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, 2002 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 [ ]
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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]
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [ ] No [X ]
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The aggregate market value of the voting stock of the registrant held by non-
affiliates of the registrant as of June 28, 2002, was $29,347,934. (1)
As of February 28, 2003, 20,490,441 shares of registrant's Common Stock, $.01
par value, were outstanding.
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(1)Excludes 6,440,148 shares held by directors, officers and shareholders
whose ownership exceeds 5% of the outstanding shares at June 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 2003 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 and Related Stockholder Matters
ITEM 13. Certain Relationships and Related Transactions
ITEM 14. Controls and Procedures
PART IV
ITEM 15. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K
Signatures
Certifications
PART I
Item 1. BUSINESS
INTRODUCTION-FORWARD LOOKING STATEMENTS
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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
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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 share
costs and to earn a share of future profits; and
- - to license our proprietary technologies to corporate partners after the
successful completion of reimbursed 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; anti-inflammatory, oncology and ophthalmology
applications; device coatings and DNA delivery. Product development programs
are primarily funded by royalties from topical prescription products
currently marketed by pharmaceutical partners, proceeds from the divestiture
of our cosmeceutical product lines in July 2000, fees we receive from
collaborative partners, and proceeds from the sale of our Analytical
Standards business in February 2003.
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 systems 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, coatings, to strands, wafers, films or microspheres. In
addition, the manufacturing is reproducible, has been 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 following arthroscopic knee surgery, and completed Phase I
human clinical trials in the first half of 2002. In August 2002, we withdrew
the proposed protocol for a Phase II clinical study in response to questions
raised by the United States Food and Drug Administration ("FDA") regarding
the duration of mild-to-moderate irritation observed in preclinical studies.
This mild-to-moderate irritation was observed following administration into
the knee joint of certain animal species. In December 2002, we announced
that we had agreed on an action plan with the FDA that could allow us to
initiate Phase II human clinical studies in the middle of 2003. We modified
the formulation of APF112 to minimize irritation, and decided to initially
target pain management following surgery to repair inguinal hernias. More
than 5.3 million abdominal surgeries are performed annually in the United
States ("U.S.") and, with the demonstration of efficacy of APF112 in the
treatment of post-surgical pain, we believe that there are more than 20
million surgical procedures performed annually in the U.S. for which the
product could be utilized.
We have also entered into fee-paying feasibility studies with several
companies to develop a variety of products using our Biochronomer(TM)
delivery systems. These products are being developed in the areas of
ophthalmology, device coatings and DNA delivery. In general, these research
and development arrangements provide for us to receive research and
development fees from our collaborators. Five of these development programs
have now moved into in vivo testing and, if they are concluded successfully,
could lead to licensing agreements under which a partner would pay for
development costs and we would receive a license fee, research and
development fees, milestone payments and a royalty upon a product's marketing
clearance and commercialization.
In February 1997, we received FDA marketing clearance for our first
pharmaceutical product based on the original patented Microsponge(R)
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 was also launched
in Canada in the third quarter of 2001 and Phase III clinical trials were
completed in Europe in 2002. In May 2002, the FDA granted marketing
clearance for a new low-dose formulation of Retin-A Micro, which was launched
in July 2002.
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 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 annual earnout amounts for the subsequent three years, the amounts of
which are dependent on the performance of the product lines sold. We
recorded approximately $3 million at the end of the first earnout period
ending June 30, 2001, which represents earnout payments received of $3.6
million less reserves for certain indemnification claims allowable under the
sale agreement, and approximately $200,000 for the second earnout period
ending June 30,2002. 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.
In February 2003, we sold the assets of our wholly-owned subsidiary, APS
Analytical Standards, Inc., to GFS Chemicals of Columbus, Ohio, for $2.1
million in cash and the right to receive royalties for the next five years.
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
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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 patent
5,968,543, issued October 19, 1999 and US patent 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 at the site
of a surgical procedure, under the skin, in joints, in the eye, or in muscle
tissue. 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.
Also under development are device applications. Because both mechanical
properties and erosion rates can be controlled, these polymers are emerging
as promising materials for device coatings that could be useful in
cardiovascular applications such as stent coatings, and in the development of
scaffolding materials used in tissue engineering.
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, device
coatings, 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.
Through an academic collaboration, 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.
PRODUCTS
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Ethical Pharmaceutical Products
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We define ethical pharmaceutical products as prescription products that are
promoted primarily through the medical profession. We are developing several
pharmaceutical product candidates that will require marketing clearance from
the FDA before they can be sold in the United States. We believe that the
benefits offered by our delivery systems will create valuable product
differentiation and advantages in large, 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 incorporating the Microsponge
technology have already been developed and commercialized:
Retin-A Micro: In February 1997, we received FDA marketing clearance 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. We believe this 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). We receive royalty
income based on the sales of this product over the life of the applicable
patents.
During 2001, Ortho launched this product in Canada and has now completed
Phase III clinical trials in Europe in preparation for a European Union
filing. Additionally, Ortho received FDA marketing clearance in the United
States for a second Retin-A Micro formulation and launched the product in
July of 2002.
Carac: In the fourth quarter of 2000, Dermik Laboratories, an Aventis
company, received U.S. marketing clearance 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. We receive royalties based on the sales of
this product over the life of the applicable patents.
Products Under Development
- --------------------------
Our efforts in pharmaceutical markets include additional applications using
our Biochronomer technology that are under development, as noted below.
The first product candidate that incorporates the Biochronomer(TM) System
targets the management of pain in patients following surgery for inguinal
hernias. With the demonstration of efficacy in treating post-surgical pain,
we believe that there will be substantial potential for this product as there
are approximately 20 million surgical procedures performed annually in the
U.S. for which the product could potentially be utilized.
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 post-operative pain but with
unpleasant side effects - nausea, disorientation, sedation, constipation,
vomiting, urinary retention and, in some situations, life-threatening
respiratory depression.
Other Products
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Analytical Standards. We initially developed microspheres (precursors to the
Microsponge system) for use as a testing standard for gauging the purity of
municipal drinking water. Marketed 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.
We have also developed standards for the calibration of spectrophotometers
and colorimeters.
In February 2003, we announced the sale of the assets of this subsidiary to
GFS Chemicals, Inc. of Columbus, Ohio for $2.1 million in cash and the right
to receive royalties for five years at rates ranging from 5% to 15% of sales
of analytical standards products.
