A.P. PHARMA, INC.
NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
TO BE HELD MAY 25, 2005
-------------------------------
To the Stockholders of A.P. Pharma, Inc.:
The Annual Meeting of Stockholders of A.P. Pharma, Inc. (the "Company") will
be held at the corporate offices at 123 Saginaw Drive, Redwood City,
California 94063, on May 25, 2005, at 9:00 a.m. local time, for the following
purposes:
1. To elect eight directors to hold office until the next Annual Meeting of
stockholders and until their successors are elected.
2. To amend the Company's 1997 Employee Stock Purchase Plan to increase by
150,000 the number of shares of common stock reserved for issuance under the
Plan.
3. To amend the Company's 2002 Equity Incentive Plan to increase by 400,000
the number of shares of common stock reserved for issuance under the Plan.
4. To ratify the appointment of Ernst & Young LLP as A.P. Pharma's
independent registered public accounting firm.
5. To transact such other business as properly may come before the meeting,
or any adjournments or postponements of the meeting.
Only stockholders of record at the close of business on March 30, 2005, are
entitled to notice of, and to vote at, the meeting and any adjournments or
postponements of the meeting. A list of such stockholders will be open to
examination by any stockholders at the Annual Meeting and for a period of ten
days prior to the Annual Meeting during ordinary business hours at the offices
of the Company located at 123 Saginaw Drive, Redwood City, California 94063.
BY ORDER OF THE BOARD OF DIRECTORS,
Julian N. Stern, Secretary
Redwood City, California
April 20, 2005
- IMPORTANT -
WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING IN PERSON,
PLEASE COMPLETE, SIGN, DATE AND RETURN THE PROXY CARD IN
THE ENCLOSED POSTPAID ENVELOPE OR FOLLOW THE TELEPHONE OR
INTERNET VOTING INSTRUCTIONS ON THE PROXY CARD AS SOON AS
POSSIBLE. THANK YOU FOR ACTING PROMPTLY.
A.P. PHARMA, INC.
123 Saginaw Drive
Redwood City, California 94063
(650) 366-2626
PROXY STATEMENT
The enclosed proxy is solicited on behalf of the Board of Directors (the
"Board") of A.P. Pharma, Inc. ("APP" or the "Company"), a Delaware
corporation. The proxy is solicited for use at the Annual Meeting of
Stockholders (the "Annual Meeting") to be held at 9:00 a.m. local time on May
25, 2005, at the Company's corporate offices at 123 Saginaw Drive, Redwood
City, California 94063. The approximate date on which this proxy statement and
the accompanying notice and proxy are first being mailed to stockholders is
April 20, 2005.
VOTING
Only stockholders of record at the close of business on March 30, 2005, are
entitled to notice of, and to vote at, the Annual Meeting and any adjournments
or postponements thereof. At the close of business on that date, the Company
had outstanding 25,132,056 shares of its Common Stock, $.01 par value (the
"Common Stock"). Holders of a majority of the outstanding shares of Common
Stock of the Company, either present in person or by proxy, will constitute a
quorum for the transaction of business at the Annual Meeting.
Holders of Common Stock are entitled to one vote for each share of Common
Stock held. In the election of directors, the eight nominees receiving the
highest number of affirmative votes of the shares present and voting at the
Annual Meeting at which a quorum is present will be elected directors.
Abstentions are included in the determination of whether a quorum is present
at the meeting and are counted in tabulations of the votes cast on proposals
presented to stockholders and have the same effect as negative votes. Proxies
marked to withhold authority for all directors will not be counted in the
election of directors. On matters other than the election of directors, if a
broker indicates on a proxy that it does not have discretionary authority as
to certain shares to vote on a particular matter (a broker non-vote), while
those shares will be included in the determination of whether a quorum is
present, broker non-votes will have no effect on those matters.
REVOCABILITY OF PROXIES
Proxies which are properly executed and received by the Company before the
Annual Meeting will be voted at the Annual Meeting. Any stockholder giving a
proxy has the power to revoke the proxy at any time prior to its exercise. A
proxy can be revoked by an instrument of revocation delivered prior to the
Annual Meeting to the Secretary of the Company, by a duly executed proxy
bearing a later date or time than the date or time of the proxy being revoked,
or at the Annual Meeting if the stockholder is present and elects to vote in
person. Mere attendance at the Annual Meeting will not serve to revoke a
proxy.
