SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
FOR ANNUAL & TRANSITION REPORTS PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
(Mark One)
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the fiscal year ended December 31, 2001 or
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
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Commission File Number: 0-16109
A.P. PHARMA, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2875566
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
123 Saginaw Drive, Redwood City, California 94063
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 366-2626
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Securities registered pursuant to Section 12 (b) of the Act: None
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Securities registered pursuant to Section 12 (g) of the Act:
Common Stock ($.01 par value)
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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 period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [ ]
---- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
---
The aggregate market value of the voting stock of the registrant held by non-
affiliates of the registrant as of February 28, 2002, was $30,845,887. (1)
As of February 28, 2002, 20,365,687 shares of registrant's Common Stock, $.01
par value, were outstanding.
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(1)Excludes 6,344,829 shares held by directors, officers and shareholders
whose ownership exceeds 5% of the outstanding shares at February 28, 2002.
Exclusion of such shares should not be construed as indicating that the
holders thereof possess the power, directly or indirectly, to direct the
management or policies of the registrant, or that such person is controlled
by or under common control with the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Form
10-K
Document Part
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Definitive Proxy Statement to be used
in connection with the 2002 Annual Meeting
of Stockholders. III
TABLE OF CONTENTS
PART I
ITEM 1. Business
ITEM 2. Properties
ITEM 3. Legal Proceedings
ITEM 4. Submission of Matters to a Vote of Security Holders
PART II
ITEM 5. Market for the Registrant's Common Equity and Related
Shareholder Matters
ITEM 6. Selected Financial Data
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk
ITEM 8. Financial Statements and Supplementary Data
ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
PART III
ITEM 10. Directors and Executive Officers of the Registrant
ITEM 11. Executive Compensation
ITEM 12. Security Ownership of Certain Beneficial Owners
and Management
ITEM 13. Certain Relationships and Related Transactions
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K
Signatures
PART I
Item 1. BUSINESS
INTRODUCTION-FORWARD LOOKING STATEMENTS
- ---------------------------------------
Except for statements of historical fact, the statements herein are forward-
looking and are subject to a number of risks and uncertainties that could
cause actual results to differ materially from the statements made. These
include, among others, uncertainty associated with timely development,
approval, launch and acceptance of new products, establishment of new
corporate alliances, progress in research and development programs and other
factors described below under the headings "APP Technology", "Products",
"Manufacturing", "Marketing", "Government Regulation", "Patents and Trade
Secrets" and "Competition". In addition, such risks and uncertainties also
include the matters discussed under Management's Discussion and Analysis of
Financial Condition and Results of Operations in Item 7 below.
COMPANY OVERVIEW
- ----------------
In this Annual Report on Form 10-K, the "Company", "A.P. Pharma", "APP",
"we", "us", and "our", refer to A.P. Pharma, Inc.
We are a specialty pharmaceutical company focused on the development of
pharmaceutical products utilizing our proprietary polymer-based drug delivery
systems. Our focus is the development and commercialization of bioerodible
injectable and implantable systems under the trade name Biochronomer(TM).
Our business strategy is twofold:
- - to develop selected proprietary products, funding them through the
preliminary phases of regulatory review before entering partnerships to earn
a share of future profits; and
- - to license our proprietary technologies to corporate partners after
completion of feasibility studies to earn research and development fees,
licensing fees, milestone payments and royalties.
Initial targeted areas of application for our drug delivery technologies
include pain management, inflammation, oncology and ophthalmology
applications. Product development programs are primarily funded by royalties
from topical products currently marketed by pharmaceutical partners and by
proceeds from the divestiture of our cosmeceutical product lines, as well as
potential fees we anticipate receiving from collaborative partners.
Bioerodible polymers are of increasing interest within the pharmaceutical and
biotechnology community for use in both drug delivery applications and as
devices. We have made substantial progress in developing bioerodible
polymers that potentially represent a significant improvement over existing
drug delivery systems. The major point of difference is that our polymers
have been specifically designed as drug delivery devices and are versatile.
Erosion times can be varied from hours to days, weeks or months and
mechanical properties can be adjusted to produce materials ranging from
injectable gels, to strands or rods, wafers or films and microspheres. In
addition, the synthesis is reproducible, can be scaled up and the polymers
are stable at room temperature, provided they are stored under anhydrous
conditions. In studies, the polymers were observed to erode to completion
and, once the drug was released, no polymer remained. In addition, the
polymers bioerode with low acidity, thus potentially allowing the delivery of
sensitive proteins and DNA.
We filed our first Investigational New Drug Application ("IND") in the fourth
quarter of 2001 for our product candidate APF112 for the treatment of post-
surgical pain, and entered human clinical trials in January 2002.
In February 1997, we received United States Food and Drug Administration
("FDA") marketing clearance for our first pharmaceutical product based on the
original patented Microsponge technology, Retin-A Micro(R), which was
licensed to Ortho Neutrogena, a member of the Johnson & Johnson family of
companies. This product was launched in the United States in March 1997.
Retin-A Micro also received marketing clearance in Canada and was launched in
the third quarter of 2001, and Phase III clinical trials were completed in
Europe in 2001. A New Drug Application ("NDA") was filed in the United
States in the third quarter of 2001 for a product line extension for Retin-A
Micro.
We licensed to Dermik Laboratories, an Aventis company, a Microsponge-based
formulation incorporating 5-fluorouracil (5-FU) for the treatment of actinic
keratoses, a precancerous skin condition. The product was launched in the
first quarter of 2001 under the brand name Carac(TM). This new product has a
number of advantages over existing topical therapies, including less
irritation with shorter duration of therapy and reduced dosage frequency.
Until July 2000, we engaged in the development, manufacturing, and out-
licensing of the aforementioned topical pharmaceutical products as well as a
variety of cosmeceutical and toiletry products. In July 2000, we sold our
cosmeceutical and toiletry product lines, together with certain technology
rights to topical pharmaceuticals, to RP Scherer, a subsidiary of Cardinal
Health. We received $25 million at closing and are entitled to receive
further earnout amounts for the subsequent three years, the amounts of which
are dependent on the performance of the product lines sold. We recorded $3
million at the end of the first earnout period, which represents earnout
payments received of $3.6 million less reserves for certain indemnification
claims allowable under the sale agreement. Under the sale agreement, we
retained the rights to our topical prescription products which are marketed
by our corporate partners, Johnson & Johnson and Aventis, and on which we
continue to receive royalties.
The Company, founded in February 1983 as a California corporation under the
name AMCO Polymerics, Inc., changed its name to Advanced Polymer Systems,
Inc. in 1984 and was reincorporated in Delaware in 1987. We changed our name
to A.P. Pharma, Inc. in May 2001 to reflect the new pharmaceutical focus of
the Company.
APP TECHNOLOGY
- --------------
We have made significant investment and progress in the development of
bioerodible drug delivery systems. Specifically, we have developed two
families of polymers, each with unique attributes. The first family is known
collectively as poly(ortho esters) under the trade name Biochronomer(TM);
polymers in the second family are known collectively as block copolymers of
poly(ortho esters) and poly(ethylene glycol) under the trade name
Bioerodimer(TM). The two polymer families are covered by US 5,968,543,
issued October 19, 1999 and US 5,939,453, issued August 17, 1999. Both are
broad composition of matter patents. A number of other patent applications
have been filed.
Current product development work takes advantage of the versatility of these
materials, and is exemplified by forms that range from injectable gels into
which drugs can be incorporated by a simple mixing procedure, to solid
devices that can be fabricated at temperatures low enough to allow the
incorporation of materials such as proteins that require mild fabrication
conditions.
Our primary focus has been on advancing our Biochronomer technology, which is
designed to release drugs at selected implantation sites - such as under the
skin, in joints, in the eye, in muscle tissue or at the site of a surgical
procedure. Key benefits of this technology include the ability to fabricate
the poly(ortho ester) polymers into a variety of drug delivery forms -
ranging from wafers and strands to microspheres and injectable gels to enable
various means of administration into the body.
The Biochronomer polymer is a poly(ortho ester) that is produced by a
condensation reaction between a diketene acetal and a diol, or mixture of
diols. This reaction is highly reproducible and kilo quantities of polymer
have been produced according to Good Manufacturing Practices (GMP).
Approximately one hundred in vivo and in vitro studies have been completed to
advance understanding of this innovative drug delivery technology. The data
demonstrate that Biochronomer systems have potential in a wide range of
applications, including pain management; osteoarthritis; anti-adhesion, anti-
inflammatory, anti-infective; ophthalmic diseases, bone growth, restenosis
and tissue engineering. Importantly, the initial toxicology data indicate
that the technology is safe for use in the body. Studies demonstrate
complete and controlled bioerosion of the polymers. Furthermore,
Biochronomer systems have controlled drug-release rates, both short-term and
long-term.
Also under development are biodegradable devices based on poly(ortho esters).
Because both mechanical properties and erosion rates can be controlled, these
polymers are emerging as promising materials for devices useful in
cardiovascular applications such as stent coatings and in the development of
scaffolding materials used in tissue engineering. In all of these
applications, the ability to also deliver drugs is a distinct advantage.
Through academic collaborations, we are also developing water-soluble
Bioerodimer polymers with the intent to maximize the concentration of anti-
cancer agents in solid tumors and to minimize their concentration in healthy
tissue. Two such approaches are currently under development.
PRODUCTS
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Ethical Pharmaceutical Products
- -------------------------------
APP defines ethical pharmaceutical products as prescription products which
are promoted primarily through the medical profession. The Company is
developing several pharmaceutical product candidates which will require
marketing clearance from the FDA before they can be sold in the United
States. The Company believes that the benefits offered by its delivery
systems will create valuable product differentiation and improvements in
large and profitable markets. Results from various preclinical studies
reaffirm that this technology offers the potential to reduce drug side
effects, maintain or improve therapeutic efficacy and potentially increase
patient compliance with a less frequent treatment regimen.
The following ethical dermatological products have been developed and
commercialized:
Retin-A Micro: In February 1997, the Company received FDA approval for
Microsponge-entrapped tretinoin for improved acne treatment. Tretinoin has
been marketed in the United States by Ortho Neutrogena (formerly Ortho
Dermatological), a Johnson & Johnson ("J&J") subsidiary, under the brand name
RETIN-A(R) since 1971. It has proven to be a highly effective topical acne
medication. However, skin irritation among sensitive individuals can limit
patient compliance with the prescribed therapy. The Company believes its
patent-protected approach to drug delivery reduces the potentially irritating
side effects of tretinoin. Ortho Dermatological began marketing this product
in March 1997 under the brand name Retin-A(R) Micro (TM). The Company
receives royalty income based on the sales of this product over the life of
the applicable patents.
During 2001, Ortho also launched this product in Canada and completed Phase
III clinical trials in Europe in preparation for a European Union filing.
Additionally, Ortho completed Phase III clinical trials in the United States
on a second Retin-A Micro formulation and filed an NDA for the product in the
third quarter of 2001.
Carac: In the fourth quarter of 2000, Dermik Laboratories, an Aventis
company, received marketing clearance for an NDA for an APP-developed
formulation containing Microsponge-entrapped 5-fluorouracil (5-FU) for the
treatment of actinic keratoses. This product was launched under the trade
name Carac(TM) in the first quarter of 2001. The Company receives royalty
income based on the sales of this product over the life of the applicable
patents.
Products Under Development
- --------------------------
APP's efforts in pharmaceutical markets include additional applications using
the Company's technology which are under development, as noted below.
Extensive toxicology studies for an injectable Biochronomer polymer have been
completed, enabling an IND to be filed in December 2001, and human clinical
studies initiated in January 2002. The first product candidate targets the
market for post-surgical pain, which currently is estimated in excess of $500
million. The Company believes this product, APF112, can fill an important
need in an area which is still much under-served.
The treatment strategy is to provide 24 to 36 hours of localized post-
surgical pain relief by delivering the drug, mepivacaine, directly to the
surgical site. Mepivacaine is a well known drug for localized pain relief,
and it has an extensive safety protocol. APF112 is designed to minimize the
use of opioids (morphine-like drugs) which are currently used in the majority
of surgical procedures as a means of managing pain but with unpleasant side
effects - nausea, disorientation, sedation, constipation, vomiting, urinary
retention and, in some situations, life-threatening respiratory depression.
The first clinical study, designed to measure the safety of APF112, was
initiated in January 2002. Later in 2002, Phase II clinical studies are
expected to be initiated to evaluate therapeutic efficacy, probably in
association with arthroscopic knee surgery.
Other Products
- --------------
While not the principal focus of APP development efforts, the Company has
applied its original technology to its analytical standards business.
Analytical Standards. APP initially developed microspheres (precursors to
the Microsponge system) for use as a testing standard for gauging the purity
of municipal drinking water. Marketed by APP nationwide, these microspheres
are suspended in pure water to form an accurate, stable, reproducible
turbidity standard for the calibration of turbidimeters used to test water
purity.
The Company has also developed standards for the calibration of
spectrophotometers and colorimeters.
MARKETING
- ---------
A key part of the Company's business strategy is to ally the Company with
pharmaceutical partners. The Company has therefore negotiated agreements
covering Microsponge delivery systems and the marketing of formulated
prescription products.
The Company is now engaged in several feasibility studies relating to its
Biochronomer systems.
In general, APP grants limited marketing exclusivity in defined markets for
defined periods to its partners. However, after development is completed and
a partner commercializes a formulated product utilizing the Company's
delivery systems, APP can exert only limited influence over the manner and
extent of the client's marketing efforts.
