of each calendar quarter, and the outstanding principal on the notes is payable in full on July 1, 2004. Page 17 $10.25 Million Credit Facility. On December 29, 2000, Ascent entered into a loan agreement with FS Ascent Investments LLC ("FS Investments"), which is affiliated with FS Private Investments, and a fifth amendment to the Series G securities purchase agreement. Pursuant to the loan agreement and the fifth amendment, Ascent will receive up to $10.25 million in financing from FS Investments. The financing is comprised of $6.25 million of 7.5% secured notes (of which the entire $6.25 million has been advanced to Ascent as of September 30, 2001) and $4.0 million of Series H preferred stock ($2,001,000 of which has been advanced as of September 30, 2001). Under the terms of the notes, Ascent will pay interest quarterly and repay the outstanding principal of the notes on June 30, 2001, unless extended to no later than December 31, 2001 at Ascent's election, or earlier upon a change in control (as defined in the loan agreement) of Ascent or certain other conditions. Ascent has currently elected to extend the maturity date until November 30, 2001. The notes are secured by Ascent's Primsol product line, including intellectual property rights of Ascent pertaining to Primsol, pursuant to a security agreement, dated as of December 29, 2000, by and between Ascent and FS Investments. The $6.25 million advanced to Ascent under the loan agreement was obtained by FS Investments from Alpharma USPD under a loan agreement between FS Investments and Alpharma USPD. Under the terms of the Series H preferred stock, Ascent will be entitled to, and the holders of the Series H preferred stock will be entitled to cause Ascent to redeem the Series H preferred stock for a price equal to the liquidation amount ($1,000 per share) of the Series H preferred stock, plus $10.0 million. The $10.0 million redemption price was recorded as a current liability and as debt issue costs as an asset on the balance sheet and was amortized to interest expense over the original six month term of the loan agreement with FS Investments. In connection with the financing, Ascent agreed to issue warrants to FS Investments to purchase up to 10,950,000 depositary shares of Ascent at an exercise price of $.05 per share (of which warrants to purchase 6,950,000 depositary shares have been issued as of September 30, 2001(1,950,000 of which were exercised as of September 30, 2001)) and reduced the exercise price of previously issued outstanding warrants to purchase a total of 5,600,000 depositary shares issued under the Series G securities purchase agreement from $3.00 to $0.05 per share, all of which warrants, as discussed below, were exercised as of March 23, 2001. The warrants issued to FS Investments to purchase 6,950,000 depositary shares (1,950,000 of which were exercised as of September 30, 2001) expire on December 29, 2007. The fair value of these warrants was recorded as a contribution to additional paid in capital of $4,219,884. The incremental value of the repriced 5,600,000 warrants was recorded as a contribution to additional paid in capital of $599,476 and as debt issue costs as an asset on the balance sheet to be amortized to interest expense over the original six month term of the loan agreement with FS Investments. The warrants, issuable for an aggregate of 9,000,000 depositary shares are issued in increments upon the extension of the due date of the principal of the note from June 30, 2001 to no later than December 31, 2001, as discussed above. The due date on the notes can be extended by Ascent until December 31, 2001 in monthly increments with the first three extensions each requiring the issuance of warrants exercisable for an aggregate of 1,000,000 depositary shares, and with each of the fourth, fifth and sixth extensions requiring the issuance of warrants exercisable for an aggregate of 2,000,000 depositary shares. On June 29, 2001, Ascent issued warrants to purchase 1,000,000 depositary shares to FS Investments to extend the due date from June 30, 2001 to July 31, 2001. The fair value of these warrants was recorded as a contribution to additional paid in capital of $469,135 and as interest expense in the quarter ended September 30, 2001. On July 30, 2001, Ascent issued warrants to purchase 1,000,000 depositary shares to FS Investments to extend the due date from July 31, 2001 to August 31, 2001. The fair value of these warrants was recorded as a contribution to additional paid in capital of $439,121 and as interest expense in the quarter ended September 30, 2001. On August 30, 2001, Ascent issued warrants to purchase 1,000,000 depositary shares to FS Investments to extend the due date from August 31, 2001 to September 30, 2001. The fair value of these warrants was recorded as a contribution to additional paid in capital of $640,463 and as interest expense in the quarter ended September 30, 2001. On September 29, 2001, Ascent issued warrants to purchase 2,000,000 depositary shares to FS Investments to extend the due date from September 30, 2001 to October 31, 2001. The fair value of these warrants was recorded as a contribution to additional paid in capital of $982,146 and was capitalized as debt issue costs on the balance sheet. The value of these warrants will be amortized as interest expense in the quarter ended December 31, 2001. Page 18 The Series H