MARKETING
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A key part of our business strategy is to form collaborations with
pharmaceutical partners. We have therefore negotiated fee-paying feasibility
agreements with several pharmaceutical and biotechnology companies for the
development of prescription products incorporating the Biochronomer delivery
system.
In general, we grant limited marketing exclusivity in defined markets for
defined periods to our partners. However, after development is completed and
a partner commercializes a formulated product utilizing our delivery systems,
we can exert only limited influence over the manner and extent of our
partner's marketing efforts.
Our key marketing relationships currently involving only the Microsponge
delivery system for prescription products are as follows:
Johnson & Johnson Inc. In May 1992, we entered into a development and
license agreement with Ortho-McNeil Pharmaceutical Corporation ("Ortho"), a
subsidiary of J&J, related to tretinoin-based products incorporating our
Microsponge technology. As part of the agreement, certain license fees and
milestone payments were paid to us by Ortho. The license fees provided Ortho
with exclusive distribution or license rights for all Ortho tretinoin
products utilizing our 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 us.
In February 1997, we 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.
We received a payment of $3,000,000 from Ortho upon receipt of the FDA
approval, of which half is a milestone payment that was recognized as revenue
in 1997 and half as prepaid royalties which was recorded as deferred
revenues. Ortho pays us a royalty on product sales. In accordance with the
licensing agreement, 25% of the royalties we earn 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 we would
regain marketing rights to the retinoid products.
Dermik. In March 1992, we restructured our 1989 joint venture agreement with
Dermik, an Aventis company. 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 us to cover two additional indications, in return for
milestone payments and royalties upon successful development. We received
$500,000 on execution of this amendment representing a milestone payment of
$250,000 and prepaid royalties of $250,000. 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 and we received a
milestone payment of $50,000. In 2002, we recognized the prepaid royalties
as revenues because Dermik decided not to pursue the two additional
applications covered by the 1999 amendment. Dermik's exclusivity will
continue as long as annual minimum royalty payments are made, governed by the
life of the applicable patents.
GOVERNMENT REGULATION
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Ethical Products
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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
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As part of our strategy to protect our current products and to provide a
foundation for future products, we have filed a number of United States
patent applications on inventions relating to specific products, product
groups, and processing technology. We have also filed foreign patent
applications on our polymer technology with the European Union, Japan,
Australia, South Africa, Canada, Korea and Taiwan. We have a total of 11
issued United States patents and an additional 98 issued foreign patents.
Currently, we have over 26 pending patent applications worldwide. The
patents on the Microsponge(R) system expire between October 2005 and
September 2016. The patents on the bioerodible systems expire between
January 2016 and November 2021.
Although we believe 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 our technology
will not be held to infringe patents held by others.
We rely on unpatented trade secrets and know-how to protect certain aspects
of our production technologies. Our employees, consultants, advisors and
corporate partners have entered into confidentiality agreements with us.
These agreements, however, may not necessarily provide meaningful protection
for our 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. We believe that our proprietary bioerodible
Biochronomer(TM) polymers have a number of important advantages. Among these
are ease of manufacturing, 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 we believe that
our 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
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As of February 28, 2003, we had 34 full-time employees, 8 of whom hold PhDs.
There were 25 employees engaged in research and development and quality
control, and 9 working in finance, business development, human resources and
administration.
We consider our relations with employees to be satisfactory. None of our
employees is covered by a collective bargaining agreement.
AVAILABLE INFORMATION
- ---------------------
We make available free of charge on or through our Internet website our
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K and all amendments to those reports as soon as reasonably
practicable after they are electronically filed with, or furnished to, the
Securities and Exchange Commission. Our Internet website address is
"www.appharma.com".
Item 2. PROPERTIES
We lease 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 $641,000.
We occupied a production facility and warehouse in Lafayette, Louisiana that
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, we 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, 2002 will
be repaid on January 25, 2005 using the proceeds from the maturities of the
United States government securities held in the irrevocable trust.
Our existing research and development and administrative facilities are not
yet being used at full capacity and management believes that these facilities
are adequate and suitable for current and anticipated needs.
Item 3. LEGAL PROCEEDINGS
None.
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, 2003, there were 460 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.
2002 High Low 2001 High Low
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First Quarter $2.900 $2.080 First Quarter $2.938 $1.625
Second Quarter 2.650 1.930 Second Quarter 3.350 1.870
Third Quarter 2.200 1.150 Third Quarter 3.100 1.400
Fourth Quarter 1.500 0.610 Fourth Quarter 3.120 1.550
Item 6. SELECTED FINANCIAL DATA
(in thousands, except per share data)
For the Years Ended and as of
December 31, 2002 2001 2000 1999 1998
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Consolidated Statements of Operations Data
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Royalties $4,026 $ 3,227 $ 2,081 $2,025 $1,724
Contract revenues 644 38 122 1,462 219
Product sales 1,145 1,122 1,163 1,210 1,131
------ ------ ----- ----- -----
Total revenues 5,815 4,387 3,366 4,697 3,074
Expenses
Cost of product sales 445 440 497 532 321
Research and development 6,699 7,348 3,713 2,471 2,371
Selling, marketing and
advertising 471 473 594 496 385
General and administrative 3,024 3,247 2,869 2,946 2,165
Interest and other income and
expense, net 658 1,192 549 (390) (578)
----- ----- ------ ----- -----
Loss from continuing
operations (4,166) (5,929) (3,758) (2,138) (2,746)
Income from discontinued
operations(1) 172 525 1,163 4,510 5,271
Gain on disposition of
discontinued operations(2) 216 2,890 11,147 -- --
----- ----- ------ ----- -----
Net income (loss) $(3,778) $(2,514) $ 8,552 $2,372 $2,525
===== ===== ====== ===== =====
Basic income (loss) per
common share:
Loss from continuing
operations $ (0.20) $ (0.29) $(0.19) $(0.11) $(0.14)
Net income (loss) $ (0.19) $ (0.12) $ 0.42 $ 0.12 $ 0.13
Diluted income (loss) per
common share:
Loss from continuing
operations $ (0.20) $ (0.29) $(0.19) $(0.11) $(0.14)
Net income (loss) $ (0.19) $ (0.12) $ 0.42 $ 0.12 $ 0.12
Weighted average common
shares outstanding - basic 20,409 20,276 20,179 20,079 19,854
Weighted average common
shares outstanding - diluted 20,409 20,276 20,213 20,252 20,381
Consolidated Balance Sheet Data
- -------------------------------
December 31,
----------------------------------------------
2002 2001 2000 1999 1998
------- ------- ------ ----- ------
Working capital $13,979 $18,075 $20,087 $13,192 $ 2,456
Total assets 17,799 23,507 26,996 19,296 17,582
Long-term debt, excluding
current portion -- -- -- 2,409 --
Shareholders' equity 15,459 19,173 21,159 12,036 9,036
(1) Income from discontinued operations represents the income attributable to
our 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 our cosmeceutical and toiletries business to RP Scherer
on July 25, 2000, and in 2001 and 2002 represents the annual earnout income
received from RP Scherer based on the performance of the business sold.