The Company's key relationships are set forth below:
Johnson & Johnson Inc. In May 1992, APP and Ortho-McNeil Pharmaceutical
Corporation ("Ortho"), a subsidiary of J&J, entered into a development and
license agreement related to tretinoin-based products incorporating APP's
Microsponge technology. As part of the agreement, certain license fees and
milestone payments were paid by Ortho to APP. The license fees provided
Ortho with exclusive distribution or license rights for all Ortho tretinoin
products utilizing the APP Microsponge system. Ortho's exclusivity will
continue as long as annual minimum royalty payments are made, governed by the
life of the applicable patents owned by the Company.
In February 1997, APP received FDA marketing clearance for the first product
covered by this agreement, Microsponge-entrapped tretinoin. This product has
been marketed by Ortho Dermatological since March 1997 as Retin-A(R) Micro
(TM). APP received a payment of $3,000,000 from Ortho upon receipt of the
FDA approval, of which half is a milestone payment which was recognized as
revenue and half as prepaid royalties which was recorded as deferred
revenues.
Dermik. In March 1992, APP and Dermik, an Aventis company, restructured
their 1989 joint venture agreement. As part of the agreement Aventis
received certain exclusive marketing rights. Product applications include a
5-FU treatment for actinic keratoses, precancerous skin lesions. In the
fourth quarter of 1999, Dermik filed an NDA for this product and expanded its
agreement with APP to cover two additional applications, in return for
milestone payments and royalties upon successful development. In the fourth
quarter of 2000 Dermik received FDA marketing clearance for the product,
which was launched under the trade name Carac(TM) in the first quarter of
2001. APP received $500,000 on the filing of the NDA, representing a
milestone payment of $250,000 and prepaid royalties of $250,000, as well as a
milestone payment of $50,000 on the receipt of marketing clearance from the
FDA. Dermik's exclusivity will continue as long as annual minimum royalty
payments are made, governed by the life of the applicable patents owned by
the Company.
GOVERNMENT REGULATION
- ---------------------
Ethical Products
- ----------------
In order to clinically test, produce and sell products for human therapeutic
use, mandatory procedures and safety evaluations established by the FDA and
comparable agencies in foreign countries must be followed. The procedure for
seeking and obtaining the required governmental clearances for a new
therapeutic product includes preclinical animal testing to determine safety
and efficacy, followed by human clinical testing. This can take many years
and require substantial expenditures. In the case of third party agreements,
we expect that our corporate partners will partially fund the testing and the
approval process with guidance from us. We intend to seek the necessary
regulatory approvals for our proprietary products as they are being
developed.
PATENTS AND TRADE SECRETS
- -------------------------
As part of the Company's strategy to protect its current products and to
provide a foundation for future products, APP has filed a number of United
States patent applications on inventions relating to specific products,
product groups, and processing technology. The Company also has filed
foreign patent applications on its polymer technology with the European
Union, Japan, Australia, South Africa, Canada, Korea and Taiwan. The Company
has a total of 10 issued United States patents and an additional 105 issued
foreign patents. Currently, the Company has over 24 pending patent
applications worldwide.
Although the Company believes the bases for these patents and patent
applications are sound, they are untested, and there is no assurance that
they will not be successfully challenged. There can be no assurance that any
patent previously issued will be of commercial value, that any patent
applications will result in issued patents of commercial value, or that APP's
technology will not be held to infringe patents held by others.
APP relies on unpatented trade secrets and know-how to protect certain
aspects of its production technologies. APP's employees, consultants,
advisors and corporate partners have entered into confidentiality agreements
with the Company. These agreements, however, may not necessarily provide
meaningful protection for the Company's trade secrets or proprietary know-how
in the event of unauthorized use or disclosure. In addition, others may
obtain access to, or independently develop, these trade secrets or know-how.
COMPETITION
- -----------
In the development of bioerodible poly(ortho esters) for implantation
applications, there is competition from a number of other bioerodible
systems, especially polymers based on lactic and glycolic acid and to a
lesser extent, polyanhydrides. The Company believes that its proprietary
bioerodible Biochronomer(TM) polymers have a number of important advantages.
Among these are ease of synthesis, ability to control both erosion times and
mechanical properties, the simultaneous drug delivery and erosion process,
resulting in complete polymer disappearance when all the drug has been
delivered. Also, the polymer bioerodes with low acidity, thus potentially
allowing the delivery of sensitive proteins and DNA.
The attribute of the second family of bioerodible polymers, the block
copolymers of poly(ortho esters) and poly(ethylene glycols) is that a
hydrophobic (water-repelling) bioerodible segment can be connected to a
water-soluble segment. There are other such polymers, but the Company
believes that its proprietary material is superior because the hydrophobic
poly(ortho ester) segment can greatly increase the efficiency of drug
entrapment making transport to tumors much more effective.
HUMAN RESOURCES
- ---------------
As of February 28, 2002, the Company had 38 full-time employees, 10 of whom
hold PhDs. There were 20 employees engaged in research and development and
quality control, 9 in production and sales activities and 9 working in
finance, business development, human resources and administration.
The Company considers its relations with employees to be satisfactory. None
of the Company's employees is covered by a collective bargaining agreement.
Item 2. PROPERTIES
The Company leases 26,067 square feet of laboratory, office and warehouse
space in Redwood City, California. The current annual rent expense for the
Redwood City facility is approximately $494,000.
The Company occupied a production facility and warehouse in Lafayette,
Louisiana which was sold to RP Scherer in July 2000. The construction of the
facility in 1986 was financed primarily by 15-year, tax-exempt industrial
development bonds. In 1995, the Company extinguished the bond liability
through an "insubstance defeasance" transaction by placing United States
government securities in an irrevocable trust to fund all future interest and
principal payments. The defeased debt balance outstanding of $2,500,000 as
of December 31, 2001 will be repaid on January 25, 2005 using the proceeds
from the maturities of the United States government securities held in the
irrevocable trust.
The Company's existing research and development and administrative facilities
are not yet being used at full capacity and management believes that such
facilities are adequate and suitable for its current and anticipated needs.
Item 3. LEGAL PROCEEDINGS
In February 2000, Douglas Kligman and Albert Kligman filed a complaint
against the Company in the U.S. District Court for the Eastern District of
Pennsylvania. The complaint alleged that the plaintiffs entered into a
partnership with the Company to pursue development and sales of a product
developed by the plantiffs. The complaint stated various claims, dissolution
of partnership, implied-in-law contract and other claims.
On September 28, 2001, the U.S. District Court for the Eastern District of
Pennsylvania granted a summary judgment in favor of A.P. Pharma, Inc.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS
Shares of the Company's common stock trade on the NASDAQ National Market,
under the symbol APPA. As of February 28, 2002, there were 476 holders of
record of the Company's common stock.
The Company has never paid cash dividends and does not anticipate paying cash
dividends in the foreseeable future. The following table sets forth for the
fiscal periods indicated, the range of high and low sales prices for the
Company's common stock on the NASDAQ National Market System.
2001 High Low 2000 High Low
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First Quarter 2.938 1.625 First Quarter 6.500 3.344
Second Quarter 3.350 1.870 Second Quarter 5.250 3.250
Third Quarter 3.100 1.400 Third Quarter 4.125 2.125
Fourth Quarter 3.120 1.550 Fourth Quarter 3.563 1.750
Item 6. SELECTED FINANCIAL DATA
(in thousands, except per share data)
For the Years Ended and as of
December 31, 2001 2000 1999 1998 1997
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Consolidated Statements of Operations Data
- ------------------------------------------
Royalties $ 3,252 $2,081 $2,025 $1,724 $1,150
License, R&D and option fees 13 122 1,462 219 1,500
Product sales 1,122 1,163 1,210 1,131 1,273
------ ----- ----- ----- -----
Total revenues 4,387 3,366 4,697 3,074 3,923
Cost of product sales 440 496 532 321 676
Research and development, net 7,348 3,713 2,471 2,371 2,354
Selling, marketing and
advertising 473 594 496 385 595
General and administrative 2,829 2,869 2,946 2,165 2,797
Interest and other, net 1,192 548 (390) (578) (753)
----- ----- ----- ----- -----
Loss from continuing operations (5,511) (3,758) (2,138) (2,746) (3,252)
Income from discontinued
operations(1) 107 1,163 4,510 5,271 1,444
Gain on disposition of
discontinued operations(2) 2,890 11,147 -- -- --
----- ----- ----- ----- -----
Net income (loss) $(2,514) $8,552 $2,372 $2,525 $(1,808)
===== ===== ===== ===== ======
Basic income (loss) per
common share:
Loss from continuing
operations $ (0.27) $(0.19) $(0.11) $(0.14) $(0.17)
Net income (loss) $ (0.12) $ 0.42 $ 0.12 $ 0.13 $(0.10)
Diluted income (loss) per
common share:
Loss from continuing
operations $ (0.27) $(0.19) $(0.11) $(0.14) $(0.17)
Net income (loss) $ (0.12) $ 0.42 $ 0.12 $ 0.12 $(0.10)
Weighted average common
shares outstanding - basic 20,276 20,179 20,079 19,854 18,779
Weighted average common
shares outstanding - diluted 20,276 20,213 20,252 20,381 19,815
Consolidated Balance Sheet Data
- -------------------------------
Working capital $18,074 $20,087 $13,192 $ 2,456 $ 3,372
Total assets 23,507 26,996 19,296 17,582 18,052
Long-term debt, excluding
current portion -- -- 2,409 -- 3,055
Shareholders' equity 19,172 21,159 12,036 9,036 4,113
(1) Income from discontinued operations represents the income attributable to
the Company's cosmeceutical and toiletries business that was sold to RP
Scherer on July 25, 2000.
(2) Gain on disposition of discontinued operations in 2000 represents the
gain on the sale of the Company's cosmeceutical and toiletries business to RP
Scherer on July 25, 2000, and in 2001 represents the earnout income received
from RP Scherer based on the performance of the business sold. This is the
first of three possible contractual payments under the sale agreement.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Summary of Critical Accounting Policies
The preparation of our financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the amounts reported in our
financial statements and accompanying notes. Estimates were made relating to
useful lives of fixed assets, valuation allowances, impairment of assets and
accruals. Actual results could differ materially from those estimates. The
items in our financial statements requiring significant estimates and
judgments are as follows:
Revenue Recognition
- -------------------
Product revenues are recorded upon shipment of products when four basic
criteria are met: 1) persuasive evidence of an arrangement exists, 2)
delivery has occurred or services have been rendered, 3) the fee is fixed and
determinable, and 4) collectibility is reasonably assured. Determination of
criteria 3 and 4 are based on management's judgments regarding the fixed
nature of the fees charged for products delivered and the collectibility of
those fees. Should changes in conditions cause management to determine these
criteria are not met for certain future transactions, revenue recognized for
any reporting period could be adversely affected.
The Company has licensing agreements that generally provide for the Company
to receive periodic minimum payments, royalties, and/or non-refundable
license fees. These licensing agreements typically require a non-refundable
license fee and allow partners to sell the Company's proprietary products in
a defined field or territory for a defined period. The license agreements
provide for APP to earn future revenue through royalty payments. These
non-refundable license fees are initially reported as deferred revenues and
recognized as revenues over the estimated life of the product to which they
relate as the Company has continuing involvement with licensees until the
related product is discontinued. Revenue recognized from deferred license
fees is classified as License, R&D and Option Fees in the accompanying
consolidated statements of operations. License fees received in connection
with arrangements where the Company has no continuing involvement are
recognized as revenue when the amounts are received or when collectibility is
assured, whichever is earlier.
Contractually required minimum royalties are recorded ratably throughout the
contractual period. Royalties in excess of minimum royalties are recognized
as earned when the related product is shipped to the customer by the
Company's licensees based on information received by the Company from its
licensees.
A milestone payment is a payment made by a third party or corporate partner
to the Company upon the achievement of a predetermined milestone as defined
in a legally binding contract. Milestone payments are recognized as revenue
when the milestone event has occurred and the Company has completed all
milestone related services such that the milestone payment is currently due
and is non-refundable.
Deferred Revenue
- ----------------
Non-refundable license fees received by the Company under arrangements where
the Company has continuing involvement are reported as deferred revenues and
amortized over the estimated life of the product to which they relate.
Prepaid royalties paid to the Company are also reported as deferred revenues.
In accordance with the respective licensing agreements, a percentage of the
royalties earned by the Company is applied against the deferred revenues,
after certain annual minimum royalty payments are met, and recognized as
revenues.
STATEMENTS OF OPERATIONS HIGHLIGHTS (in thousands)
- --------------------------------------------------
For the Years Ended December 31, Annual % Change
-------------------------------- ---------------
2001 2000 1999 01/00 00/99
------ ------ ------ ----- -----
Royalties $3,252 $2,081 $2,025 56% 3%
License, R&D and option fees 13 122 1,462 (89%) (92%)
Product sales 1,122 1,163 1,210 (4%) (4%)
------ ------ ------
Total revenues 4,387 3,366 4,697 30% (28%)
Cost of product sales 440 496 532 (11%) (7%)
Research and development, net 7,348 3,713 2,471 98% 50%
Selling and marketing 473 594 496 (20%) 20%
General and administrative 2,829 2,869 2,946 (1%) (3%)
2001 2000 1999
---- ---- ----
Expenses expressed as a percentage
of total revenues:
Cost of sales 10% 15% 11%
Research and development, net 167% 110% 53%
Selling and marketing 11% 18% 11%
General and administrative 64% 85% 63%
Results of Operations for the years ended December 31, 2001 and 2000
- --------------------------------------------------------------------
Except for statements of historical fact, the statements herein are forward-
looking and are subject to a number of risks and uncertainties that could
cause actual results to differ materially from the statements made. These
include, among others, uncertainty associated with timely development,
approval, launch and acceptance of new products, establishment of new
corporate alliances, progress in research and development programs, and other
risks described below or identified from time to time in the Company's
Securities and Exchange Commission filings.