preferred stock is entitled to cumulative annual dividends payable on December 31, 2001 at the rate of 7.5% of the liquidation preference (as defined in the loan agreement dated as of December 29, 2000 between Ascent and FS Investments LLC). As of September 30, 2001 cumulative dividends are $8,812. The Series H preferred stock is redeemable at the redemption price at any time after the due date or the occurrence of a change in control (each as defined in such loan agreement) of Ascent at the option of the holders of the Series H preferred stock holding at least 80% of the shares of such stock then outstanding. Ascent may redeem all of the Series H preferred stock at the redemption price at any time. The holders of Series H preferred stock generally do not have any voting rights. In connection with entering into the merger agreement, BancBoston Ventures Inc., Flynn Partners and the entities affiliated with FS Private Investments entered into a note agreement with Ascent. Under the note agreement, BancBoston Ventures Inc., Flynn Partners and the entities affiliated with FS Private Investments agreed that, until the earliest to occur of the termination of the merger agreement pursuant to its terms, the closing of the merger and January 31, 2002: - they would not transfer any of our securities unless the transferee agrees in writing to become bound by the terms of the note agreement; and - they would not convert any convertible subordinated notes into equity securities of Ascent. Such holders of convertible subordinated notes also agreed to waive the requirement that we issue additional warrants to them as a condition to our right to redeem the convertible subordinated notes in connection with the merger and waived any required notices of the merger or the anticipated redemption of the notes upon consummation of the merger. In addition, under the note agreement, FS Ascent Investments agreed that until the earliest to occur of the termination of the merger agreement pursuant to its terms, the closing of the merger and January 31, 2002, it would: - not take any action that would cause us to redeem any or all of the Series H preferred stock or take any action to cause us to repay our 7.5% subordinated note; - extend the date on which we are required to repay the principal amount of our 7.5% subordinated note to December 31, 2001 for no additional consideration other than as required under the terms of the notes; - extend the date on which we are required to repay the principal amount of our 7.5% subordinated note to January 31, 2002 if the merger is not completed by December 31, 2001; - waive any required notices of the merger and the anticipated redemption of the 7.5% subordinated note upon the completion of the merger; and - agree that all unexercised warrants held by FS Ascent Investments terminate immediately prior to the completion of the merger. Page 19 Future Capital Requirements. Ascent's future capital requirements will depend on many factors, including the costs and margins on sales of its products, success of its commercialization activities and arrangements, particularly the level of product sales, its ability to maintain and, in the future, expand its sales and marketing capability and resume product development, its ability to maintain its manufacturing and marketing relationships, its ability to enter into and maintain any co-promotion agreements, its ability to acquire and successfully integrate businesses and products, the time and cost involved in maintaining and, in the future, obtaining regulatory approvals, the costs involved in prosecuting, enforcing and defending patent claims and competing technological and market developments. Ascent's business strategy requires a significant commitment of funds to engage in product and business acquisitions and to maintain sales and marketing capabilities and manufacturing relationships necessary to promote Orapred and Primsol. Ascent anticipates that, based upon its current operating plan, including anticipated sales of Primsol and Orapred and its existing capital resources and access to the remaining $1.0 million under its credit facility with FS Investments, it will not have enough cash to fund operations through December 31, 2001. The Company also does not have sufficient funds to repay debt or interest on such debt which becomes due in December 2001. As a result, Ascent will need additional funds in December 2001 to fund operations and to repay outstanding debt, including interest payments, in December 2001. If adequate funds are not available, Ascent may be required to (i) obtain funds on unfavorable terms that may require Ascent to relinquish rights to certain of its technologies or products or that would significantly dilute Ascent's stockholders, (ii) significantly scale back or terminate operations and/or (iii) seek relief under applicable bankruptcy laws. Interest payments under the 8% subordinated notes due June 1, 2005 in the principal amount of $8.7 million are due and payable semiannually in June and December of each year. During fiscal 2001, Ascent will be required to pay an aggregate of $868,371 in interest under the 8% subordinated notes due June 1, 2005. As of September 30, 2001, $349,965 of such interest payments had been paid. Interest payments under the $4.0 and $10.0 million credit facilities with the funds affiliated with FS Private Investments are due and payable on the last day of each calendar quarter. During fiscal 2001, Ascent will be required to pay an aggregate of $300,000 under the $4.0 million credit facility and an aggregate of $750,000 under the $10.0 million credit facility. As of September 30, 2001, $787,500 of such interest payments had been paid. As of November 1, 2001, Ascent has borrowed $9.25 million of the $10.25 million 7.5% credit facility with FS Investments and during fiscal 2001 will be required to pay an aggregate of $397,552 in interest. As of September 30, 2001, $280,365 of such interest payments had been paid. These interest payments and the repayments of the notes are subject to the note agreement described above and our merger agreement with Medicis. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations", which is effective January 1, 2003. SFAS No. 143 addresses the financial accounting and reporting for obligations and retirement costs related to the retirement of tangible long-lived assets. The Company does not expect that the adoption of SFAS No. 143 will have a material impact on its financial statements. In July 2001, the FASB issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business combinations be accounted for under the purchase method only and that certain acquired intangible assets in a business combination be recognized as assets apart from goodwill. SFAS No. 142 requires that ratable amortization of goodwill be replaced with periodic tests of the goodwill's impairment and that intangible assets other than goodwill be amortized over their useful lives. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The provisions of SFAS No. 142 will be effective for fiscal years beginning after December 15, 2001, and will thus be adopted by Ascent, as required, in fiscal year 2002. Ascent does not believe that the adoption of SFAS No.141 and SFAS No. 142 will have any effect on its financial statements. Page 20 In August 2001, the FASB issued SFAS No. 144 , "Accounting for the Impairment or Disposal of Long-Lived Assets", which is effective January 1, 2002. SFAS No. 144 supersedes SFAS No. 121, " Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of", and the accounting and reporting provisions relating to the disposal of a segment of a business of Accounting Principles Board Opinion No. 30. The Company does not expect that the adoption of SFAS No. 144 will have a material impact on its financial statements. CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS This Quarterly Report on Form 10-Q contains forward-looking statements. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects," "intends" and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause THE COMPANY'S ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE INDICATED BY SUCH FORWARD-LOOKING STATEMENTS. THESE FACTORS INCLUDE, WITHOUT LIMITATION, THOSE SET FORTH BELOW. In addition, any forward-looking statements represent the Ascent's estimates only as of the date of this Quarterly Report on Form 10-Q as first filed with the Securities and Exchange Commission and should not be relied upon as representing Ascent's estimates as of any subsequent date. While Ascent may elect to update forward-looking statements at some point in the future, Ascent specifically disclaims any obligation to do so, even if its estimates change. WE HAVE NOT BEEN PROFITABLE We have incurred net losses since our inception. As of September 30, 2001, our accumulated deficit was approximately $104.5 million. We received our first revenues from product sales in July 1997. If the merger with Medicis does not occur on November 15, 2001, we expect to incur additional significant operating losses at least over the next 12 months and expect cumulative losses to increase. We expect the merger to close on November 15, 2001. We expect that our losses will fluctuate from quarter to quarter based upon factors such as sales and marketing initiatives, competition, any product acquisitions of ours and the extent and severity of illness during cold and flu seasons. These quarterly fluctuations may be substantial. WE WILL REQUIRE ADDITIONAL FUNDING TO REPAY DEBT AND TO FUND OPERATIONS AND WE MAY NOT BE ABLE TO OBTAIN ANY If the merger with Medicis does not occur on November 15, 2001, we anticipate that, based upon our current operating plan, including anticipated sales of Primsol and Orapred, our existing capital resources and access to the remaining $1.0 million under our credit facility with FS Ascent Investments, we would not have enough cash to fund operations through December 31, 2001. We also do not have sufficient funds to repay debt or interest on such debt which becomes due in December 2001. We expect the merger to close on November 15, 2001. As a result, we will need additional funds in December 2001 to fund operations and to repay outstanding debt, including interest payments. If adequate funds are not available, we may be required to (i) obtain funds on unfavorable terms that may require us to relinquish rights to certain of our technologies or products or that would significantly dilute our stockholders, (ii) significantly scale back or terminate current operations and/or (iii) seek relief under applicable bankruptcy laws. Any of such cases would have a material adverse effect on our business. Page 21 In addition, in their report on our December 31, 2000 financial statements contained in our Annual