These are the first two 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
- -------------------
Royalties
- ---------
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 our
licensees based on information that we receive from our licensees.
Contract Revenues
- -----------------
We have licensing agreements that generally provide for us 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 our proprietary products in a defined field or
territory for a defined period. The license agreements provide for us 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 we have
continuing involvement with licensees until the related product is
discontinued. Revenue recognized from deferred license fees is classified as
Contract Revenues in the accompanying consolidated statements of operations.
License fees received in connection with arrangements where our company has
no continuing involvement are recognized as contract revenues when the
amounts are received or when collectibility is assured, whichever is earlier.
A milestone payment is a payment made to us by a third party or corporate
partner upon the achievement of a predetermined milestone as defined in a
legally binding contract. Milestone payments are recognized as contract
revenue when the milestone event has occurred and we have completed all
milestone related services such that the milestone payment is currently due
and is non-refundable.
Contract revenues also relate to research and development arrangements that
generally provide for our company to invoice research and development fees
based on full-time equivalent hours for each project. Revenues from these
arrangements are recognized as the related development costs are incurred.
These revenues approximate the costs incurred.
Product Revenues
- ----------------
Product revenues relate to our sales of analytical standards for the
calibration of turbidimeters used to test water purity and 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.
STATEMENTS OF OPERATIONS HIGHLIGHTS (in thousands)
- --------------------------------------------------
For the Years Ended December 31, Annual % Change
-------------------------------- ---------------
2002 2001 2000 02/01 01/00
------ ------ ------ ----- -----
Royalties $4,026 $3,227 $2,081 25% 55%
Contract revenues 644 38 122 1,595% (69%)
Product sales 1,145 1,122 1,163 2% (4%)
------ ------ ------
Total revenues 5,815 4,387 3,366 33% 30%
Expenses
Cost of product sales 445 440 497 --% (11%)
Research and development 6,699 7,348 3,713 (9%) 98%
Selling and marketing 471 473 594 --% (20%)
General and administrative 3,024 3,247 2,869 (7%) 13%
Results of Operations for the years ended December 31, 2002 and 2001
- --------------------------------------------------------------------
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 our Securities and
Exchange Commission filings.
Our 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, we may receive
non-refundable upfront fees, milestone payments and royalties based on third
party product sales.
Royalties for 2002 increased by $799,000 or 25%, to $4,026,000 from
$3,227,000 in the prior year. This increase related to a 29% increase in
royalties earned on sales of Carac(TM), a topical prescription treatment for
actinic keratoses that was launched in the first quarter of 2001 by our
marketing partner, Dermik Laboratories, an Aventis company. Also, royalties
on sales of Retin-A(R) Micro by Ortho Neutrogena, a Johnson and Johnson
company, increased by 23% over the prior year following the launch of a new
low-dose formulation in July 2002 after FDA marketing clearance and a direct-
to-consumer advertising program of the product. Royalty income is expected
to increase in 2003 assuming continued market share growth for the Retin-A
Micro product line, the continuation of Ortho Neutrogena's direct-to-consumer
advertising program and the continued growth of Carac sales.
Contract revenues for 2002 were $644,000 compared with $38,000 in the prior
year. This was due to the initiation of collaborative research and
development arrangements with prospective corporate partners during the year,
and the forfeiture by a partner of certain rights to a proprietary
Microsponge(R) formulation.
Product revenues for 2002 relating to sales of analytical standards increased
by 2% or $23,000 to $1,145,000 from $1,122,000 in the prior year. Gross
profit on sales of analytical standards were flat at 61%. In February 2003,
we sold the assets of APS Analytical Standards, Inc., to GFS Chemicals of
Columbus, Ohio and do not expect to report product sales or cost of sales
relating to this business in the future.
Research and development expense for 2002 decreased by $649,000, or 9%, to
$6,699,000 from $7,348,000 due mainly to the delayed entry into Phase II
clinical trials of our product candidate for post-surgical pain management
incorporating our Biochronomer(TM) drug delivery system. This compares with
higher expenses incurred in the prior year related to preparation for the
filing of an Investigational New Drug Application (IND), together with the
costs associated with the manufacture of GMP materials for use in clinical
programs. Research and development expense is expected to increase in 2003
as our lead product candidate enters Phase II human clinical studies in mid-
year. The delay caused by the withdrawal of the Phase II protocol in August
2002 deferred a portion of the anticipated increase in research and
development spending until 2003. This delay could result in a delay in the
filing of a New Drug Application ("NDA") for APF112, and hence could result
in a delay in the product candidate's marketing clearance and initiation of
revenue streams.
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 includes proof of concept in
animals and Phase I, II, and III clinical studies in humans. Each step of
this process is typically more expensive than the previous one, so success in
development 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.
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
Drug
Indication Compound Delivery Duration Status
- ---------- -------- ----------------- ------
Acute pain relief Mepivacaine Less than 1 week Pre-Phase II
(post-surgical)
Site-specific Meloxicam 2-4 weeks Pre-IND
Anti-inflammatory
Chronic pain
Relief Mepivacaine 4-6 weeks Preclinical
Post-surgical
Anti-adhesions Undisclosed Less than 1 week Research
In addition, several feasibility studies are ongoing with corporate
collaborators in the areas of ophthalmology, device coating, restenosis and
immune stimulation.