The Company's revenues are derived principally from royalties, license and
research and development fees and sales of analytical standards products.
Under strategic alliance arrangements entered into with certain corporations,
APP can receive non-refundable upfront fees, milestone payments and royalties
based on third party product sales.
Royalties for 2001 increased by $1,171,000 or 56%, to $3,252,000 from
$2,081,000 in the prior year. This increase related primarily to royalties
earned on sales of Carac(TM), a topical prescription treatment for actinic
keratoses which was launched in the first quarter of 2001 by the Company's
marketing partner, Dermik Laboratories, an Aventis company. Royalties on
sales of Retin-A(R) Micro by Ortho Neutrogena, a Johnson and Johnson company,
also increased following a direct-to-consumer advertising program of the
product. Product revenues for 2001 relating to sales of analytical standards
decreased by 4% or $41,000 to $1,122,000 from $1,163,000 in the prior year.
Royalty income is expected to increase in 2002 assuming the continuation of
the direct-to-consumer advertising program for Retin-A Micro and anticipated
growth of Carac sales. Product revenues from sales of analytical standards
are expected to be flat.
Gross profit on sales of analytical standards increased from 57% to 61% due
mainly to a change in the sales mix with fewer sales of lower margin
instruments. Gross profit on product sales is expected to remain essentially
unchanged in 2002.
Research and development expense for 2001 increased by $3,635,000, or 98%, to
$7,348,000 from $3,713,000 due mainly to costs of preclinical studies
required for the filing of an Investigational New Drug Application (IND)
involving the Company's bioerodible Biochronomer(TM) drug delivery system for
a treatment for post-surgical pain, and the Company's ongoing product
development programs. Research and development expense is expected to
increase in 2002 as the Company's lead product candidate, APF112 for the
treatment of post-surgical pain, entered human clinical studies in early
2002.
The scope and magnitude of future research and development expenses are
difficult to predict at this time given the number of studies that will need
to be conducted for any of our potential products. In general,
biopharmaceutical development involves a series of steps - beginning with
identification of a potential target and including, among others, proof of
concept in animals and Phase I, II, and III clinical studies in humans - each
of which is typically more expensive than the previous step. Success in
development therefore results in increasing expenditures. Our research and
development expenses currently include costs for scientific personnel, animal
studies, supplies, equipment, consultants, patent filings, overhead
allocation and sponsored research at academic and research institutions.
Future research and development expenses would also include costs related to
human clinical trials.
The major components of R&D expenses for 2001, 2000 and 1999 were as follows
(in thousands):
2001 2000 1999
------ ------ ------
General research and
development costs $4,167 $2,900 $2,381
Polymer development and
preclinical programs 3,181 813 90
----- ----- -----
$7,348 $3,713 $2,471
===== ===== =====
Selling and marketing expense for analytical standards products for 2001
decreased by $121,000 or 20% to $473,000 from $594,000 due mainly to lower
advertising expenses on sales of analytical standards. Selling and marketing
expense is expected to remain essentially unchanged in 2002.
General and administrative expense for 2001 of $2,829,000 remained unchanged
from the prior year. General and administrative expense includes salaries
and related expenses, professional fees, directors' fees, investor relations
costs, insurance expense and overhead allocation, and is expected to increase
only moderately in 2002, primarily due to increased investor relations
activities.
Interest income for 2001 increased by $289,000, or 35%, to $1,106,000 from
$817,000 due mainly to the receipt of $25 million in July 2000 as proceeds
from the sale of the Company's cosmeceutical and toiletries product lines to
RP Scherer Corporation. Interest expense for 2001 decreased by $294,000, or
100%, to $0 due to the repayment of all previously outstanding debt upon the
Company's receipt of the $25 million proceeds from RP Scherer. Interest
income is expected to decrease in 2002 as cash balances decrease and if
interest rates remain constant.
On July 25, 2000, the Company completed the sale of certain technology rights
for topical pharmaceuticals and its cosmeceutical product lines and
associated assets to RP Scherer Corporation, a subsidiary of Cardinal Health,
Inc. Income/loss from discontinued operations represents the net
contribution/loss attributable to the cosmeceutical and toiletries product
lines which were sold to RP Scherer Corporation in July 2000. For the year
2001, the net income from discontinued operations totaled $108,000, compared
with $1,163,000 in the prior year.
The gain recorded in 2001 related to the disposition of discontinued
operations includes net earnout income of $3 million from the sale of the
Company's cosmeceutical product lines in the prior year, which represents
additional earnout income of $3.6 million less reserves for certain
indemnification claims allowable under the sale agreement. The earnout
income is the first of three contractual annual payments, the amounts of
which are dependent on the performance of the cosmeceutical business. The
gain on disposition of discontinued operations in the prior year represents
the gain realized on the sale of the cosmeceutical business completed in July
2000.
Results of Operations for the years ended December 31, 2000 and 1999
- --------------------------------------------------------------------
Royalties for 2000 increased by $56,000 or 3% to $2,081,000 from $2,025,000
in the prior year. This increase related to increased sales of Retin-A(R)
Micro by Ortho Neutrogena, a Johnson and Johnson company. Product revenues
for 2000 relating to sales of analytical standards, decreased by $47,000 or
4% to $1,163,000 from $1,210,000 in the prior year. License, R&D and option
fees of $122,000 decreased by $1,340,000 or 92% from $1,462,000 in the prior
year due mainly to the absence of revenues from the sale of a proprietary
product line in the prior year.
Gross profit on sales of analytical standards improved slightly from 56% to
57% due mainly to lower production labor costs resulting from staff turnover.
Research and development expense for 2000 increased by $1,242,000 or 50% over
the prior year to $3,713,000 from $2,471,000 due mainly to the initiation of
preliminary toxicology studies on the Company's bioerodible Biochronomer(TM)
delivery systems.
Selling and marketing expense for analytical standards products for 2000
increased by $98,000 or 20% over the prior year to $594,000 from $496,000 due
mainly to higher commission expense on sales of analytical standards and
higher overhead allocation compared with the prior year.
General and administrative expense decreased by 3% or $77,000 from the prior
year to $2,869,000 from $2,946,000 due mainly to reduced travel expenses and
outside services.
Interest income for 2000 increased by $616,000 or 307% over the prior year to
$817,000 from $201,000 due mainly to the receipt of $25 million in July 2000
as proceeds from the sale of the Company's cosmeceutical and toiletries
product lines to RP Scherer Corporation. Interest expense for 2000 decreased
by $291,000 or 50% to $294,000 from $585,000 due to the repayment of all
outstanding debt on the receipt of the $25 million proceeds from RP Scherer.
Income from discontinued operations represents the net contribution
attributable to the sale of the cosmeceutical and toiletries product lines
which were sold to RP Scherer Corporation in July 2000. For the year 2000,
the net contribution totaled $1,163,000, being the contribution earned in the
seven months prior to the closing of the sale transaction in July 2000,
compared with $4,510,000 in the full twelve months of the prior year. This
decrease was also due to unabsorbed overhead at the manufacturing facility in
Louisiana, resulting from a planned reduction in inventory levels and a shift
in sales mix from toiletries to cosmeceutical products which require less
Microsponge system entrapment.
Products in Development
- -----------------------
We have a number of product candidates in various stages of development, some
of which are the subject of collaborations with potential corporate partners.
The following table sets forth the current opportunities for our own
portfolio of product candidates, the compound selected, the delivery time and
the status.
CURRENT OPPORTUNITIES
Indication Compound Delivery Time Status
- ---------- -------- ------------- ------
Acute pain relief Mepivacaine Short term Phase I
(post-surgical)
Site-specific Meloxicam Medium term Pre-IND
Anti-inflammatory
In addition, several collaborative feasibility studies are ongoing in the
areas of ophthalmology, restenosis, fertility, osteoporosis and immune
stimulation.
Capital Resources and Liquidity
- -------------------------------
Total assets as of December 31, 2001 were $23,507,000 compared with
$26,996,000 at December 31, 2000. Cash, cash equivalents and marketable
securities decreased by $3,029,000 to $19,494,000 at December 31, 2001 from
$22,523,000 at December 31, 2000.
Net cash used in operating activities for the years ended December 31, 2001,
2000 and 1999 was $6,491,000, $3,116,000 and $842,000, respectively. The
increase in net cash used in operating activities was primarily due to
increased research and development expenses resulting from preclinical
studies required for the filing of an Investigational New Drug Application
("IND") involving the Company's bioerodible Biochronomer(TM) drug delivery
system for a treatment for post-surgical pain.
Net cash provided by investing activities for the years ended December 31,
2001 and 2000 was $3,550,000 and $8,972,000, respectively, compared to cash
used in investing activities of $176,000 for the year ended December 31,
1999. The changes in 2001 and 2000 as compared to 1999 were primarily the
result of proceeds from the disposition of discontinued operations.
Net cash provided by financing activities was $66,000 for the year ended
December 31, 2001 compared to net cash used in financing activities of
$3,068,000 for the year ended December 31, 2000 and net cash provided by
financing activities of $635,000 for the year ended December 31, 1999. The
net cash provided by financing activities in 2001 was mainly due to proceeds
from issuance of shares under the Employee Stock Purchase Plan. The change
in the year 2000 was primarily the result of repayment of the Company's long-
term debt.
In the current year, the Company has also financed its operations, including
technology and product research and development, from royalties on Retin-A
Micro and Carac, earnout income from RP Scherer, the sales of analytical
standard products and interest earned on short-term investments.
The Company's existing cash and cash equivalents, marketable securities,
collections of trade accounts receivable, together with interest income and
other revenue-producing activities including royalties, license and option
fees and R&D fees, are expected to be sufficient to meet the Company's cash
needs for at least two years, assuming no changes to existing business plans.
The Company's future capital requirements will depend on numerous factors
including, among others, royalties from sales of products of third party
licensees; the Company's ability to enter into collaborative research and
development and licensing agreements; progress of product candidates in
preclinical and clinical trials; investment in new research and development
programs; time required to gain regulatory approvals; resources that the
Company devotes to self-funded products; the Company's ability to obtain and
retain funding from third parties under collaborative arrangements; potential
acquisitions of technology, product candidates or businesses; and the costs
of defending or prosecuting any patent opposition or litigation necessary to
protect the Company's proprietary technology.
The Company occupies leased facilities under an agreement that expires in
three years. The Company also leases certain office equipment under
operating leases. The contractual obligations for the next five years and
thereafter are as follows:
Years Ending Minimum
December 31, Payments
----------- --------
2002 $ 681,396
2003 693,048
2004 590,568
2005 8,088
2006 and thereafter 7,414
---------
$1,980,514
=========
Recent Accounting Pronouncements
- --------------------------------
In July 2001, the FASB issued FAS 141, "Business Combinations" (FAS 141).
FAS 141 supersedes APB 16, "Business Combinations," and FAS 38, "Accounting
for Preacquisition Contingencies of Purchased Enterprises." FAS 141 requires
the purchase method of accounting for all business combinations initiated
after June 30, 2001 and eliminates the pooling-of-interests method. FAS 141
also includes guidance on the initial recognition and measurement of goodwill
and other intangible assets arising from business combinations completed
after June 30, 2001.
In July 2001, the FASB issued FAS 142, "Goodwill and Other Intangible Assets"
(FAS 142). FAS 142 supersedes APB 17, "Intangible Assets," and requires the
discontinuance of goodwill amortization. In addition, FAS 142 includes
provisions regarding the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the testing for impairment of existing
goodwill and other intangibles out of previously reported goodwill and other
intangibles. FAS 142 is required to be applied for fiscal years beginning
after December 15, 2001, with certain early adoption permitted. The Company
does not expect the adoption of FAS 142 to have a material effect on its
financial condition or results of operations.
In August 2001, the FASB issued FAS 143, "Accounting for Asset Retirement
Obligations" (FAS 143). FAS 143 addresses financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets
and the associated retirement costs. The Company does not expect the
adoption of FAS 143, which will be effective for the Company's fiscal year
ending December 31, 2002, to have a material effect on its financial
condition or results of operations.
In October 2001, the FASB issued FAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (FAS 144), which supersedes FAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of" (FAS 121). FAS 144 addresses financial accounting and
reporting for the impairmment of long-lived assets and for long-lived assets
to be disposed of. However, FAS 144 retains the fundamental provisions of
FAS 121 for: 1) recognition and measurement of the impairment of long-lived
assets to be held and used; and 2) measurement of long-lived assets to be
disposed of by sale. FAS 144 is effective for fiscal years beginning after
December 15, 2001. The Company does not expect the adoption of FAS 144 to
have a material effect on its financial condition or results of operations.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
- -------------------------------------------------
Our business is subject to various risks, including those described below.
You should carefully consider these risk factors, together with all of the
other information included in this Form 10-K. Any of these risks could
materially adversely affect our business, operating results and financial
condition.
OUR BUSINESS IS AT AN EARLY STAGE OF DEVELOPMENT.
Our business is at an early stage of development. Our ability to produce
bioerodible drug delivery systems that progress to and through clinical
trials is subject to, among other things:
- success with our research and development efforts;
- selection of appropriate therapeutic compounds for delivery;
- the required regulatory approval.
Successful development of delivery systems will require significant
preclinical and clinical testing prior to regulatory approval in the United
States and elsewhere. In addition, we will need to determine whether any
potential products can be manufactured in commercial quantities at an
acceptable cost. Our efforts may not result in a product that can be
marketed. Because of the significant scientific, regulatory and commercial
milestones that must be reached for any of our research programs to be
successful, any program may be abandoned, even after significant resources
have been expended.