Report on Form 10-K, PricewaterhouseCoopers LLP, our independent public accountants, states that there is substantial doubt about our ability to continue as a going concern. WE DERIVE A SIGNIFICANT PORTION OF OUR REVENUE FROM A SMALL NUMBER OF CUSTOMERS AND OUR REVENUE WOULD DECLINE SIGNIFICANTLY IF WE LOSE A CUSTOMER OR IF A CUSTOMER CANCELS OR DELAYS AN ORDER. Because we depend on a small number of customers, our revenue would decline significantly if we lose a customer, or if a customer cancels or delays an order. Sales to Warner Lambert Company accounted for 20% of our net revenues for the year ended December 31, 2000 and 50% of our net revenues for the year ended December 31, 1999. In addition, sales to McKesson HBOC accounted for 11% of our net revenues for the year ended December 31, 2000 and 5% of our net revenues for the year ended December 31, 1999. We do not have any long-term contracts with any of our customers. We expect to continue to derive a majority of our revenues from a limited number of customers in the near future. YOU WILL NOT BE ABLE TO CONTROL OUR CORPORATE EVENTS BECAUSE FS PRIVATE INVESTMENTS OWNS APPROXIMATELY 67% OF OUR SECURITIES FS Private Investments beneficially owns approximately 67% of our securities, including depositary shares issuable upon conversion of outstanding convertible notes and the exercise of outstanding warrants as of September 30, 2001. Accordingly, FS Private Investments, by virtue of its majority ownership of our securities, has the power, acting alone, to elect a majority of our board of directors over a three year period and has the ability to determine the outcome of any corporate actions requiring stockholder approval, including without limitation, the proposed merger with Medicis, regardless of how our other stockholders may vote. FS Private Investments' interests could conflict with the interests of our other stockholders. For instance, in the event of a merger involving the Company, the first $28.95 million, plus accumulated interest, in proceeds will be paid to FS Private Investments as repayment of currently outstanding debt, $13.0 million in proceeds will be paid to FS Private Investments as repayment of Series H preferred stock ($12.0 million of which was outstanding as of September 30, 2001), plus additional payments required under the terms of certain outstanding securities to certain other lenders. THERE IS UNCERTAINTY AS TO THE MARKET ACCEPTANCE OF OUR TECHNOLOGY AND PRODUCTS The commercial success of Orapred syrup and Primsol solution will depend upon their acceptance by pediatricians, pediatric nurses and third party payors as clinically useful, cost-effective and safe. Factors that we believe will materially affect market acceptance of these products include: - the safety, efficacy, side effect profile, taste, dosing and ease of administration of the product; - the patent and other proprietary position of the product; - brand name recognition; and - price. The failure to achieve market acceptance of Orapred syrup and Primsol solution would have a material adverse effect on our business. Page 22 WE FACE SIGNIFICANT COMPETITION IN THE PEDIATRIC PHARMACEUTICAL INDUSTRY The pediatric pharmaceutical industry is highly competitive and characterized by rapid and substantial technological change. We may be unable to successfully compete in this industry. Our competitors include several large pharmaceutical companies that market pediatric products in addition to products for the adult market, including GlaxoSmithKline, which markets Ceftin oral suspension and which competes with our Primsol product; Eli Lilly and Company, which markets Ceclor suspension and which competes with our Primsol product; the Ortho-McNeil Pharmaceutical Division of Johnson & Johnson, Inc., which markets Tylenol suspension and which would compete with our acetaminophen extended release product; and Muro Pharmaceuticals, Inc., which markets Prelone and which competes with our Orapred product. We currently market three products as alternative treatments for pediatric indications for which products with the same active ingredient are well-entrenched in the market. Our products compete with products that do not contain the same active ingredient but are used for the same indication and are well entrenched within the pediatric market. Moreover, our products are reformulations of existing drugs of other manufacturers and may have significantly narrower patent or other competitive protection. Moreover, we may face competition from companies that develop generic versions of any of our products. If generic version of our products are introduced, the selling prices of our products and our profit margins may decrease because of the increased competition. Particular competitive factors that we believe may affect us include: - many of our competitors have well known brand names that have been promoted over many years; - many of our competitors offer well established, broad product lines and services which we do not offer; and - many of our competitors have substantially greater financial, technical and human resources than we have, including greater experience and capabilities in undertaking preclinical studies and human clinical trials, obtaining FDA and other regulatory approvals and marketing pharmaceuticals. WE ARE DEPENDENT ON THIRD PARTY MANUFACTURERS AND THEIR MANUFACTURING CAPACITY We have no manufacturing