The major components of research and development expenses for 2002, 2001 and
2000 were as follows (in thousands):
2002 2001 2000
------ ------ ------
Internal general research
and development costs $4,827 $4,167 $2,879
External polymer
development and
preclinical programs 1,872 3,181 834
----- ----- -----
$6,699 $7,348 $3,713
===== ===== =====
Internal general research and development costs include employee salaries and
benefits, laboratory supplies, depreciation, professional fees and allocation
of overhead. External polymer development and preclinical programs include
expenditures on technology and product development, preclinical evaluation,
regulatory and toxicology consultants, and polymer manufacturing, all of
which are performed by third parties.
Selling and marketing expense for analytical standards products for 2002 was
essentially flat at $471,000 compared with $473,000 in the prior year.
Following the sale of the Analytical Standards business in February 2003 we
will not incur these selling and marketing expenses.
General and administrative expense for 2002 of $3,024,000 decreased by
$223,000 or 7% from $3,247,000 in the prior year due mainly to decreased
professional fees and a provision for doubtful note receivable, partially
offset by higher investor relations expenses. 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 be consistent in 2003.
General and administrative expenses in 2001 included an allowance for
doubtful accounts of $418,000 relating to a note receivable arising from our
sale of certain proprietary rights to a consumer product in 1999. As
payments on the note were not received on a timely basis, an allowance was
recorded against the note. In 2002, an additional allowance of $19,000 was
recorded on the remaining outstanding balance, net of payments received.
Payments received were recorded as recovery of the receivable.
Interest income for 2002 decreased by $516,000 to $590,000 from $1,106,000
due mainly to reduced interest rates on reduced cash balances. Interest
income is expected to decrease in 2003 as cash balances decrease.
On July 25, 2000, we completed the sale of certain technology rights for
topical pharmaceuticals and 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 2002, the net
income from discontinued operations relating to changes in estimates totaled
$172,000, compared with $525,000 in the prior year.
The gain on disposition of discontinued operations recorded in 2002 of
$216,000 related mainly to the net earnout income resulting from the sale of
our cosmeceutical product lines in 2000, compared with $2,890,000 in the
prior year. The earnout income is the second of three contractual annual
payments, the amounts of which are dependent on the performance of the
cosmeceutical business.
Under the terms of the agreement with RP Scherer, we guaranteed a minimum
gross profit percentage on RP Scherer's combined sales of products to Ortho
Neutrogena and Dermik ("Gross Profit Guaranty"). The guaranty period
commenced on July 1, 2000 and ends on the earlier of July 1, 2010 or the end
of two consecutive guaranty periods where the combined gross profit on sales
to Ortho and Dermik equals or exceeds the guaranteed gross profit. Payments
for the Gross Profit Guaranty aggregated $243,000 for the first two guaranty
years. We expect the annual Gross Profit Guaranty payments to range from
approximately $100,000 to $150,000 for the remainder of the guaranty period.
Results of Operations for the years ended December 31, 2001 and 2000
- --------------------------------------------------------------------
Royalties for 2001 increased by $1,146,000 or 55%, to $3,227,000 from
$2,081,000 in 2000. 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 our 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 2000.
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.
Research and development expense for 2001 increased by $3,635,000, or 98%, to
$7,348,000 from $3,713,000 in 2000 due mainly to costs of preclinical studies
required for the filing of an Investigational New Drug Application (IND)
involving our bioerodible Biochronomer(TM) drug delivery system for a
treatment for post-surgical pain, and our ongoing product development
programs.
Selling and marketing expense for analytical standards products for 2001
decreased by $121,000 or 20% to $473,000 from $594,000 in 2000 due mainly to
lower advertising expenses on sales of analytical standards.
General and administrative expense for 2001 of $3,247,000 increased by
$378,000 or 13% over 2000 due mainly to a reserve recorded on a note
receivable. General and administrative expense includes salaries and related
expenses, professional fees, directors' fees, investor relations costs,
insurance expense and overhead allocation.
Interest income for 2001 increased by $289,000, or 35%, to $1,106,000 from
$817,000 in 2000 due mainly to the receipt of $25 million in July 2000 as
proceeds from the sale of our 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.
On July 25, 2000, we 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 $525,000, compared with
$1,163,000 in 2000.
The gain recorded in 2001 related to the disposition of discontinued
operations includes net earnout income of approximately $3 million from the
sale of our 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 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.
Capital Resources and Liquidity
- -------------------------------
Total assets as of December 31, 2002 were $17,799,000 compared with
$23,507,000 at December 31, 2001. Cash, cash equivalents and marketable
securities decreased by $5,373,000 to $14,121,000 at December 31, 2002 from
$19,494,000 at December 31, 2001.
Net cash used in operating activities for the years ended December 31, 2002,
2001 and 2000 was $5,131,000, $6,491,000 and $3,116,000, respectively. The
decrease in net cash used in operating activities from 2001 to 2002 was
primarily due to reduced research and development expenses resulting from the
delay in the initiation of the Phase II human clinical studies for our
product candidate for post-surgical pain.
Net cash provided by investing activities for the years ended December 31,
2002, 2001 and 2000 was $4,720,000, $3,550,000 and $8,972,000, respectively,
with decreasing proceeds from the sale of our discontinued operations in each
of 2001 and 2002, offset by higher net sales of marketable securities in
2002.
Net cash provided by financing activities was $75,000 for the year ended
December 31, 2002 compared to $66,000 for the year ended December 31, 2001
and net cash used in financing activities of $3,068,000 for the year ended
December 31, 2000. The net cash provided by financing activities in 2002 and
2001 was mainly due to proceeds from issuances of shares under the Employee
Stock Purchase Plan. The cash used in financing activities in 2000 was
primarily the result of the repayment of our long-term debt.
In the current year, we have also financed our operations, including
technology and product research and development, from royalties received on
sales of Retin-A Micro and Carac, earnout income from RP Scherer, the profits
from the sale of analytical standard products and interest earned on short-
term investments.
On February 13, 2002 ("closing date"), we completed the sale of the assets of
our wholly-owned subsidiary, APS Analytical Standards, Inc. to GFS Chemicals,
Inc., a private company based in Columbus, Ohio. We received $2.1 million in
cash on the closing date and we are entitled to receive royalties on sales
varying from 5% to 15% for five years following the closing, with guaranteed
minimum annual royalty payments.