WE MAY NEED ADDITIONAL CAPITAL TO CONDUCT OUR OPERATIONS AND DEVELOP OUR
PRODUCTS, AND OUR ABILITY TO OBTAIN THE NECESSARY FUNDING IS UNCERTAIN.
We may require additional capital resources in order to conduct our
operations and develop our products. While we estimate that our existing
capital resources, royalty income and interest income will be sufficient to
fund our current level of operations for at least the next two years based on
current business plans, we cannot guarantee that this will be the case. The
timing and degree of any future capital requirements will depend on many
factors, including:
- continued scientific progress in our research and development programs;
- the magnitude and scope of our research and development programs;
- our ability to maintain and establish strategic collaborations or
partnerships for research, development, clinical testing, manufacturing and
marketing;
- our progress with preclinical and clinical trials;
- the time and costs involved in obtaining regulatory approvals;
- the costs involved in preparing, filing, prosecuting, maintaining,
defending and enforcing patent claims.
We intend to acquire additional funding through strategic collaborations, in
the form of license fees, research and development fees and milestone
payments. In the event that additional funds are obtained through
arrangements with collaborative partners, these arrangements may require us
to relinquish rights to some of our technologies, product candidates or
products that we would otherwise seek to develop and commercialize ourselves.
If sufficient funding is not available, we may be required to delay, reduce
the scope of or eliminate one or more of our research or development
programs, each of which could have a material adverse effect on our business.
ENTRY INTO CLINICAL TRIALS WITH ONE OR MORE PRODUCTS MAY NOT RESULT IN ANY
COMMERCIALLY VIABLE PRODUCTS.
We do not expect to generate any significant revenues from product sales for
a period of several years. We may never generate revenues from product sales
or become profitable because of a variety of risks inherent in our business,
including risks that:
- clinical trials may not demonstrate the safety and efficacy of our
products;
- completion of clinical trials may be delayed, or costs of clinical trials
may exceed anticipated amounts;
- we may not be able to obtain regulatory approval of our products, or may
experience delays in obtaining such approvals;
- we may not be able to manufacture our delivery systems economically on a
commercial scale;
- we and our licensees may not be able to successfully market our products.
WE DEPEND ON OUR COLLABORATORS TO HELP US COMPLETE THE PROCESS OF DEVELOPING
AND TESTING OUR PRODUCTS AND OUR ABILITY TO DEVELOP AND COMMERCIALIZE
PRODUCTS MAY BE IMPAIRED OR DELAYED IF OUR COLLABORATIVE PARTNERSHIPS ARE
UNSUCCESSFUL.
Our strategy for the development, clinical testing and commercialization of
our products requires entering into collaborations with corporate partners,
licensors, licensees and others. We are dependent upon the subsequent
success of these other parties in performing their respective
responsibilities and the cooperation of our partners. Our collaborators may
not cooperate with us or perform their obligations under our agreements with
them. We cannot control the amount and timing of our collaborators'
resources that will be devoted to our research activities related to our
collaborative agreements with them. Our collaborators may choose to pursue
existing or alternative technologies in preference to those being developed
in collaboration with us.
Under collaborative agreements with collaborators, we may rely significantly
on them, among other activities, to:
- fund research and development activities with us;
- pay us fees upon the achievement of milestones; and
- market with us any commercial products that result from our
collaborations.
OUR RELIANCE ON THE RESEARCH ACTIVITIES OF OUR NON-EMPLOYEE SCIENTIFIC
ADVISORS AND OTHER RESEARCH INSTITUTIONS, WHOSE ACTIVITIES ARE NOT WHOLLY
WITHIN OUR CONTROL, MAY LEAD TO DELAYS IN TECHNOLOGICAL DEVELOPMENTS.
We have relationships with scientific advisors at academic and other
institutions, some of whom conduct research at our request. These scientific
advisors are not our employees and may have commitments to, or consulting or
advisory contracts with, other entities that may limit their availability to
us. We have limited control over the activities of these advisors and,
except as otherwise required by our collaboration and consulting agreements,
can expect only limited amounts of their time to be dedicated to our
activities. If our scientific advisors are unable or refuse to contribute to
the development of any of our potential discoveries, our ability to generate
significant advances in our technologies will be significantly harmed.
THE LOSS OF KEY PERSONNEL COULD SLOW OUR ABILITY TO CONDUCT RESEARCH AND
DEVELOP PRODUCTS.
Our future success depends to a significant extent on the skills, experience
and efforts of our executive officers and key members of our scientific
staff. We may be unable to retain our current personnel or attract or
assimilate other highly qualified management and scientific personnel in the
future. The loss of any or all of these individuals could harm our business
and might significantly delay or prevent the achievement of research,
development or business objectives.
BECAUSE WE OR OUR COLLABORATORS MUST OBTAIN REGULATORY APPROVAL TO MARKET OUR
PRODUCTS IN THE UNITED STATES AND FOREIGN JURISDICTIONS, WE CANNOT PREDICT
WHETHER OR WHEN WE WILL BE PERMITTED TO COMMERCIALIZE OUR PRODUCTS.
Federal, state and local governments in the United States and governments in
other countries have significant regulations in place that govern many of our
activities. The preclinical testing and clinical trials of the products that
we develop ourselves or that our collaborators develop are subject to
government regulation and may prevent us from creating commercially viable
products from our discoveries. In addition, the sale by us or our
collaborators of any commercially viable product will be subject to
government regulation from several standpoints, including the processes of:
- manufacturing;
- advertising and promoting;
- selling and marketing;
- labeling; and
- distributing.
We may not obtain regulatory approval for the products we develop and our
collaborators may not obtain regulatory approval for the products they
develop. Regulatory approval may also entail limitations on the indicated
uses of a proposed product.
The regulatory process, particularly for biopharmaceutical products like
ours, is uncertain, can take many years and requires the expenditure of
substantial resources. Any product that we or our collaborative partners
develop must receive all relevant regulatory agency approvals or clearances,
if any, before it may be marketed in the United States or other countries.
In particular, human pharmaceutical therapeutic products are subject to
rigorous preclinical and clinical testing and other requirements by the Food
and Drug Administration in the United States and similar health authorities
in foreign countries. The regulatory process, which includes extensive
preclinical testing and clinical trials of each product in order to establish
its safety and efficacy, is uncertain, can take many years and requires the
expenditure of substantial resources.
Data obtained from preclinical and clinical activities is susceptible to
varying interpretations that could delay, limit or prevent regulatory agency
approvals or clearances. In addition, delays or rejections may be
encountered as a result of changes in regulatory agency policy during the
period of product development and/or the period of review of any application
for regulatory agency approval or clearance for a product. Delays in
obtaining regulatory agency approvals or clearances could:
- significantly harm the marketing of any products that we or our
collaborators develop;
- impose costly procedures upon our activities or the activities of our
collaborators;
- diminish any competitive advantages that we or our collaborative partners
may attain; or
- adversely affect our ability to receive royalties and generate revenues
and profits.
In addition, the marketing and manufacturing of drugs and biological products
are subject to continuing FDA review, and later discovery of previously
unknown problems with a product, its manufacture or its marketing may result
in the FDA requiring further clinical research or restrictions on the product
or the manufacturer, including withdrawal of the product from the market.
WE FACE INTENSE COMPETITION FROM OTHER COMPANIES.
Most or all of the products we could develop or commercialize will face
competition from different therapeutic agents intended for treatment of the
same indications or from other products incorporating drug delivery
technologies. The competition potentially includes all of the pharmaceutical
companies in the world. Many of these pharmaceutical companies have greater
financial resources, technical staff and manufacturing and marketing
capabilities than we do. To the extent that we develop or market products
incorporating drugs that are off-patent, or are being developed by multiple
companies, we will face competition from other companies developing and
marketing similar products.
Pharmaceutical companies are increasingly using advertising, including
direct-to-consumer advertising, in marketing their products. The costs of
such advertising are very high and are increasing. It may be difficult for
our company to compete with larger companies investing greater resources in
these marketing activities.
Other pharmaceutical companies are aggressively seeking to obtain new
products by licensing products or technology from other companies. We will
be competing to license or acquire products or technology with companies with
far greater financial and other resources.
INABILITY TO OBTAIN SPECIAL MATERIALS COULD SLOW DOWN OUR RESEARCH AND
DEVELOPMENT PROCESS.
Some of the critical materials and components used in our developed products
are sourced from a single supplier. An interruption in supply of a key
material could significantly delay our research and development process.
Special materials must often be manufactured for the first time for use in
drug delivery systems, or materials may be used in the systems in a manner
different from their customary commercial uses.
Special materials or components must be fabricated for use in our drug
delivery systems, or materials may be used in the systems in a manner
different from their customary commercial uses. The quality of materials can
be critical to the performance of a drug delivery system, so a reliable
source of a consistent supply of materials is important. Materials or
components needed for our drug delivery systems may be difficult to obtain on
commercially reasonable terms, particularly when relatively small quantities
are required, or if the materials traditionally have not been used in
pharmaceutical products.
PATENTS AND OTHER INTELLECTUAL PROPERTY PROTECTION MAY BE DIFFICULT TO OBTAIN
OR INEFFECTIVE.
Patent protection generally has been important in the pharmaceutical
industry. Our existing patents may not cover future products, additional
patents may not be issued, and current patents or patents issued in the
future may not provide meaningful protection or prove to be of commercial
benefit.
In the United States, patents are granted for specified periods of time.
Some of our earlier patents have expired, or will expire, over the next
several years.
Other companies may successfully challenge our patents in the future. Others
may also challenge the validity or enforceability of our patents in
litigation. If any challenge is successful, other companies may then be able
to use the invention covered by the patent without payment. In addition, if
other companies are able to obtain patents that cover any of our technologies
or products, we may be subject to liability for damages and our activities
could be blocked by legal action unless we can obtain licenses to those
patents.
In addition, we utilize significant unpatented proprietary technology and
rely on unpatented trade secrets and proprietary know-how to protect certain
aspects of our products and technologies and the methods used to manufacture
them. Other companies have or may develop similar technology which will
compete with our technology.
OUR ROYALTY REVENUES COULD DECLINE.
Our royalty revenues in future periods could vary significantly. Major
factors which could have an effect on our royalty revenues include, but are
not limited to:
- our partners' decisions about amounts and timing of advertising support
for Retin-A Micro and Carac.
- our partners' decisions about other promotion and marketing support for
Retin-A Micro and Carac.
- the timing of approvals for new product applications both in the United
States and abroad.
- the expiration or invalidation of patents.
- decreases in licensees' sales of product due to competition, manufacturing
difficulties or other factors that affect sales of product, including
regulatory restrictions on the advertising of pharmaceutical products.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company's exposure to market rate risk for changes in interest rates
relates primarily to its investment portfolio. APP does not use derivative
financial instruments. The Company manages its interest rate risk by
maintaining an investment portfolio primarily consisting of debt instruments
of high credit quality and relatively short average maturities. The Company
also manages its interest rate risk by maintaining sufficient cash and cash
equivalents such that it is typically able to hold its investments to
maturity. At December 31, 2001, the Company's cash equivalents, and
marketable securities include corporate and other debt securities of
$19,288,548. Short-term investments with effective maturities of less than
three months totaled $3,412,103. Investments with maturities between three
months and one year totaled $7,101,830. Investments with maturities between
one and two years totaled $8,774,615. Notwithstanding its efforts to manage
interest rate risks, there can be no assurances that it will be adequately
protected against the risks associated with interest rate fluctuations.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
A.P. Pharma, Inc.
Consolidated Balance Sheets
- ---------------------------
December 31,
-------------------------
2001 2000
---- ----
Assets
Current Assets:
Cash and cash equivalents $ 3,617,927 $ 6,493,336
Marketable securities 15,876,445 16,029,320
Accounts receivable less allowance
for doubtful accounts of $660 and
$223,235 at December 31, 2001 and
2000, respectively 338,275 490,578
Receivables for royalties, license fees
and R&D fees 1,129,668 1,200,554
Inventory 60,567 71,079
Advances to officers and employees -- 34,018
Prepaid expenses and other 600,945 730,964
---------- ----------
Total current assets 21,623,827 25,049,849
Property and equipment, net 1,667,904 1,795,313
Other long-term assets 215,283 151,000
---------- ----------
Total Assets $ 23,507,014 $ 26,996,162
========== ==========
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ 346,674 $ 329,305
Accrued expenses 1,409,091 1,499,552
Accrued disposition costs 1,479,005 2,488,242
Income taxes payable -- 255,358
Deferred revenue 314,706 390,201
---------- ----------
Total current liabilities 3,549,476 4,962,658
Deferred revenue - long-term 785,266 874,250
---------- ----------
Commitments and Contingencies
(Notes 4 and 9)
Shareholders' Equity:
Preferred stock, 2,500,000 shares
authorized; none issued or
outstanding at December 31,
2001 and 2000 -- --
Common stock, $.01 par value,
50,000,000 shares authorized;
20,357,115 and 20,206,064 issued
and outstanding at December 31,
2001 and 2000, respectively 203,571 202,061
Deferred compensation -- (79,890)
Additional paid-in capital 86,187,573 85,901,145
Accumulated deficit (67,456,428) (64,942,829)
Accumulated other comprehensive
income 237,556 78,767
---------- ----------
Total Shareholders' Equity 19,172,272 21,159,254
---------- ----------
Total Liabilities and Shareholders'
Equity $ 23,507,014 $ 26,996,162
========== ==========
See accompanying notes to consolidated financial statements.
A.P. Pharma, Inc.