facilities. Instead, we rely on third parties to manufacture our products in accordance with current Good Manufacturing Practices requirements prescribed by the FDA. In particular, we rely on Lyne Laboratories, Inc. for the manufacture of Orapred syrup and Primsol solution. We expect to continue to be dependent on third party manufacturers for the production of all of our products. There are a limited number of manufacturers that operate under the FDA's Good Manufacturing Practices requirements and capable of manufacturing our products. As a result, we may experience difficulty in obtaining adequate capacity for our future needs. In the event that we are unable to obtain contract manufacturing, or obtain manufacturing on commercially reasonable terms, we may not be able to commercialize our products as planned. To the extent that we enter into manufacturing arrangements with third parties, we are dependent upon these third parties to perform their obligations in a timely manner and in accordance with applicable government regulations. Page 23 We have no experience in manufacturing on a commercial scale and no facilities or equipment to do so. If we determine to develop our own manufacturing capabilities, we will need to recruit qualified personnel and build or lease the requisite facilities and equipment. We may not be able to successfully develop our own manufacturing capabilities. Moreover, it may be very costly and time consuming for us to try and develop the capabilities. WE ARE DEPENDENT UPON SOLE SOURCE SUPPLIERS FOR OUR PRODUCTS Some of our supply arrangements require that we buy all of our requirements of a particular product exclusively from the other party to the contract. Moreover, for two of our products, we have qualified only two suppliers. Any interruption in supply from any of our suppliers or their inability to manufacture our products in accordance with the FDA's Good Manufacturing Practices requirements may adversely affect us in a number of ways, including our being unable to meet commercial demand for our products. WE ARE DEPENDENT UPON A THIRD PARTY DISTRIBUTOR We distribute our products through a third party distribution warehouse. We have no experience with the distribution of products and rely on the third party distributor to perform order entry, customer service and collection of accounts receivable on our behalf. The success of this arrangement is dependent on, among other things, the skills, experience and efforts of the third party distributor. THE PRICING OF OUR PRODUCTS IS SUBJECT TO DOWNWARD PRESSURES The availability of reimbursement by governmental and other third party payors affects the market for our pharmaceutical products. These third party payors continually attempt to contain or reduce healthcare costs by challenging the prices charged for medical products and services. We expect to experience pricing pressure due to the trend toward managed healthcare, the increasing influence of health maintenance organizations and additional legislative proposals. We may not be able to sell our products profitably if reimbursement is unavailable or limited in scope or amount. WE MAY NOT BE ABLE TO MAINTAIN OR OBTAIN REGULATORY APPROVALS The production and the marketing of our products are subject to extensive regulation by federal, state and local governmental authorities in the United States and other countries. If we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions and criminal prosecutions. Moreover, if our financial condition improves sufficiently such that we resume product development, clearing the regulatory process for the commercial marketing of a pharmaceutical product takes many years and requires the expenditure of substantial resources. We have had only limited experience in filing and prosecuting applications necessary to gain regulatory approvals. Thus, we may not be able to obtain regulatory approvals to conduct clinical trials of or manufacture or market any future potential products. Factors that may affect the regulatory process for any future product candidates we may have include: - our analysis of data obtained from preclinical and clinical activities is subject to confirmation and interpretation by regulatory authorities, which could delay, limit or prevent regulatory approval; Page 24 - we or the FDA may suspend clinical trials at any time if the participants are being exposed to unanticipated or unacceptable health risks; and - any regulatory approval to market a product may be subject to limitations on the indicated uses for which we may market the product. These limitations may limit the size of the market for the product. As to products for which we have or, with respect to future product candidates, if any, obtain marketing approval, we, the manufacturer of the product, if other than us, and the manufacturing facilities will be subject to continual review and periodic inspections by the FDA. The subsequent discovery of previously unknown problems with the product, manufacturer or facility may result in restrictions on the product or manufacturer, including withdrawal of the product from the market. We also are subject to numerous and varying foreign regulatory requirements governing the design and conduct of clinical trials and the manufacturing and marketing of our products. The approval procedure varies among countries. The time required to obtain foreign approvals