Our 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
research and development fees, are expected to be sufficient to meet our cash
needs for at least the next two years, assuming no changes to existing
business plans.
Our future capital requirements will depend on numerous factors including,
among others, royalties from sales of products of third party licensees; our
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 we devote to self-funded products;
potential acquisitions of technology, product candidates or businesses; and
the costs of defending or prosecuting any patent opposition or litigation
necessary to protect our proprietary technology.
We occupy leased facilities under an agreement that expires in two years. We
also lease certain office equipment under operating leases. The contractual
obligations for the next five years and thereafter are as follows, in
thousands:
Years Ending Minimum
December 31, Payments
----------- --------
2003 $ 705
2004 602
2005 12
2006 7
-----
$1,326
=====
Reclassifications
- -----------------
Certain reclassifications have been made to the prior year financial
statements to conform with the presentation in 2002.
The provision for doubtful note receivable in 2001 was reclassified from
income from discontinued operations to general and administrative expenses.
A milestone payment received in 2001 was reclassified from royalty revenue to
contract revenues. License, research and development, and option fees were
reclassified to contract revenues.
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. The adoption of FAS 141 did not have a material effect
on our financial position or results of operations.
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 was required to be applied for fiscal years beginning
after December 15, 2001, with certain early adoption permitted. The adoption
of FAS 142 did not have a material effect on our financial position 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. FAS 143 was effective for our year
ended December 31, 2002, and did not have a material effect on our financial
position 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 was effective for fiscal years beginning after
December 15, 2001. The adoption of FAS 144 did not have a material effect on
our financial condition or results of operations.
In June 2002, the FASB issued FAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities," which addresses accounting for restructuring,
discountinued operation, plant closing, or other exit or disposal activity.
FAS 146 requires companies to recognize costs associated with exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. FAS 146 is to be applied
prospectively to exit or disposal activities initiated after December 31,
2002. The adoption of FAS 146 is not expected to have a significant impact
on our financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45 (or FIN 45),
"Guarantor's Accounting and Disclosure requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 elaborates on the
existing disclosure requirements for most guarantees, including residual
value guarantees issued in conjunction with operating lease agreements. It
also clarifies that at the time a company issues a guarantee, the company
must recognize an initial liability for the fair value of the obligation it
assumes under that guarantee and must disclose that information in its
interim and annual financial statements. The initial recognition and
measurement provisions apply on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure requirements are effective
for financial statements of interim or annual periods ending after December
15, 2002. The adoption of the disclosure requirements in November 2002 and
the recognition requirements in January 2003 of FIN 45 neither had nor are
anticipated to have a material impact on our results of operations or
financial position.
In November 2002, the FASB issued Emerging Issues Task Force (EITF) Issue No.
00-21, "Revenue Arrangements with Multiple Deliverables." EITF Issue No. 00-
21 addresses certain aspects of the accounting by a company for arrangements
under which it will perform multiple revenue-generating activities. EITF
Issue No. 00-21 addresses when and how an arrangement involving multiple
deliverables should be divided into separate units of accounting. EITF Issue
No. 00-21 provides guidance with respect to the effect of certain customer
rights due to company nonperformance on the recognition of revenue allocated
to delivered units of accounting. EITF Issue No. 00-21 also addresses the
impact on the measurement and/or allocation of arrangement consideration of
customer cancellation provisions and consideration that varies as a result of
future actions of the customer or the company. Finally, EITF Issue No. 00-21
provides guidance with respect to the recognition of the cost of certain
deliverables that are excluded from the revenue accounting for an
arrangement. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003.
We are currently evaluating the effect that the adoption of EITF Issue No.
00-21 will have on our results of operations and financial position.
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-
Based Compensation - Transition and Disclosure" (or FAS 148). FAS 148 amends
FAS 123 "Accounting for Stock-Based Compensation" to provide alternative
methods of transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In addition, FAS 148
amends the disclosure requirements of FAS 123 to require more prominent
disclosures in both annual and interim financial statements about the method
used on reported results. The additional disclosure requirements of FAS 148
are effective for fiscal years ending after December 15, 2002. We have
elected to continue to follow the intrinsic value method of accounting as
prescribed by Accounting Principles Board Opinion No. 25 (or APB 25),
"Accounting for Stock Issued to Employees," to account for employee stock
options, and have adopted the disclosure requirements of FAS 148.
In January 2003, the FASB issued Interpretation No. 46 (or FIN 46),
"Consolidation of Variable Interest Entities." FIN 46 requires a variable
interest entity to be consolidated by a company if that company is subject to
a majority of the risk of loss from the variable interest entity's activities
or entitled to receive a majority of the entity's residual returns or both.
The consoidation requirements of FIN 46 apply immediately to variable
interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or interim
period beginning after June 15, 2003. Certain of the disclosure requirements
apply to all financial statements issued after January 31, 2003, regardless
of when the variable interest entity was established. We do not have
variable interest entities and do not expect the adoption of FIN 46 to have a
material impact on our results of operations and financial position.
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 BIOERODIBLE DRUG DELIVERY SYSTEM BUSINESS IS AT AN EARLY STAGE OF
DEVELOPMENT.
Our bioerodible drug delivery system 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 and our licensees may not be able to successfully market our products.
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 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 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.