Consolidated Statements of Operations
- -------------------------------------
Year Ended December 31,
-----------------------
2001 2000 1999
---- ---- ----
Revenues
Royalties $ 3,251,523 $ 2,081,025 $ 2,024,817
License, R&D and option fees 13,479 122,297 1,461,842
Product sales 1,122,260 1,162,537 1,209,914
---------- ---------- ----------
Total revenues 4,387,262 3,365,859 4,696,573
Expenses
Cost of product sales 440,270 496,439 532,470
Research and development, net 7,348,497 3,713,089 2,471,144
Selling and marketing 472,632 594,226 496,054
General and administrative 2,829,071 2,868,935 2,945,594
---------- ---------- ----------
Operating loss (6,703,208) (4,306,830) (1,748,689)
---------- ---------- ----------
Interest expense -- (294,374) (585,313)
Interest income 1,106,056 816,864 200,650
Other income (expense), net 85,845 26,224 (4,157)
--------- --------- ----------
Loss from continuing operations (5,511,307) (3,758,116) (2,137,509)
Income from discontinued operations 107,708 1,162,984 4,509,896
Gain on disposition of discontinued
operations, net of taxes 2,890,000 11,147,487 --
---------- ---------- ----------
Net income (loss) $(2,513,599) $ 8,552,355 $ 2,372,387
========== ========== ==========
Basic income (loss) per share:
Loss from continuing operations $ (0.27) $ (0.19) $ (0.11)
========== ========== ==========
Net income (loss) $ (0.12) $ 0.42 $ 0.12
========== ========== ==========
Diluted income (loss) per share:
Loss from continuing operations $ (0.27) $ (0.19) $ (0.11)
========== ========== ==========
Net income (loss) $ (0.12) $ 0.42 $ 0.12
========== ========== ==========
Weighted average common shares
outstanding - basic 20,276,080 20,179,280 20,078,912
========== ========== ==========
Weighted average common shares
outstanding - diluted 20,276,080 20,213,095 20,252,381
========== ========== ==========
See accompanying notes to consolidated financial statements.
A.P. Pharma, Inc.
Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss)
- -------------------------------------------------------------------------------
For the Years Ended December 31, 2001, 2000 and 1999
Accumulated
Other
Additional Compre-
Common Stock Deferred Paid-In Accumulated hensive Shareholders'
Shares Amount Compensation Capital Deficit Income Equity
---------- -------- --------- ----------- ----------- ------------ ------------
Balance, December
31, 1998 19,993,311 $199,933 $(499,294) $85,202,994 $(75,867,571) -- $ 9,036,062
Options exercised 3,719 37 -- 19,489 -- -- 19,526
Fair value of
stock issued to
non-employees 8,506 85 -- 37,415 -- -- 37,500
Amortization of
restricted stock -- -- 199,716 -- -- -- 199,716
Common stock issued
to employees under
the Employee Stock
Purchase Plan 43,506 435 -- 160,142 -- -- 160,577
Warrants exercised 70,000 700 -- 209,300 -- -- 210,000
Net income and
comprehensive
income -- -- -- -- 2,372,387 -- 2,372,387
---------- ------- -------- --------- ----------- -------- ----------
Balance, December
31, 1999 20,119,042 $201,190 $(299,578) $85,629,340 $(73,495,184) -- $12,035,768
Comprehensive
income:
Net income -- -- -- -- 8,552,355 -- 8,552,355
Net unrealized
gain on
marketable
securities -- -- -- -- -- 78,767 78,767
----------
Comprehensive
income 8,631,122
----------
Fair value of
stock issued to
non-employees 10,197 102 -- 40,398 -- -- 40,500
Amortization of
restricted stock -- -- 219,688 -- -- -- 219,688
Common stock issued
to employees under
the Employee Stock
Purchase Plan 36,825 369 -- 111,807 -- -- 112,176
Warrants exercised 40,000 400 -- 119,600 -- -- 120,000
---------- ------- -------- ---------- ----------- -------- ----------
Balance, December
31, 2000 20,206,064 $202,061 $ (79,890) $85,901,145 $(64,942,829) $ 78,767 $21,159,254
Comprehensive
loss:
Net loss -- -- -- -- (2,513,599) -- (2,513,599)
Net unrealized
gain on
marketable
securities -- -- -- -- -- 158,789 158,789
----------
Comprehensive
Loss (2,354,810)
----------
Restricted stock
awards 35,000 350 -- 32,725 -- -- 33,075
Fair value of common
stock issued
to non-employees
for services 79,942 799 -- 177,700 -- -- 178,499
Expense associated
with stock options
granted to non-
employees -- -- -- 10,568 -- -- 10,568
Amortization of
restricted stock -- -- 79,890 -- -- -- 79,890
Common stock issued
to employees under
the Employee Stock
Purchase Plan 36,109 361 -- 65,435 -- -- 65,796
---------- ------- -------- ---------- ----------- -------- ----------
Balance, December
31, 2001 20,357,115 $203,571 $ -- $86,187,573 $(67,456,428) $ 237,556 $19,172,272
========== ======= ======== ========== =========== ======== ==========
See accompanying notes to consolidated financial statements.
A.P. Pharma, Inc.
Consolidated Statements of Cash Flows
- --------------------------------------
For the Year Ended December 31,
-------------------------------------
2001 2000 1999
--------- --------- ---------
Cash flows from operating activities:
Net income (loss) $ (2,513,599) $ 8,552,355 $ 2,372,387
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Gain on disposition of discontinued
operations (2,890,000) (11,147,487) --
Allowance for claims relating to sale
of discontinued operations (712,000) -- --
Gain on sale of marketable securities (83,852) -- --
Depreciation and amortization 399,686 374,962 379,978
Provision for doubtful accounts and
note receivable 198,830 206,968 7,891
Amortization of deferred revenue (164,479) (390,193) (131,211)
Stock and stock option compensation
awards to non-employees 189,417 40,500 37,500
Restricted stock awards 112,615 179,745 199,716
Amortization of premium/discount and
accretion of marketable securities 170,855 (101,531) --
Loss on retirements of fixed assets 4,417 -- --
Changes in operating assets and liabilities:
Accounts receivable 152,303 2,882,480 (1,055,390)
Receivables for royalties, license fees
and R&D fees 70,886 292,080 804,218
Inventory 10,512 (10,429) (1,627)
Advances to officers and employees 34,018 50,614 254,315
Prepaid expenses and other (68,811) (411,758) 96,933
Other long-term assets (64,283) 191,047 (166,680)
Accounts payable 17,369 (700,229) 205,899
Accrued expenses (90,461) 236,366 (318,203)
Accrued disposition costs (1,009,237) (2,946,589) --
Income taxes payable (255,358) (208,622) 13,480
Accrued settlement liability -- -- (1,300,000)
---------- --------- ----------
Net cash (used in) provided by
continuing activities (6,491,172) (2,909,721) 1,399,206
Cash used in discontinued operations -- (206,281) (2,241,348)
---------- --------- ----------
Net cash used in operating activities (6,491,172) (3,116,002) (842,142)
---------- --------- ----------
Cash flows from investing activities:
Proceeds from disposition of discontinued
operations 3,602,000 25,000,000 --
Purchases of property and equipment (276,694) (178,966) (175,524)
Purchases of marketable securities (16,409,995) (18,854,008) --
Maturities of marketable securities 16,634,656 3,004,986 --
---------- --------- ----------
Net cash provided by (used in) investing
activities 3,549,967 8,972,012 (175,524)
---------- --------- ----------
Cash flows from financing activities:
Repayment of long-term debt -- (3,300,044) (3,755,416)
Proceeds from long-term debt and warrants
issued -- -- 4,000,000
Proceeds from the exercise of common
stock options and warrants -- 120,000 229,526
Proceeds from issuance of shares under
the Employee Stock Purchase Plan 65,796 112,176 160,577
---------- --------- ----------
Net cash provided by (used in) financing
activities 65,796 (3,067,868) 634,687
---------- --------- ----------
Net increase (decrease) in cash and cash
equivalents (2,875,409) 2,788,142 (382,979)
Cash and cash equivalents at the beginning
of the year 6,493,336 3,705,194 4,088,173
---------- --------- ----------
Cash and cash equivalents at the end of
the year $ 3,617,927 $6,493,336 $3,705,194
========== ========= =========
Cash paid for interest $ -- $ 244,243 $ 478,375
========== ========= =========
Cash paid for taxes $ 27,486 $ 244,044 $ 51,500
========== ========= =========
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------
DECEMBER 31, 2001, 2000 AND 1999
- --------------------------------
Note 1 Business
A.P. Pharma, Inc. ("APP" or the "Company") is developing patented polymer-
based delivery systems to enhance the safety and effectiveness of
pharmaceutical compounds. Projects are currently conducted under feasibility
and development arrangements with pharmaceutical and biotechnology companies.
New products and technologies under development include bioerodible polymers
for injectable and implantable drug delivery.
On July 25, 2000, the Company completed the sale of certain technology rights
for topical pharmaceuticals and its cosmeceutical product lines and other
assets ("cosmeceutical and toiletry business") to RP Scherer Corporation, a
subsidiary of Cardinal Health, Inc. The Company received $25 million up-
front and could receive additional amounts over the next three years relating
to the performance of the cosmeceutical and toiletry business (Note 12).
On May 9, 2001, the Company's shareholders approved a change in the Company's
name to A.P. Pharma, Inc.
Note 2 Summary of Significant Accounting Policies
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the financial statements of the
Company and its wholly owned subsidiary, APS Analytical Standards, Inc. All
significant intercompany balances and transactions have been eliminated in
consolidation.
Cash Equivalents and Marketable Securities
- ------------------------------------------
For purposes of the Consolidated Statements of Cash Flows and Consolidated
Balance Sheets, the Company considers all short-term investments that have
effective maturities of less than three months from dates of purchases to be
cash equivalents. Investments with effective maturities longer than three
months are classified as marketable securitites. Investments consist
primarily of commercial paper, bankers acceptances, master notes and
corporate debt securities. The Company has classified all its investments in
certain debt and equity securities as "available-for-sale", and therefore are
recorded at fair value with unrealized gains and losses reported as a
separate component of shareholders' equity.
Financial Instruments
- ---------------------
The carrying value of financial instruments, including marketable securities
and accounts receivable, approximate fair value. Financial instruments that
potentially subject the Company to concentrations of credit risk consist
primarily of cash equivalents, short-term investments and trade accounts
receivable. The Company invests excess cash in a variety of high grade
short-term, interest-bearing securities. This diversification of risk is
consistent with our policy to ensure safety of principal and maintain
liquidity.
Derivative Instruments and Hedging Activities
- ---------------------------------------------
In accordance with Financial Accounting Standards Board (FASB) Statement No.
133 "Accounting for Derivative Instruments and Hedging Activities" (FAS 133),
the Company is required to recognize all derivatives as either assets or
liabilities in the consolidated balance sheets and measure those instruments
as fair value. However, as the Company does not use or hold derivatives, the
adoption of FAS 133 in 2001 did not affect the results of operations or the
financial position of the Company.
Inventory
- ---------
Inventory is stated at the lower of cost or market value, utilizing the
average cost method.
Property and Equipment
- ----------------------
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets as follows: equipment and machinery, 3 to 10
years; furniture and fixtures, 5 years; and leasehold improvements, over the
shorter of the respective lease terms or the respective useful lives of the
leasehold improvements.
Long-Lived Assets, Including Goodwill and Other Intangibles
- -----------------------------------------------------------
As circumstances dictate, the Company evaluates whether changes have occurred
that would require revision of the remaining estimated lives of recorded
long-lived assets, including goodwill, or that render those assets not
recoverable. Recoverability of assets to be held and used is determined by
comparing the undiscounted net cash flows of long-lived assets to their
respective carrying values. If such assets are considered to be impaired,
the amount of impairment to be recognized is measured based on the projected
discounted cash flows using an appropriate discount rate. See "Recent
Accounting Pronouncements".
Stock-Based Compensation
- ------------------------
The Company has elected to account for stock-based compensation related to
employees using the intrinsic value method. Accordingly, except for stock
options issued to non-employees and restricted stock awards to employees, no
compensation cost has been recognized for the Company's stock option plans
and stock purchase plan. Compensation related to options granted to non-
employees is periodically remeasured as earned.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Estimates were
made relating to useful lives of fixed assets, valuation allowances,
impairment of assets and accruals. Actual results could differ materially
from those estimates.
Revenue Recognition
- -------------------
Product revenues are recorded upon shipment of products when four basic
criteria are met: 1) persuasive evidence of an arrangement exists, 2)
delivery has occurred or services have been rendered, 3) the fee is fixed and
determinable, and 4) collectibility is reasonably assured. Determination of
criteria 3 and 4 are based on management's judgments regarding the fixed
nature of the fees charged for products delivered and the collectibility of
those fees. Should changes in conditions cause management to determine these
criteria are not met for certain future transactions, revenue recognized for
any reporting period could be adversely affected.
The Company has licensing agreements that generally provide for the Company
to receive periodic minimum payments, royalties, and/or non-refundable
license fees. These licensing agreements typically require a non-refundable
license fee and allow partners to sell the Company's proprietary products in
a defined field or territory for a defined period. The license agreements
provide for APP to earn future revenue through royalty payments. These non-
refundable license fees are initially reported as deferred revenues and
recognized as revenues over the estimated life of the product to which they
relate as the company has continuing involvement with licensees until the
related product is discontinued. Revenue recognized from deferred license
fees is classified as License, R&D and Option Fees in the accompanying
consolidated statements of operations. License fees received in connection
with arrangements where the Company has no continuing involvement are
recognized as revenue when the amounts are received or when collectibility is
assured, whichever is earlier.
Contractually required minimum royalties are recorded ratably throughout the
contractual period. Royalties in excess of minimum royalties are recognized
as earned when the related product is shipped to the end customer by the
Company's licensees based on information received by the Company from its
licensees.