often differs from that required to obtain FDA approval. Approval by the FDA does not ensure approval by regulatory authorities in other countries. ANY PROMOTION ARRANGEMENTS DEPEND ON THE SUPPORT OF OUR COLLABORATORS We plan to continue to seek to enter into arrangements to promote some pharmaceutical products of third parties to pediatricians in the United States. The success of any arrangement is dependent on, among other things, the third party's commitment to the arrangement, the financial condition of the third party and market acceptance of the third party's products. WE ARE EXPOSED TO PRODUCT LIABILITY CLAIMS Our business exposes us to potential product liability risks which are inherent in the testing, manufacturing, marketing and sale of pharmaceuticals. Product liability claims might be made by consumers, health care providers or pharmaceutical companies or others that sell our products. If product liability claims are made with respect to our products, we may need to recall the products or change the indications for which they may be used. A recall of a product would have a material adverse effect on our business, financial condition and results of operations. WE HAVE LIMITED PRODUCT LIABILITY COVERAGE AND WE MAY NOT BE ABLE TO OBTAIN IT IN THE FUTURE Our product liability coverage is expensive and we have purchased only limited coverage. This coverage is subject to various deductibles. In the future, we may not be able to maintain or obtain the necessary product liability insurance at a reasonable cost or in sufficient amounts to protect us against losses. Accordingly, product liability claims could have a material adverse effect on our business, financial condition and results of operations. Page 25 WE MAY BECOME INVOLVED IN PROCEEDINGS RELATING TO INTELLECTUAL PROPERTY RIGHTS Because our products are based on existing compounds rather than new chemical entities, we may become parties to patent litigation and interference proceedings. The types of situations in which we may become parties to litigation or proceedings include: - if our competitors file patent applications that claim technology also claimed by us, we may participate in interference or opposition proceedings to determine the priority of invention; - if third parties initiate litigation claiming that our processes or products infringe their patent or other intellectual property rights, we will need to defend against such proceedings; - we may initiate litigation or other proceedings against third parties to enforce our patent rights; or - we may initiate litigation or other proceedings against third parties to seek to invalidate the patents held by them or to obtain a judgment that our products or processes do not infringe their patents. An adverse outcome in any litigation or interference proceeding could subject us to significant liabilities to third parties and require us to cease using the technology that is at issue or to license the technology from third parties. We may not be able to obtain any required licenses on commercially acceptable terms or at all. Thus, an unfavorable outcome in any patent litigation or interference proceeding could have a material adverse effect on our business, financial condition or results of operations. The cost to us of any patent litigation or interference proceeding, even if resolved in our favor, could be substantial. Uncertainties resulting from the initiation and continuation of patent litigation or interference proceedings could have a material adverse effect on our ability to compete in the marketplace. Patent litigation and interference proceedings may also absorb significant management time. OUR PATENT LICENSES ARE SUBJECT TO TERMINATION We are a party to a number of patent licenses that are important to our business and seek to enter into additional patent licenses in the future. These licenses impose various commercialization, sublicensing, royalty, insurance and other obligations on us. If we fail to comply with these requirements, the licensor will have the right to terminate the license, which could have a material adverse effect on our business, financial condition or results of operations. OUR BUSINESS COULD BE ADVERSELY AFFECTED IF WE CANNOT ADEQUATELY PROTECT OUR PROPRIETARY KNOW-HOW We must maintain the confidentiality of our trade secrets and other proprietary know-how. We seek to protect this information by entering into confidentiality agreements with our employees, consultants, any outside scientific collaborators and other advisors. These agreements may be breached by the other party. We may not be able to obtain an adequate, or perhaps, any remedy to address the breach. In addition, our trade secrets may otherwise become known or be independently developed by our competitors. Page 26 WE ARE SUBJECT TO TECHNOLOGICAL UNCERTAINTY IN ANY DEVELOPMENT EFFORTS THAT WE MAY RESUME We have introduced only three internally-developed products, Pediamist nasal saline spray, Primsol trimethoprim solution and Orapred syrup into the market. Although we have completed development of products and have filed applications with the FDA for marketing approval, any future product candidates we may have would require additional formulation, preclinical studies, clinical trials and regulatory approval prior to any commercial sales. Moreover, in December 1999, due to limitations on resources, we suspended the