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 more
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. 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
Our exposure to market rate risk for changes in interest rates relates
primarily to our investment portfolio. We do not use derivative financial
instruments. We manage our interest rate risk by maintaining an investment
portfolio primarily consisting of debt instruments of high credit quality and
relatively short average maturities. We also manage our interest rate risk
by maintaining sufficient cash and cash equivalents such that we are
typically able to hold our investments to maturity. At December 31, 2002 and
2001, respectively, our cash equivalents and marketable securities include
corporate and other debt securities of approximately $13,665,000 and
$19,289,000. Short-term investments with effective maturities of less than
three months totaled approximately $2,826,000 and $3,412,000 at December 31,
2002 and 2001, respectively. Investments with maturities between three
months and one year at December 31, 2002 and 2001, respectively, totaled
$5,618,000 and $7,102,000. Investments with maturities between one and two
years totaled $5,221,000 and $8,775,000 at December 31, 2002 and 2001,
respectively. Notwithstanding our efforts to manage interest rate risks,
there can be no assurances that we 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
(in thousands except par value and shares)
- ------------------------------------------
December 31,
-------------------------
2002 2001
---- ----
Assets
Current Assets:
Cash and cash equivalents $ 3,282 $ 3,618
Marketable securities 10,839 15,876
Accounts receivable less allowance
for doubtful accounts of $28 and
$1 at December 31, 2002 and
2001, respectively 291 338
Receivables from contract revenues 1,214 1,130
Inventory 68 61
Prepaid expenses and other current
assets, less allowance for doubtful
note receivable of $437 and $417 at
December 31, 2002 and 2001,
respectively 280 601
------- -------
Total current assets 15,974 21,624
Property and equipment, net 1,636 1,668
Other long-term assets 189 215
------- -------
Total Assets $ 17,799 $ 23,507
======= =======
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ 286 $ 346
Accrued expenses 945 1,409
Accrued disposition costs 514 1,479
Deferred revenue 250 315
------- -------
Total current liabilities 1,995 3,549
Deferred revenue - long-term 345 785
------- -------
Commitments and Contingencies
(Note 8)
Shareholders' Equity:
Preferred stock, 2,500,000 shares
authorized; none issued or
outstanding at December 31,
2002 and 2001 -- --
Common stock, $.01 par value,
50,000,000 shares authorized;
20,467,440 and 20,357,115 issued
and outstanding at December 31,
2002 and 2001, respectively 205 204
Additional paid-in capital 86,413 86,188
Accumulated deficit (71,235) (67,456)
Accumulated other comprehensive
income 76 237
------- -------
Total Shareholders' Equity 15,459 19,173
------- -------
Total Liabilities and Shareholders'
Equity $ 17,799 $ 23,507
======= =======
See accompanying notes to consolidated financial statements.
A.P. Pharma, Inc.
Consolidated Statements of Operations
(in thousands except per share data)
- -------------------------------------
Year Ended December 31,
-----------------------
2002 2001 2000
---- ---- ----
Revenues
Royalties $ 4,026 $ 3,227 $ 2,081
Contract revenues 644 38 122
Product sales 1,145 1,122 1,163
------ ------ ------
Total revenues 5,815 4,387 3,366
Expenses
Cost of product sales 445 440 497
Research and development 6,699 7,348 3,713
Selling and marketing 471 473 594
General and administrative 3,024 3,247 2,869
------ ------ ------
Operating loss (4,824) (7,121) (4,307)
------- ------ ------
Interest expense -- -- (294)
Interest income 590 1,106 817
Other income, net 68 86 26
------ ----- ------
Loss from continuing operations (4,166) (5,929) (3,758)
Income from discontinued operations 172 525 1,163
Gain on disposition of discontinued
operations, net of taxes 216 2,890 11,147
------ ------ ------
Net income (loss) $(3,778) $(2,514) $ 8,552
====== ====== ======
Basic income (loss) per share:
Loss from continuing operations $ (0.20) $ (0.29) $ (0.19)
====== ====== ======
Net income (loss) $ (0.19) $ (0.12) $ 0.42
====== ====== ======
Diluted income (loss) per share:
Loss from continuing operations $ (0.20) $ (0.29) $ (0.19)
====== ====== ======
Net income (loss) $ (0.19) $ (0.12) $ 0.42
====== ====== ======
Weighted average common shares
outstanding - basic 20,409 20,276 20,179
====== ====== ======
Weighted average common shares
outstanding - diluted 20,409 20,276 20,213
====== ====== ======
See accompanying notes to consolidated financial statements.
A.P. Pharma, Inc.
Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss)
(in thousands)
- -------------------------------------------------------------------------------
For the Years Ended December 31, 2002, 2001 and 2000
Accumulated
Other
Additional Compre-
Common Stock Deferred Paid-In Accumulated hensive Shareholders'
Shares Amount Compensation Capital Deficit Income Equity
---------- -------- --------- ----------- ----------- ------------ ------------
Balance, December
31, 1999 20,119 $201 $(299) $85,629 $(73,495) -- $12,036
Comprehensive
income:
Net income -- -- -- -- 8,552 -- 8,552
Net unrealized
gain on
marketable
securities -- -- -- -- -- 79 79
------
Comprehensive
income 8,631
------
Fair value of
stock issued to
non-employees 10 -- -- 40 -- -- 40
Amortization of
restricted stock -- -- 219 -- -- -- 219
Common stock issued
to employees under
the Employee Stock
Purchase Plan and
warrants exercised 77 1 -- 232 -- -- 233
------ --- ---- ------ ------- ---- ------
Balance, December
31, 2000 20,206 $202 $ (80) $85,901 $(64,943) $ 79 $21,159
Comprehensive
loss:
Net loss -- -- -- -- (2,514) -- (2,514)
Net unrealized
gain on
marketable
securities -- -- -- -- -- 159 159
------
Comprehensive
loss (2,355)
------
Fair value of common
stock issued
to non-employees
for services and
restricted stock
awards 115 1 -- 211 -- -- 212
Expense associated
with stock options
granted to non-
employees -- -- -- 11 -- -- 11
Amortization of
restricted stock -- -- 80 -- -- -- 80
Common stock issued
to employees under
the Employee Stock
Purchase Plan 36 -- -- 65 -- -- 65
------ --- ---- ------ ------- ---- ------
Balance, December
31, 2001 20,357 $203 $ -- $86,188 $(67,457) $ 238 $19,172
Comprehensive
loss:
Net loss -- -- -- -- (3,778) -- (3,778)
Net unrealized
loss on
marketable
securities -- -- -- -- -- (162) (162)
------
Comprehensive
loss (3,940)
------
Fair value of common stock
issued to non-employees
for services and
restricted stock
awards 47 1 -- 129 -- -- 130
Expenses associated
with stock options
granted to
non-employees -- -- -- 22 -- -- 22
Common stock issued
to employees under
the Employee Stock
Purchase Plan 63 1 -- 74 -- -- 75
------ --- ---- ------ ------- ---- ------
Balance, December
31, 2002 20,467 $205 $ -- $86,413 $(71,235) $ 76 $15,459
====== === ==== ====== ======= ==== ======
See accompanying notes to consolidated financial statements.
A.P. Pharma, Inc.