A milestone payment is a payment made by a third party or corporate partner
to the Company upon the achievement of a predetermined milestone as defined
in a legally binding contract. Milestone payments are recognized as revenue
when the milestone event has occurred and the Company has completed all
milestone related services such that the milestone payment is currently due
and is non-refundable.
Deferred Revenue
- ----------------
Non-refundable license fees received by the Company under arrangements where
the Company has continuing involvement are reported as deferred revenues and
amortized over the estimated life of the product to which they relate.
Prepaid royalties paid to the Company are also reported as deferred revenues.
In accordance with the respective licensing agreements, a percentage of the
royalties earned by the Company is applied against the deferred revenues,
after certain annual minimum royalty payments are met, and recognized as
revenues.
Earnings (Loss) Per Share
- -------------------------
The Company reports both basic earnings (loss) per share, which is computed
by dividing net income (loss) by the weighted-average number of common shares
outstanding, and diluted earnings per share, which is computed by dividing
net income (loss) by the total of weighted-average number of common shares
outstanding and dilutive potential common shares outstanding (Note 11).
Concentrations of Credit Risk
- -----------------------------
Financial instruments which potentially expose the Company to concentrations
of credit risk consist primarily of trade accounts receivable and receivables
from royalties, license fees and research and development fees.
Approximately 82% and 79% of the recorded trade receivables and receivables
from royalties, license fees and research and development fees were
concentrated with two and five customers in the pharmaceutical, cosmetic and
personal care industries as of December 31, 2001 and 2000, respectively.
Approximately 75%, 62% and 67% of the recorded net sales were concentrated
with two, one and three customers for the years ended December 31, 2001, 2000
and 1999, respectively. To reduce credit risk, the Company performs ongoing
credit evaluations of its customers' financial conditions. The Company does
not generally require collateral for customers with accounts receivable
balances.
Segment and Geographic Information
- ----------------------------------
The Company's operations are confined to a single business segment, the
design and commercialization of polymer technologies for pharmaceutical and
other applications.
Royalty revenues from two domestic customers amounted to approximately 49%
and 26% of total revenues for the year ended December 31, 2001. Royalty
revenues from one domestic customer amounted to approximately 62% of total
revenues for the year ended December 31, 2000. Revenues from three domestic
customers amounted to 43%, 13% and 11% for the year ended December 31, 1999.
Recent Accounting Pronouncements
- --------------------------------
In July 2001, the FASB issued FAS 141, "Business Combinations" (FAS 141).
FAS 141 supersedes APB 16, "Business Combinations," and FAS 38, "Accounting
for Preacquisition Contingencies of Purchased Enterprises." FAS 141 requires
the purchase method of accounting for all business combinations initiated
after June 30, 2001 and eliminates the pooling-of-interests method. FAS 141
also includes guidance on the initial recognition and measurement of goodwill
and other intangible assets arising from business combinations completed
after June 30, 2001.
In July 2001, the FASB issued FAS 142, "Goodwill and Other Intangible Assets"
(FAS 142). FAS 142 supersedes APB 17, "Intangible Assets," and requires the
discontinuance of goodwill amortization. In addition, FAS 142 includes
provisions regarding the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill and the testing for impairment of existing
goodwill and other intangibles out of previously reported goodwill and other
intangibles. FAS 142 is required to be applied for fiscal years beginning
after December 15, 2001, with certain early adoption permitted. The Company
does not expect the adoption of FAS 142 to have a material effect on its
financial condition or results of operations.
In August 2001, the FASB issued FAS 143, "Accounting for Asset Retirement
Obligations" (FAS 143). FAS 143 addresses financial accounting and reporting
for obligations associated with the retirement of tangible long-lived assets
and the associated retirement costs. The Company does not expect the
adoption of FAS 143, which will be effective for the Company's fiscal year
ending December 31, 2002, to have a material effect on its financial
condition or results of operations.
In October 2001, the FASB issued FAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" (FAS 144), which supersedes FAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed Of" (FAS 121). FAS 144 addresses financial accounting and
reporting for the impairmment of long-lived assets and for long-lived assets
to be disposed of. However, FAS 144 retains the fundamental provisions of
FAS 121 for: 1) recognition and measurement of the impairment of long-lived
assets to be held and used; and 2) measurement of long-lived assets to be
disposed of by sale. FAS 144 is effective for fiscal years beginning after
December 15, 2001. The Company does not expect the adoption of FAS 144 to
have a material effect on its financial condition or results of operations.
Reclassifications
- -----------------
Certain reclassifications have been made to the prior year financial
statements to conform with the presentation in 2001.
Note 3 Related Party Transactions
The Company has entered into agreements with Large Scale Biology Corp.("LSB
Corp.") formerly known as Biosource Technologies, Inc. of which Toby
Rosenblatt, a member of the Company's Board of Directors, is a stockholder
and a former director. Agreements between APP and LSB were made prior to
1998 and were settled and closed in 1999. All agreements between APP and LSB
Corp. were considered and approved by a vote of the disinterested directors
(Note 4).
Note 4 Legal Proceedings
In November, 1997 LSB Corp. filed a complaint against the Company in the San
Mateo Superior Court. LSB Corp. claimed damages from the Company on the
grounds that the Company had failed to pay certain minimum amounts allegedly
due under a contract for the supply of melanin. In December 1998, the
Company reached a settlement agreement with LSB Corp. In 1999, the
settlement liability of $1,300,000 was paid to LSB Corp. in cash.
In February 2000, Douglas Kligman and Albert Kligman filed a complaint
against the Company in the U.S. District Court for the Eastern District of
Pennsylvania. The complaint alleged that the plaintiffs entered into a
partnership with the Company to pursue development and sales of a product
developed by the plantiffs. The complaint stated various claims, dissolution
of partnership, implied-in-law contract and other claims. The complaint
alleged damages in excess of $75,000, but otherwise made no specific damage
claim. On September 28, 2001, the U.S. District Court for the Eastern
District of Pennsylvania granted a summary judgment in favor of A.P. Pharma,
Inc.
Note 5 Cash Equivalents and Marketable Securities
The Company considers all its investments in debt and equity securities as
available-for-sale and, accordingly, these investments are recorded at fair
value. Realized gains totaled $84,000, $6,000, and $0 for the years ended
December 31, 2001, 2000 and 1999, respectively. There were no realized
losses for the years ended December 31, 2001, 2000 and 1999. The cost of
securities sold is based on the specific identification method.
At December 31, 2001 and 2000, the amortized cost and estimated market value
of investments in debt securities are set forth in the tables below:
December 31, 2001
------------------------------------------------
Unrealized Unrealized Estimated
Cost Gains Losses Market Value
------ ---------- ---------- ------------
Available-for-Sale:
Corporate debt
securities $10,071,430 $187,405 $(1,663) $10,257,172
Other debt securities 8,979,562 51,814 -- 9,031,376
---------- ------- ----- ----------
Totals $19,050,992 $239,219 $(1,663) $19,288,548
========== ======= ===== ==========
December 31, 2000
------------------------------------------------
Unrealized Unrealized Estimated
Cost Gains Losses Market Value
------ ---------- ---------- ------------
Available-for-Sale:
Corporate debt
securities $ 7,997,117 $ 52,813 $ -- $ 8,049,930
Other debt securities 14,209,778 26,424 (470) 14,235,732
---------- ------- ----- ----------
Totals $22,206,895 $ 79,237 $ (470) $22,285,662
========== ======= ===== ==========
The table below summarizes fair value disclosures at December 31:
2001 2000
----------------------- ----------------------
Fair Fair
Cost Value Cost Value
---- ---------- --------- ----------
Cash Equivalents $ 3,412,103 $ 3,412,103 $ 6,343,300 $ 6,256,342
Marketable Securities 15,638,889 15,876,445 15,863,595 16,029,320
---------- ---------- ---------- ----------
Totals $19,050,992 $19,288,548 $22,206,895 $22,285,662
========== ========== ========== ==========
The cost and estimated fair value of available-for-sale debt securities as of
December 31, 2001, by contractual maturity, consisted of the following:
Estimated
Cost Market Value
----------- ------------
Available-for-Sale:
Due in one year or less $ 9,433,765 $10,513,933
Due after one year
through two years 9,617,227 8,774,615
---------- ----------
Totals $19,050,992 $19,288,548
========== ==========
Note 6 Inventory
The major components of inventory are as follows:
December 31,
---------------------------
2001 2000
---- ----
Raw materials $27,284 $43,387
Finished goods 33,283 27,692
------- ------
Total inventory $60,567 $71,079
======= ======
Note 7 Property and Equipment
Property and equipment consist of the following:
December 31,
---------------------------
2001 2000
---------- ----------
Leasehold improvements $1,355,053 $1,358,320
Furniture and equipment 3,263,421 3,206,744
---------- ----------
Total property and equipment 4,618,474 4,565,064
Accumulated depreciation
and amortization (2,950,570) (2,769,751)
---------- ----------
Property and equipment, net $1,667,904 $1,795,313
========== =========
Depreciation expense amounted to $399,686, $374,962 and $379,978 for the
years ended December 31, 2001, 2000 and 1999, respectively.
Note 8 Long-Term Debt
In March 1999, the Company obtained a $4,000,000 term loan with a fixed
interest rate of 13.87%. The loan was secured by the assets of the Company's
manufacturing facility in Louisiana and a portion of the Company's accounts
receivable. Principal and interest payments were due in equal monthly
installments over a period of forty-eight months commencing March 1999. The
term loan was obtained mainly to refinance scheduled debt payments made in
the first quarter of 1999. In July 2000, the Company extinguished the debt,
as repayment was necessary to release liens on the assets sold as part of the
cosmeceutical and toiletry business (Note 12). All costs incurred in
obtaining the financing arrangement were capitalized as deferred loan costs,
and were amortized over the life of the loans using the interest method.
Interest expense in 2001, 2000 and 1999 totaled $0, $244,243 and $478,375,
respectively.
In September 1995, the Company extinguished $2,500,000 of Industrial Revenue
Bonds through an "insubstance defeasance" transaction by placing
approximately $2,500,000 of United States government securities in an
irrevocable trust to fund all future interest and principal payments. In
accordance with the agreement, the investments held in the irrevocable trust
shall be the exclusive source of all principal and interest payments and the
Company has no liability for any shortfall in payments due. In addition, the
Company has relinquished all rights with respect to the amounts held in the
trust. The defeased debt balance outstanding of $2,500,000 as of December
31, 2001 will be repaid on January 15, 2005 using the proceeds from the
maturities of the United States government securities held in the irrevocable
trust. In accordance with generally accepted accounting principles, the bond
liability and related assets held in trust are not reflected in the
accompanying balance sheets.
Note 9 Commitments
Lease Commitments: Total rental expense for property and equipment was
$516,012, $586,991 and $803,140 for 2001, 2000 and 1999, respectively. Rental
expense differs from cash payments under lease arrangements of $147,600,
$61,500 and $0, in 2001, 2000 and 1999 as the Company's sales agreement to RP
Scherer (Note 12) allowed for RP Scherer to occupy a portion of the leased
office facilities rent-free through January 25, 2002. The total amount of
free rent provided to RP Scherer was charged to discontinued operations in
2000.
The Company's future minimum lease payments under noncancelable operating
leases for facilities as of December 31, 2001, are as follows:
Years Ending Minimum
December 31, Payments
------------ -----------
2002 $ 681,396
2003 693,048
2004 590,568
2005 8,088
2006 and thereafter 7,414
----------
$1,980,514
==========
Note 10 Shareholders' Equity
Shareholders Rights Plan: On August 19, 1996, the Board of Directors approved
a Shareholders Rights Plan under which shareholders of record on September 3,
1996 received a dividend of one Preferred Stock purchase right ("Rights") for
each share of common stock outstanding. The Rights were not exercisable
until 10 business days after a person or group acquired 20% or more of the
outstanding shares of common stock or announced a tender offer which could
have resulted in a person or group beneficially owning 20% or more of the
outstanding shares of common stock (an "Acquisition") of the Company. The
Board of Directors approved an increase in threshold to 30% in December 1997.
Each Right, should it become exercisable, will entitle the holder (other than
acquirer) to purchase company stock at a discount. The Board of Directors
may terminate the Rights plan or, under certain circumstances, redeem the
rights.
In the event of an Acquisition without the approval of the Board, each Right
will entitle the registered holder, other than an acquirer and certain
related parties, to buy at the Right's then current exercise price a number
of shares of common stock with a market value equal to twice the exercise
price.
In addition, if at the time when there was a 30% shareholder, the Company
were to be acquired by merger, shareholders with unexercised Rights could
purchase common stock of the acquirer with a value of twice the exercise
price of the Rights.
The Board may redeem the Rights for $0.01 per Right at any time prior to
Acquisition. Unless earlier redeemed, the Rights will expire on August 19,
2006.
Stock-Based Compensation Plans: The Company has two types of stock-based
compensation plans, a stock purchase plan and stock option plans.
In 1997, the stockholders approved the Company's 1997 Employee Stock Purchase
Plan (the "Plan"). Under the 1997 Employee Stock Purchase Plan, the Company
is authorized to issue up to 400,000 shares of common stock to its employees,
nearly all of whom are eligible to participate. Under the terms of the Plan,
employees can elect to have up to a maximum of 10 percent of their base
earnings withheld to purchase the Company's common stock. The purchase price
of the stock is 85 percent of the lower of the closing prices for the
Company's common stock on: (i) the first trading day in the enrollment
period, as defined in the Plan, in which the purchase is made, or (ii) the
purchase date. The length of the enrollment period may not exceed a maximum
of 24 months. Enrollment dates are the first business day of May and
November provided that the first enrollment date was April 30, 1997.