development of our products indefinitely. If we resume product development, we will be required to successfully address a number of technological challenges to complete the development of our potential products. These products may have undesirable or unintended side effects, toxicities or other characteristics that may prevent or limit commercial use. WE MAY BE UNSUCCESSFUL WITH ANY FUTURE CLINICAL TRIALS THAT WE MAY RESUME In order to obtain regulatory approvals for the commercial sale of any future products we may have under development, if any, we will be required to demonstrate through preclinical testing and clinical trials that the product is safe and efficacious. The results from preclinical testing and early clinical trials of a product that is under development may not be predictive of results that will be obtained in large-scale later clinical trials. In December 1999, due to limitations on resources, we suspended the development of our products indefinitely. The rate of completion of our clinical trials, if any, is dependent on the rate of patient enrollment, which is beyond our control. We may not be able successfully to complete any clinical trial of a potential product within a specified time period, if at all, including because of a lack of patient enrollment. Moreover, clinical trials may not show any potential product to be safe or efficacious. Thus, the FDA and other regulatory authorities may not approve any of our potential products for any indication. If we are unable to complete a clinical trial of one of our potential products, if the results of the trial are unfavorable or if the time or cost of completing the trial exceeds our expectation, assuming we resume product development, our business, financial condition or results of operations could be materially adversely affected. WE ARE DEPENDENT ON A FEW KEY EMPLOYEES WITH KNOWLEDGE OF THE PEDIATRIC PHARMACEUTICAL INDUSTRY We are highly dependent on the principal members of our management and scientific staff, particularly Dr. Clemente, the president and chairman of our board of directors. The loss of the services of Dr. Clemente could have a material adverse effect on our business. UNCERTAINTY OF HEALTHCARE REFORM MEASURES In both the United States and some foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the healthcare system. Further proposals are likely. The potential for adoption of these proposals affects and will affect our ability to raise capital, obtain additional collaborative partners and market our products. WE NEED TO ATTRACT AND RETAIN HIGHLY SKILLED PERSONNEL WITH KNOWLEDGE OF DEVELOPING AND MANUFACTURING PEDIATRIC PHARMACEUTICALS Recruiting and retaining qualified scientific personnel to perform research and development is critical to our success. Any growth and expansion into areas and activities requiring additional expertise would expected to require the addition of new management personnel and the development of additional expertise by existing management personnel. We may not be able to attract and retain highly skilled personnel on acceptable terms given the competition for experienced scientists among pharmaceutical and health care companies, universities and non-profit research institutions. ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In January 1997, the Securities and Exchange Commission issued Financial Reporting Release 48, also known as FRR 48, "Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative Information About Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments and Derivative Commodity Instruments". FRR 48 requires disclosure of qualitative and quantitative information about market risk inherent in derivative financial instruments, other financial instruments, and derivative commodity instruments beyond those required under generally accepted accounting principles. Page 27 In the ordinary course of business, Ascent is exposed to interest rate risk for its subordinated and convertible subordinated notes. All of the notes have fixed annual rates of either 7.5% or 8.0%. At September 30, 2001, the fair value of these notes was estimated to approximate carrying value. Market risk was estimated as the potential increase in fair value resulting from a hypothetical 10% decrease in the Company's weighted average short-term borrowing rate at September 30, 2001, which was not materially different from the quarter-end carrying value. PART II. OTHER INFORMATION ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS a) See Part 1, "Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources," for a description of (i) equity securities of Ascent sold by Ascent during the fiscal quarter ended June 30, 2001 which were not registered under the Securities Act of 1933, as amended (each of which was issued pursuant to Section 4(2) of the Securities Act), and (ii) working capital and restrictions and other limitations upon payment of dividends, which information is incorporated herein by reference. ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K a) Exhibits See the Exhibit Index on Page 29 for a list of exhibits filed as part of this Quarterly Report on Form 10-Q, which Exhibit Index is incorporated herein by reference. b) Reports on Form 8-K None. Page 28 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, thereunto duly authorized.

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ASCENT PEDIATRICS INC 10-Q