Consolidated Statements of Cash Flows
- --------------------------------------
For the Year Ended December 31,
-------------------------------------
2002 2001 2000
--------- --------- ---------
Cash flows from operating activities:
Net income (loss) $ (3,778) $ (2,514) $ 8,552
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Income from discontinued operations (172) (525) (1,163)
Gain on disposition of discontinued
operations (216) (2,890) (11,147)
Allowance for claims relating to sale
of discontinued operations -- (712) --
Gain on sale of marketable securities (81) (84) --
Depreciation and amortization 460 400 375
Provision for doubtful accounts and
note receivable 47 419 207
Stock and stock option compensation
awards to non-employees 119 189 41
Restricted stock awards 33 113 180
Amortization of premium/discount and
accretion of marketable securities 22 171 (102)
Loss on retirements of fixed assets 3 4 --
Changes in operating assets and liabilities:
Accounts receivable (30) (22) 2,882
Receivables from contract revenues (84) (441) 292
Inventory (7) 11 (10)
Advances to officers and employees -- 34 51
Prepaid expenses and other 321 223 (412)
Other long-term assets 26 (64) 191
Accounts payable (60) 17 (700)
Accrued expenses (464) (184) 236
Deferred revenue (505) (164) (390)
------ ------- ------
Net cash used in continuing operating
activities (4,366) (6,019) (917)
Cash used in discontinued operations (765) (472) (2,199)
------ ------- -------
Net cash used in operating activities (5,131) (6,491) (3,116)
------ ------- -------
Cash flows from investing activities:
Proceeds from disposition of discontinued
operations 216 3,602 25,000
Purchases of property and equipment (430) (277) (179)
Purchases of marketable securities (12,564) (16,410) (18,854)
Maturities of marketable securities 17,498 16,635 3,005
------ ------- -------
Net cash provided by investing activities 4,720 3,550 8,972
------ ------- -------
Cash flows from financing activities:
Repayment of long-term debt -- -- (3,300)
Proceeds from the exercise of common
stock options and warrants -- -- 120
Proceeds from issuance of shares under
the Employee Stock Purchase Plan 75 66 112
------ ------- -------
Net cash provided by (used in) financing
activities 75 66 (3,068)
------ ------- -------
Net increase (decrease) in cash and cash
equivalents (336) (2,875) 2,788
Cash and cash equivalents at the beginning
of the year 3,618 6,493 3,705
------ ------ -------
Cash and cash equivalents at the end of
the year $ 3,282 $ 3,618 $ 6,493
====== ====== ======
Supplemental Cash Flow Data:
Cash paid for interest $ -- $ -- $ 244
====== ======= ======
Cash paid for taxes $ 13 $ 27 $ 244
====== ======= ======
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------
DECEMBER 31, 2002, 2001 AND 2000
- --------------------------------
Note 1 Business
A.P. Pharma, Inc. ("APP") 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, we completed the sale of certain technology rights for our
topical pharmaceuticals and cosmeceutical product lines and other assets
("cosmeceutical and toiletry business") to RP Scherer Corporation, a
subsidiary of Cardinal Health, Inc. The terms of the agreement with RP
Scherer provided for a payment of $25 million at closing and additional
earnout amounts based on the performance of business sold over a period of
three years ending June 30, 2003. We received an aggregate of $3.8 million
during the first two years of the earnout period. We are entitled to receive
an additional amount in 2003 which will depend on the performance of the
business sold (see Note 11 "Discontinued Operations").
Note 2 Summary of Significant Accounting Policies
Principles of Consolidation
- ---------------------------
The consolidated financial statements include the financial statements of APP
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, we consider all short-term investments that have original
maturities of less than three months 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. We have
classified all our 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 our financial instruments, including marketable
securities and accounts receivable, approximate fair value. Financial
instruments that potentially subject us to concentrations of credit risk
consist primarily of cash equivalents, short-term investments and trade
accounts receivable. We invest 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.
Allowance for Doubtful Accounts and Note Receivable
- ---------------------------------------------------
Allowances are recorded for accounts and note receivable at such time
management determines that the collection of those receivables is not
reasonably assured. Interest income under the terms of note receivable
agreement is recorded when cash is received or collectiblity is reasonably
assured.
The note receivable, net of the related reserve, is included in prepaid
expenses and other assets in the accompanying balance sheet.
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 5 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
- -----------------
As circumstances dictate, we evaluate whether changes have occurred that
would require revision of the remaining estimated lives of recorded long-
lived assets 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
- ------------------------
We have 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 and
directors, no compensation cost has been recognized for our stock option
plans and stock purchase plan. Compensation related to options granted to
non-employees is periodically remeasured as earned.
In accordance with FAS No. 123, "Accounting for Stock-Based Compensation," as
amended by FAS No. 148, "Accounting for Stock-Based Compensation-Transition
and Disclosure," we have provided, below, the pro forma disclosures of the
effect on net income (loss) and income (loss) per share as if FAS No. 123 had
been applied in measuring compensation expense for all periods presented (see
Note 9 "Shareholders' Equity").
2002 2001 2000
----------- ----------- ---------
Net income (loss)
- as reported $(3,778) $(2,514) $ 8,552
Add back:
Deduct:
Stock-based employee
compensation expense
determined under FAS
123 (601) (696) (1,293)
------- -------- -------
Net income (loss)
- pro-forma $(4,379) $(3,210) $7,259
====== ====== ======
Basic income (loss) per
common share - as
reported $(0.19) $(0.12) $0.42
Basic income (loss) per
common share - pro-forma $(0.21) $(0.16) $0.36
Diluted income (loss) per
common share - as reported $(0.19) $(0.12) $0.42
Diluted income (loss) per
common share - pro-forma $(0.21) $(0.16) $0.36
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
- -------------------
Royalties
- ---------
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 our
licensees based on information provided to us by our licensees.
Contract Revenues
- -----------------
We have licensing agreements that generally provide for periodic minimum
payments, royalties, and/or non-refundable license fees. These licensing
agreements typically require a non-refundable license fee and allow our
partners to sell our 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 we have continuing
involvement with licensees until the related product is discontinued.
Revenue recognized from deferred license fees is classified as Contract
revenues in the accompanying consolidated statements of operations. License
fees received in connection with arrangements where we have no continuing
involvement are recognized as contract revenues when the amounts are received
or when collectibility is assured, whichever is earlier.