Approximately 46 percent of eligible employees participated in the Plan in
2001. Under the Plan, the Company issued 36,109 shares in 2001, 36,825
shares in 2000 and 43,506 shares in 1999. The weighted average fair value of
purchase rights granted during 2001, 2000 and 1999 were $1.47, $1.90 and
$3.05, respectively. The weighted average exercise price of the purchase
rights exercised during 2001, 2000 and 1999 were $1.82, $3.05 and $3.69,
respectively. The Company had 230,401 and 266,510 shares reserved for
issuance under the stock purchase plan at December 31, 2001 and 2000,
respectively.
The Company has various stock option plans for employees, officers, directors
and consultants. The Company grants stock options under the 1992 Stock
Option Plan ("1992 Plan") and the Non-Qualified Stock Plan. The Company is
authorized to issue up to 4,000,000 and 250,000 shares under the 1992 Plan
and Non-Qualified Stock Plan, respectively. The options are granted at fair
market value and expire no later than ten years from the date of grant. The
options are exercisable in accordance with vesting schedules that generally
provide for them to be fully exercisable four years after the date of grant.
Any shares that are issuable upon exercise of options granted under the 1992
Plan and the Non-Qualified Stock Plan that expire or become unexercisable for
any reason without having been exercised in full are available for future
grant and issuance under the same stock option plan.
The 1992 Plan expired in March 2002. A new stock option plan will be
proposed for shareholder approval at the annual shareholders' meeting on May
22, 2002.
In 2001, the Company granted options to purchase 47,500 shares of common
stock to non-employees under the 1992 Plan. These options were granted in
exchange for services to be rendered and vest over a period of two to four
years. The Company recorded compensation expense related to option grants to
non-employees of approximately $11,000 in 2001, which represents the fair
market value of the portion of the awards that vested during 2001. The
unvested shares held by consultants have been and will be revalued using the
Black-Scholes option pricing model at the end of each accounting period. No
stock options were granted to non-employees in 2000 or 1999.
The following table summarizes option activity for 2001, 2000 and 1999:
2001 2000 1999
----------------- ------------------ --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------------- ------------------ --------------------
Outstanding at beginning
of year 3,910,177 $5.87 3,660,048 $6.30 3,567,183 $6.32
Granted 467,000 2.51 507,000 3.12 125,047 5.69
Exercised -- -- -- -- (3,719) 5.25
Expired or Cancelled (950,135) 6.46 (256,871) 6.56 (28,463) 6.81
--------- --------- ---------
Outstanding at end of year 3,427,042 5.25 3,910,177 5.87 3,660,048 6.30
========= ========= =========
Options exercisable at
year end 2,674,679 5.93 3,224,583 6.33 3,013,164 6.46
Shares available for future
grant at year end 193,933 176,056 196,185
Weighted-average fair
value of options granted
during the year $1.32 $1.70 $3.00
The following table summarizes information about stock options outstanding at
December 31, 2001:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Range of Remaining Remaining Remaining
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- ----------- ----------- ----------- --------- ----------- ---------
$1.69-$3.50 916,500 9.1 years $ 2.75 236,847 $ 3.11
$4.00-$5.38 1,046,500 4.6 4.83 992,332 4.87
$5.44-$7.00 868,500 4.1 6.05 849,958 6.06
$7.13-$10.88 595,542 3.9 8.64 595,542 8.64
--------- ---------
$1.69-$10.88 3,427,042 5.6 $ 5.25 2,674,679 $ 5.93
========= =========
The Company has adopted the disclosure only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation." Accordingly, except for stock
options issued to non-employees and restricted stock awards to employees, no
compensation cost has been recognized for the various stock option plans and
stock purchase plan. The compensation cost that has been charged against
income for the stock options issued to non-employees and restricted stock
awards to employees was $123,183, $179,745 and $199,716 for 2001, 2000 and
1999, respectively. Had compensation cost for the Company's stock-based
compensation plans been determined consistent with the fair value method
provisions of SFAS No. 123, the Company's net income (loss) and income (loss)
per common share would have changed to the pro-forma amounts indicated below:
2001 2000 1999
----------- ----------- ---------
Net income (loss)
- as reported $(2,513,599) $ 8,552,355 $ 2,372,387
Net income (loss)
- pro-forma (3,209,743) 7,259,817 1,073,712
Basic income (loss) per
common share - as
reported (0.12) 0.42 0.12
Basic income (loss) per
common share - pro-forma (0.16) 0.36 0.05
Diluted income (loss) per
common share - as reported (0.12) 0.42 0.12
Diluted income (loss) per
common share - pro-forma (0.16) 0.36 0.05
For stock options, the fair value of each option grant is estimated on the
date of grant using the Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 2001, 2000 and 1999,
respectively: dividend yield of zero for all years; annualized volatility of
62 percent, 58 percent and 52 percent; risk-free interest rates of 4.3
percent, 4.8 percent and 6.6 percent; and expected life of five years for all
the stock option plans.
For the stock purchase plan, the fair value of each award is also estimated
using the Black-Scholes option pricing model. For purchase rights granted in
2001, the multiple option approach with the following assumptions was used
for expected terms of eighteen and twenty-four months: risk free interest
rates of 2.4 percent and 4.2 percent; volatility factors of 71 percent and 67
percent; and dividend yield of zero. The purchase rights granted in 2000
were valued using the following assumptions for expected terms of six,
twelve, eighteen and twenty-four months: risk-free interest rate of 6.4
percent; volatility of 58 percent; and dividend yield of zero. The purchase
rights granted in 1999 were valued using the following assumptions for
expected terms of six, twelve, eighteen and twenty-four months, respectively:
risk-free interest rate of 4.6 percent; volatility of 55 percent; and
dividend yield of zero.
In 2001, the Company accelerated the vesting of options to purchase 40,000
shares of common stock held by the directors who departed the board as part
of the refocusing of the Company. As the exercise prices of these options
exceeded the Company's fair market value per share on the date of
acceleration, the Company did not record compensation expense associated with
these stock option accelerations.
Also in 2001, the Company modified the 1992 Stock Option Plan to extend the
exercise period of vested stock options upon employee termination, from up to
30 days after the date of termination to up to 90 days after the date of
termination. The Company did not record compensation expense associated with
this modification in 2001, as none of the affected options were exercised
during 2001 and the number of stock options that may be affected in future
periods was not estimable on the date of modification.
Note 11 Earnings Per Share
The following table sets forth the computation of the Company's basic and
diluted loss per share:
2001 2000 1999
---- ---- ----
Loss from continuing operations $(5,511,307) $(3,758,116) $(2,137,509)
========== ========== ==========
Net income (loss) (2,513,599) 8,552,355 2,372,387
========== ========== ==========
Shares calculation:
Weighted average shares
outstanding - basic 20,276,080 20,179,280 20,078,912
Effect of dilutive securities:
Stock options, employee stock
purchase plan and stock to be
issued to directors -- 32,712 125,762
Warrants -- 1,103 47,707
---------- ---------- ----------
Weighted average shares
outstanding - diluted 20,276,080 20,213,095 20,252,381
========== ========== ==========
Basic income (loss) per common
share:
Loss from continuing operations $ (0.27) $ (0.19) $ (0.11)
========== ========== ==========
Net income (loss) $ (0.12) $ 0.42 $ 0.12
========== ========== ==========
Diluted income (loss) per common
share:
Loss from continuing operations $ (0.27) $ (0.19) $ (0.11)
========== ========== ==========
Net income $ (0.12) $ 0.42 $ 0.12
========== ========== ==========
The following options and warrants were outstanding during the periods
presented, but were not included in the computation of diluted earnings per
share since inclusion of these potentially dilutive securities would have
been anti-dilutive for the periods presented:
2001 2000 1999
---- ---- ----
Number outstanding 3,427,042 3,571,590 2,816,970
Range of exercise prices $1.69 - $10.88 $3.88 - $15.00 $5.00 - $15.00
Note 12 Discontinued Operations
On July 25, 2000, the Company completed the sale of certain technology rights
for topical pharmaceuticals and its cosmeceutical product lines and other
assets ("cosmeceutical and toiletry business") to RP Scherer Corporation, a
subsidiary of Cardinal Health, Inc. The Company received $25 million at
closing and is entitled to receive further earnout amounts for the subsequent
three years, the amounts of which are dependent on the performance of the
product lines sold. In 2001, the Company received an additional $3.6 million
due to the performance of the business sold. The cosmeceutical and toiletry
business is reported as a discontinued operation for all periods presented in
the accompanying Consolidated Statements of Operations.
Revenues relating to the discontinued operation totaled $0, $10,199,000 and
$15,148,000 for the years ended December 31, 2001, 2000 and 1999,
respectively.
"Gain on disposal of discontinued operations" in the accompanying
Consolidated Statement of Operations for the year ended December 31, 2001 is
reported net of allowances for claims made by RP Scherer, mostly due to an
indemnification claim relating to inventory deemed obsolete, pursuant to the
agreement. "Gain on disposal of discontinued operations" for the year ended
December 31, 2000 is reported net of a provision for income taxes of
$450,000.
The following table sets forth the Company's basic and diluted income per
common share from discontinued operations excluding the gain on sale for the
years ended December 31, 2001, 2000 and 1999:
For the years ended December 31,
--------------------------------
2001 2000 1999
---- ---- ----
Basic income per common
share from discontinued
operations $0.01 $0.06 $0.22
Diluted income per common
share from discontinued
operations $0.01 $0.06 $0.22
Note 13 Defined Contribution Plan
The Company sponsors a defined contribution plan covering substantially all
of its employees. In the past three calendar years, the Company made
matching contributions equal to 50% of each participant's contribution during
the plan year up to a maximum amount equal to the lesser of 3% of each
participant's annual compensation or $5,250, $5,100 and $4,800 for the 2001,
2000 and 1999 calendar years, respectively. The Company may also contribute
additional discretionary amounts as it may determine. For the years ended
December 31, 2001, 2000 and 1999, the Company contributed to the plan
approximately $56,000, $106,000 and $122,000, respectively. No discretionary
contributions have been made to the plan since its inception.
Note 14 Income Taxes
Income tax expense for the years ended December 31, 2001, 2000 and 1999
consisted of:
2001 2000 1999
---- ---- ----
Federal - current $ -- $304,500 $ --
State -- 145,500 --
------- ------- -------
$ -- $450,000 $ --
======= ======= =======
A reconciliation of the federal statutory rate of 35% (34% in 1999) to the
Company's effective tax rate is as follows:
December 31,
------------------------
2001 2000 1999
---- ---- ----
U.S. statutory rate (benefit) 35.00% 35.00% 34.00%
State taxes, net of federal income
tax benefit -- -- --
Net losses without benefits (35.71) -- --
Alternative minimum tax -- -- --
Utilization of temporary differences
for which no benefit was previously
recognized -- (34.58) (32.22)
Nondeductible expenses 0.71 (0.42) (1.78)
----- ----- -----
Total tax expense (benefit) --% --% --%
===== ===== =====
At December 31, 2001, the Company had net federal operating loss
carryforwards of approximately $65,000,000 for income tax reporting purposes
and California operating loss carryforwards of approximately $900,000. The
federal net operating losses expire beginning in 2003, if not utilized. The
California net operating loss carryforwards expire beginning in 2002, if not
utilized. The Company also has federal alternative minimum tax credit
carryforwards of approximately $133,000, which can be carried forward
indefinitely.
The Company also has research and experimental tax credits aggregating
approximately $1,500,000 and $700,000 for federal and California purposes,
respectively. The federal credit carryforwards expire beginning in 2002.
The California credits carry over indefinitely until utilized.
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of
December 31, 2001 and 2000 are presented below:
2001 2000
------------ -----------
Deferred tax assets:
Deferred research expenditures $ 200,000 $ 214,800
Accruals and reserves not
currently deductible for tax
purposes 1,400,000 461,500
Net operating loss carryforwards 22,300,000 22,240,200
Credit carryforwards 2,400,000 3,144,700
Other -- 2,900
---------- ----------
Gross deferred tax assets 26,300,000 26,064,100
Less valuation allowance (26,300,000) (26,010,500)
---------- ----------
Total deferred tax assets -- 53,600
---------- ----------
Deferred tax liabilities:
Property and equipment -- (53,600)
---------- ----------
Total deferred tax liabilities -- (53,600)
---------- ----------
Net deferred tax assets
(liabilities) $ -- $ --
========== ==========
The valuation allowance increased by approximately $289,500 for the year
ended December 31, 2001 and decreased by approximately $604,500 and
$3,312,000 for the years ended December 31, 2000, and 1999, respectively.
Management believes that sufficient uncertainty exists regarding the
realizability of these items and, accordingly, a valuation allowance is
required.
Gross deferred tax assets as of December 31, 2000 include approximately
$2,800,000 relating to the exercise of stock options, for which any related
tax benefits will be credited to equity when realized.
Note 15 Ortho Neutrogena Corporation
In May 1992, APP entered into development and licensing and investment
agreements with Ortho Neutrogena (formerly Ortho-McNeil Pharmaceutical
Corporation) ("Ortho") for the development of retinoid products. The first
product is a Microsponge system entrapment of tretinoin (trans-retinoic acid
or "t-RA"), a prescription acne drug product for which FDA approval was
received in February 1997. A second product licensed to Ortho is a
Microsponge entrapment of a retinoid to be used for the treatment of
photodamaged skin.