A milestone payment is a payment made by a third party or corporate partner
to us upon the achievement of a predetermined milestone as defined in a
legally binding contract. Milestone payments are recognized as contact
revenue when the milestone event has occurred and we have completed all
milestone related services such that the milestone payment is currently due
and is non-refundable.
Contract revenues also relate to research and development arrangements that
generally provide for the company to invoice research and development fees
based on full-time equivalent hours for each project. Revenues from these
arrangements are recognized as the related development costs are incurred.
These revenues approximate the costs incurred.
Product Revenues
- ----------------
Product revenues relate to our sales of analytical standards for the
calibration of turbidimeters used to test water purity and 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.
Earnings (Loss) Per Share
- -------------------------
Basic earnings (loss) per share is computed based on the weighted-average
number of common shares outstanding. Diluted earnings per share is computed
based on the weighted-average number of common shares outstanding and
dilutive potential common shares outstanding. See Note 10 "Earnings Per
Share".
Concentrations of Credit Risk
- -----------------------------
Financial instruments which potentially expose our company to concentrations
of credit risk consist primarily of trade accounts receivable and receivables
from contract revenues. Approximately 70% and 82% of the trade receivables
and receivables from contract revenues were concentrated with two customers
in the pharmaceutical industry as of December 31, 2002 and 2001,
respectively. Approximately 73%, 75% and 62% of the net sales were
concentrated with two, two and one customers for the years ended December 31,
2002, 2001 and 2000, respectively. To reduce credit risk, we perform ongoing
credit evaluations of our customers' financial conditions. We do not
generally require collateral for customers with accounts receivable balances.
Segment and Geographic Information
- ----------------------------------
Our operations are confined to a single business segment, the design and
commercialization of polymer technologies for pharmaceutical and other
applications. Substantially all of our revenues are derived from customers
within the United States.
Royalty and contract revenues from two domestic customers amounted to
approximately 44% and 29% of total revenues for the year ended December 31,
2002. Royalty revenues from two domestic customers amounted to approximately
49% and 26% of total revenues for the year ended December 31, 2001. Revenues
from one domestic customer amounted to 62% for the year ended December 31,
2000.
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. The adoption of FAS 141 did not have a material effect
on our financial position or results of operations.
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 was required to be applied for fiscal years beginning
after December 15, 2001, with certain early adoption permitted. The adoption
of FAS 142 did not have a material effect on our financial position 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. FAS 143 was effective for our year
ended December 31, 2002, and did not have a material effect on our financial
position 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 was effective for fiscal years beginning after
December 15, 2001. The adoption of FAS 144 did not have a material effect on
our financial condition or results of operations.
In June 2002, the FASB issued FAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities," which addresses accounting for restructuring,
discountinued operation, plant closing, or other exit or disposal activity.
FAS 146 requires companies to recognize costs associated with exit or
disposal activities when they are incurred rather than at the date of a
commitment to an exit or disposal plan. FAS 146 is to be applied
prospectively to exit or disposal activities initiated after December 31,
2002. The adoption of FAS 146 is not expected to have a significant impact
on our financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45 (or FIN 45),
"Guarantor's Accounting and Disclosure requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 elaborates on the
existing disclosure requirements for most guarantees, including residual
value guarantees issued in conjunction with operating lease agreements. It
also clarifies that at the time a company issues a guarantee, the company
must recognize an initial liability for the fair value of the obligation it
assumes under that guarantee and must disclose that information in its
interim and annual financial statements. The initial recognition and
measurement provisions apply on a prospective basis to guarantees issued or
modified after December 31, 2002. The disclosure requirements are effective
for financial statements of interim or annual periods ending after December
15, 2002. The adoption of the disclosure requirements in November 2002 and
the recognition requirements in January 2003 of FIN 45 neither had nor are
anticipated to have a material impact on our results of operations or
financial position.
In November 2002, the FASB issued Emerging Issues Task Force (EITF) Issue No.
00-21, "Revenue Arrangements with Multiple Deliverables." EITF Issue No. 00-
21 addresses certain aspects of the accounting by a company for arrangements
under which it will perform multiple revenue-generating activities. EITF
Issue No. 00-21 addresses when and how an arrangement involving multiple
deliverables should be divided into separate units of accounting. EITF Issue
No. 00-21 provides guidance with respect to the effect of certain customer
rights due to company nonperformance on the recognition of revenue allocated
to delivered units of accounting. EITF Issue No. 00-21 also addresses the
impact on the measurement and/or allocation of arrangement consideration of
customer cancellation provisions and consideration that varies as a result of
future actions of the customer or the company. Finally, EITF Issue No. 00-21
provides guidance with respect to the recognition of the cost of certain
deliverables that are excluded from the revenue accounting for an
arrangement. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003.
We are currently evaluating the effect that the adoption of EITF Issue No.
00-21 will have on our results of operations and financial position.
In December 2002, the FASB issued Statement No. 148, "Accounting for Stock-
Based Compensation - Transition and Disclosure" (or FAS 148). FAS 148 amends
FAS 123 "Accounting for Stock-Based Compensation" to provide alternative
methods of transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In addition, FAS 148
amends the disclosure requirements of FAS 123 to require more prominent
disclosures in both annual and interim financial statements about the method
used on reported results. The additional disclosure requirements of FAS 148
are effective for fiscal years ending after December 15, 2002. We have
elected to continue to follow the intrinsic value method of accounting as
prescribed by Accounting Principles Board Opinion No. 25 (or APB 25),
"Accounting for Stock Issued to Employees," to account for employee stock
options, and have adopted the disclosure requirements of FAS 148.
In January 2003, the FASB issued Interpretation No. 46 (or FIN 46),
"Consolidation of Variable Interest Entities." FIN 46 requires a variable
interest entity to be consolidated by a company if that company is subject to
a majority of the risk of loss from the variable interest entity's activities
or entitled to receive a majority of the entity's residual returns or both.
The consoidation requirements of FIN 46 apply immediately to variable
interest entities created after January 31, 2003. The consolidation
requirements apply to older entities in the first fiscal year or interim
period beginning after June 15, 2003. Certain of the disclosure requirements
apply to all financial statements issued after January 31, 2003, regardless
of when the variable interest entity was established. We do not have
variable interest entities and do not expect the adoption of FIN 46 to have a
material impact on our results of operations and financial position.
Reclassifications
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Certain reclassifications have been made to the prior year financial
stat