In February 1995, APP received $750,000 in prepaid royalties and an
additional $750,000 as a milestone payment on the submission to the FDA of
its New Drug Application for the tretinoin prescription acne treatment. The
milestone payment was recognized as revenue upon receipt. The prepaid
royalties of $750,000 were recorded as deferred revenues. In February 1997,
upon receipt of approval from the FDA to market Retin-A Micro(R) (tretinoin
gel) microsphere for the treatment of acne, APP received $3,000,000 from
Ortho, $1,500,000 of which was a milestone payment that was recognized as
revenue in 1997 and $1,500,000 of which was prepaid royalties that was
recorded as deferred revenues. As of December 31, 2001, $863,000 of these
payments remained in deferred revenues. Ortho pays APP a royalty on product
sales. In accordance with the licensing agreement, 25% of the royalties
earned by APP is applied against deferred revenues after certain annual
minimum royalty payments are met. Should these minimums not be achieved,
Ortho would lose its exclusivity and APP would regain marketing rights to the
retinoid products.
Note 16 Dermik
In March 1992, the Company and Dermik, an Aventis company, restructured a
1989 joint venture agreement. As part of the agreement, Aventis received
certain exclusive marketing rights. Product applications include a 5-FU
treatment for actinic keratoses. In the fourth quarter of 1999, Dermik filed
an NDA for this product and expanded its agreement with the Company to cover
two additional applications, in return for milestone payments and royalties
upon successful development. In the fourth quarter of 2000, Dermik received
FDA marketing clearance for the product, which was launched under the trade
name Carac(TM) in 2001. APP received $500,000 on the filing of the NDA,
representing a milestone payment of $250,000 and prepaid royalties of
$250,000 as well as a milestone payment of $50,000 on the receipt of
marketing clearance from the FDA. As of December 31, 2001, $237,000 of these
payments remained in deferred revenues. Dermik's exclusivity wil continue as
long as annual minimum royalty payments are made, governed by the life of the
applicable patents owned by the Company.
Note 17 Historical Quarterly Results of Operations (Unaudited)
The following table presents summarized historical quarterly results of
operations for each of the fiscal quarters in the Company's fiscal years
ended December 31, 2001 and 2000. These quarterly results are unaudited,
but, in the opinion of management, have been prepared on the same basis as
the Company's audited financial information and include all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of the information set forth therein.
HISTORICAL QUARTERLY RESULTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
First Second Third Fourth
Year Ended December 31, 2001 Quarter Quarter Quarter Quarter
- ---------------------------- ------- ------- ------- -------
Product sales $ 295 $ 301 $ 243 $ 283
Cost of sales 93 113 87 146
Operating expenses 2,191 2,409 2,813 3,236
Interest and other, net 350 350 224 265
Loss from continuing operations (963) (1,172) (1,707) (1,669)
Discontinued operations (158) (25) 3,198 (17)
Net income (loss) (1,121) (1,197) 1,491 (1,686)
Basic (loss) income per common share:
Loss from continuing operations (0.05) (0.06) (0.08) (0.08)
Net income (0.06) (0.06) 0.07 (0.08)
Diluted (loss) income per common share:
Loss from continuing operations (0.05) (0.06) (0.08) (0.08)
Net income (loss) (0.06) (0.06) 0.07 (0.08)
First Second Third Fourth
Year Ended December 31, 2000 Quarter Quarter Quarter Quarter
- ---------------------------- ------- ------- ------- -------
Product sales $ 305 $ 305 $ 281 $ 272
Cost of sales 56 132 117 192
Operating expenses 1,322 1,751 1,662 2,441
Interest and other, net (90) (12) 234 417
Loss from continuing operations (738) (1,026) (658) (1,336)
Discontinued operations 958 392 11,216 (256)
Net income (loss) 220 (634) 10,558 (1,592)
Basic (loss) income per common share:
Loss from continuing operations (0.04) (0.05) (0.03) (0.07)
Net income (loss) 0.01 (0.03) 0.52 (0.08)
Diluted (loss) income per common share:
Loss from continuing operations (0.04) (0.05) (0.03) (0.07)
Net income (loss) 0.01 (0.03) 0.52 (0.08)
Independent Auditors' Report
The Board of Directors and Shareholders
A.P. Pharma, Inc.:
We have audited the accompanying consolidated balance sheets of A.P. Pharma,
Inc. (formerly "Advanced Polymer Systems, Inc.") and subsidiaries as of
December 31, 2000 and the related consolidated statements of operations,
shareholders' equity and comprehensive income, and cash flows for each of the
years in the two-year period ended December 31, 2000. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we
plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of A.P.
Pharma, Inc. and subsidiaries as of December 31, 2000, and the results of
their operations and their cash flows for each of the years in the two-year
period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States of America.
/s/KPMG LLP
Mountain View, California
February 16, 2001
Report of Ernst & Young LLP, Independent Auditors
The Board of Directors and Shareholders
A.P. Pharma, Inc.
We have audited the accompanying consolidated balance sheet of A.P. Pharma,
Inc. (formerly Advanced Polymer Systems, Inc.) as of December 31, 2001, and
the related consolidated statements of operations, shareholders' equity and
comprehensive income, and cash flows for the year then ended. Our audit also
included the financial statement schedule listed in the Index at Item
14(a)(2) for the year ended December 31, 2001. These financial statements
and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audit. The financial statements of A.P. Pharma, Inc.
for the year ended December 31, 2000, were audited by other auditors whose
report dated February 16, 2001, expressed an unqualified opinion on those
statements.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the 2001 consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of A.P. Pharma, Inc. at December 31, 2001 and the consolidated results of its
operations and its cash flows for the year then ended, in conformity with
accounting principles generally accepted in the United States. Also, in our
opinion, the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
/s/Ernst & Young LLP
Palo Alto, California
February 21, 2002
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
The Company filed a current report on Form 8-K on December 19, 2001
reporting Changes in Registrant's Certifying Accountants.
Part III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
APP incorporates by reference the information set forth under the captions
"Nomination and Election of Directors" and "Executive Compensation" of the
Company's Proxy Statement (the "Proxy Statement") for the annual meeting of
shareholders to be held on May 22, 2002.
Item 11. EXECUTIVE COMPENSATION
APP incorporates by reference the information set forth under the caption
"Executive Compensation" of the Proxy Statement.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The Company incorporates by reference the information set forth under the
caption "Beneficial Stock Ownership" of the Proxy Statement.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company incorporates by reference the information set forth under the
caption "Certain Transactions" of the Proxy Statement.
Part IV
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K
(a) 1. Financial Statements
The financial statements and supplementary data set forth in Part II
of the 10-K Annual Report are incorporated herein by reference.
2. Financial Statement Schedules
Schedule II Valuation Accounts
All other schedules have been omitted because the information is not
required or is not so material as to require submission of the
schedule, or because the information is included in the financial
statements or the notes thereto.
3. Exhibits
2.1-Copy of Asset Purchase Agreement between Registrant and RP
Scherer South, Inc. dated June 21, 2000. (7)
3-A-Copy of Registrant's Certificate of Incorporation. (1)
3-B-Copy of Registrant's Bylaws. (1)
10-C-Registrant's 1992 Stock Plan dated August 11, 1992. (2)*
10-D-Registrant's 1997 Employee Stock Purchase Plan dated March 5,
1997. (5)*
10-E-Lease Agreement between Registrant and Metropolitan Life
Insurance Company for lease of Registrant's executive offices
in Redwood City dated as of November 17, 1997. (6)
10-N-Agreement with Johnson & Johnson dated April 14, 1992. (3)
10-X-Registrant's Non-Qualified Plan
21-Proxy Statement for the Annual Meeting of Shareholders. (4)
23.1-Consent of Independent Auditors, E&Y.
23.2-Consent of Independent Auditors, KPMG.
(b) Reports on Form 8-K
The Company filed a current report on Form 8-K on December 19, 2001
reporting Changes in Registrant's Certifying Accountants.
(c) Exhibits
The Company hereby files as part of this Form 10-K the exhibits listed
in Item 14(a)3 as set forth above.
(d) Financial Statement Schedules
See Item 14(a)2 of this Form 10-K.
- --------------------------------------------------------------------------
(1)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Registration Statement on Form S-1 (Registration No. 33-15429) and
incorporated herein by reference.
(2)Filed as Exhibit No. 28.1 to Registrant's Registration Statement on
Form S-8 (Registration No. 33-50640), and incorporated herein by
reference.
(3)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1992, and
incorporated herein by reference.
(4)To be filed supplementally.
(5)Filed as an Exhibit No. 99.1 to Registrant's Registration Statement on
Form S-8 (Registration No. 333-35151), and incorporated herein by
reference.
(6)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1997, and
incorporated herein by reference.
(7)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Form 8-K dated July 25, 2000, and incorporated herein by reference.
* Management Contract or Compensatory plans.
SIGNATURES
Pursuant to the requirement of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
A.P. PHARMA, INC.
By: /S/Michael O'Connell
----------------------------------------------
Michael O'Connell
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears
below constitutes and appoints Michael O'Connell and Gordon Sangster, jointly
and severally, his or her attorneys-in-fact, each with the power of
substitution, for him or her in any and all capacities, to sign any
amendments to this Annual Report on Form 10-K and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
Signature Title Date
- --------------------------------------------------------------------------
/S/ Michael O'Connell President and Chief March 26, 2002
- ------------------------- Executive Officer --------------
Michael O'Connell (Principal Executive Officer)
/S/ Gordon Sangster Chief Financial Officer March 26, 2002
- ------------------------- (Principal Financial and --------------
Gordon Sangster Accounting Officer)
/S/ Paul Goddard Chairman of the Board of March 26, 2002
- ------------------------- Directors --------------
Paul Goddard
/S/ Stephen Drury Director March 26, 2002
- ------------------------- --------------
Stephen Drury
/S/ Peter Riepenhausen Director March 26, 2002
- ------------------------- --------------
Peter Riepenhausen
/S/ Toby Rosenblatt Director March 26, 2002
- ------------------------- --------------
Toby Rosenblatt
/S/ Gregory Turnbull Director March 26, 2002
- ------------------------- --------------
Gregory Turnbull
/S/ Dennis Winger Director March 26, 2002
- ------------------------- --------------
Dennis Winger
Schedule II
Valuation and Qualifying Accounts
Additions
Charged to Deductions
Beginning Cost and and write- Ending
Balance Expense offs Balance
- ---------------------------------------------------------------------------
December 31, 2001
Accounts receivable, allowance
for doubtful accounts $223,235 $ 1,142 $223,717 $ 660
December 31, 2000
Accounts receivable, allowance
for doubtful accounts $ 27,301 $206,968 $ 11,034 $223,235
December 31, 1999
Accounts receivable, allowance
for doubtful accounts $ 96,284 $ 7,891 $ 76,874 $ 27,301
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to incorporation by reference in the Registration Statements on
Form S-8 (Nos. 33-18942, 33-21829, 33-29084, 33-50640, 333-06841, 333-35151
and 333-60585) and on Form S-3 (Nos. 33-47399, 33-51326, 33-67936, 33-82562,
33-88972, 333-00759, 333-042527 and 333-69815) and in the related
prospectuses of A.P. Pharma, Inc. of our report dated February 21, 2002, with
respect to the consolidated financial statements and schedule of A.P. Pharma,
Inc. (formerly Advanced Polymer Systems, Inc.) included in the Annual Report
(Form 10-K) for the year ended December 31, 2001.
/s/Ernst & Young LLP
Palo Alto, California
March 26, 2002
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
A.P. Pharma, Inc.:
We consent to incorporation by reference in the Registration Statements (Nos.
33-18942, 33-21829, 33-29084, 33-50640, 333-06841, 333-35151 and 333-60585)
on Forms S-8 of A.P. Pharma, Inc. and in the Registration Statements (Nos.
33-47399, 33-51326, 33-67936, 33-82562, 33-88972, 333-00759, 333-042527 and
333-69815) on Forms S-3 of A.P. Pharma, Inc. of our report dated February 16,
2001, relating to the consolidated balance sheets of A.P. Pharma, Inc. and
subsidiaries as of December 31, 2000 and the related consolidated statements
of operations, shareholders' equity and comprehensive income and cash flows
for each of the years in the two-year period ended December 31, 2000, which
report appears in the December 31, 2000 annual report on Form 10-K of A.P.
Pharma, Inc.
/s/KPMG LLP
Mountain View, California
March 26, 2002
EXHIBIT INDEX
Form 10-K Annual Report
2.1-Copy of Asset Purchase Agreement between Registrant and RP Scherer
South, Inc. dated June 21, 2000. (7)
3-A-Copy of Registrant's Certificate of Incorporation. (1)
3-B-Copy of Registrant's Bylaws. (1)
10-C-Registrant's 1992 Stock Plan dated August 11, 1992. (2)*
10-D-Registrant's 1997 Employee Stock Purchase Plan dated March 5, 1997. (5)*
10-E-Lease Agreement between Registrant and Metropolitan Life Insurance
Company for lease of Registrant's executive offices in Redwood City
dated as of November 17, 1997. (6)
10-N-Agreement with Johnson & Johnson dated April 14, 1992. (3)
10-X-Registrant's Non-Qualified Stock Plan.
21-Proxy Statement for the Annual Meeting of Shareholders. (4)
23-Consent of Independent Auditors.
- --------------------------------------------------------------------------
(1)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Registration Statement on Form S-1 (Registration No. 33-15429) and
incorporated herein by reference.
(2)Filed as Exhibit No. 28.1 to Registrant's Registration Statement on Form
S-8 (Registration No. 33-50640), and incorporated herein by reference.
(3)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1992, and
incorporated herein by reference.
(4)To be filed supplementally.
(5)Filed as an Exhibit No. 99.1 to Registrant's Registration Statement on
Form
S-8 (Registration No. 333-35151), and incorporated herein by reference.
(6)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1997, and
incorporated herein by reference.
(7)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Form 8-K dated July 25, 2000, and incorporated herein by reference.
* Management Contract or Compensatory plans.