SOLICITATION OF PROXIES
Solicitation of proxies may be made by directors, officers and other employees
of the Company by personal interview, telephone, telegraph, telefax or
electronic communications. No additional compensation will be paid for any
such services. Costs of solicitation will be borne by the Company. APP will,
upon request, reimburse the reasonable fees and expenses of banks, brokerage
houses or other nominees or fiduciaries for forwarding proxy materials to, and
obtaining authority to execute proxies from, beneficial owners for whose
accounts they hold shares of Common Stock.
PROPOSAL ONE
ELECTION OF DIRECTORS
Eight directors are to be elected to the Board at the Annual Meeting, each to
serve for a one year term until the Annual Meeting to be held in 2006, and
until his or her successor has been qualified and elected. All the nominees
presently are directors of APP. It is intended that proxies received will be
voted "FOR" the election of the nominees, unless marked to the contrary.
The Board has no reason to believe that any of the nominees will be unable or
unwilling to serve as a director if elected. If any nominee should become
unavailable prior to the election, the accompanying proxy will be voted for
the election of any nominee who is designated by the present Board of
Directors to fill the vacancy.
INFORMATION CONCERNING THE BOARD OF DIRECTORS AND EXECUTIVE OFFICERS
The nominees for Directors of APP and their ages and position with the Company
are as follows:
DIRECTOR
NAME AGE POSITION WITH COMPANY SINCE
- ----------------------- --- --------------------- --------
Paul Goddard, Ph.D. 55 Chairman 2000
Stephen A. Drury (1)(2) 67 Director 1999
Michael O'Connell 55 President and Chief Executive
Officer 2000
Peter Riepenhausen (3)(4) 68 Director 1991
Toby Rosenblatt (1)(2)(3)(4) 66 Director 1983
Gregory Turnbull (1)(2)(3)(4) 66 Director 1986
Dennis Winger (1)(2) 57 Director 1993
Robert Zerbe, M.D. 54 Director 2002
<FN>
- ----------------
(1) Member of the Audit Committee of the Board.
(2) Member of the Finance Committee of the Board.
(3) Member of the Compensation and Stock Option Committee of the
Board.
(4) Member of the Nominating and Governance Committee of the Board.
</FN>
The other executive officers of APP and their ages and position with the
Company are as follows:
EXECUTIVE
NAME AGE POSITION WITH COMPANY SINCE
- ----------------------- --- ---------------------- ---------
John Barr, Ph.D. 45 Vice President of Research
and Development 1997
Gordon Sangster 52 Chief Financial Officer,
Vice President of Finance 1993
Paul Goddard, Ph.D. -- chairman of A.P. Pharma board of directors since
November 2000. From 1998 to 2000, Dr. Goddard was President and Chief
Executive Officer of Elan's pharmaceutical division. From 1991 to 1998, Dr.
Goddard served as Chairman and Chief Executive Officer of Neurex Corporation.
In 1998, Neurex was acquired by Elan. Prior to Neurex, Dr. Goddard held
various senior management positions at SmithKline Beecham. Dr. Goddard also
serves as Chairman of the Board for ARYx Therapeutics, Inc. and Xenoport,
Inc., and as a director for Adolor, Inc., Molecular Devices, Inc. and Onyx
Pharmaceuticals, Inc.
Stephen A. Drury -- director of A.P. Pharma since May 1999. Mr. Drury is
currently a healthcare financial advisor and a private investor. Prior to his
retirement in 1997, he was Executive Vice President and a director of Owen
Healthcare from 1992 and Senior Vice President and Chief Financial Officer of
Integrated Health Services, Inc. from 1989 until 1992. Prior to that, Mr.
Drury served as Senior Vice President of Thomson McKinnon Securities and
managing director of its Healthcare Capital Markets Group from 1985 to 1989.
Michael O'Connell -- director since August 2000 and Chief Executive Officer
and President of A.P. Pharma since August 2000; he originally joined A.P.
Pharma in July 1992 as Vice President and Chief Financial Officer. From 1980
to 1992, Mr. O'Connell served with The Cooper Companies, Inc. (formerly
CooperVision, Inc.) in a number of financial positions including Vice
President and corporate controller. Mr. O'Connell is a Fellow of the
Institute of Chartered Accountants of England and Wales.
Peter Riepenhausen -- director of A.P. Pharma since April 1991. Mr.
Riepenhausen is a business consultant. He was chairman, Europe for Align
Technology, Inc. from 2000 until 2002 and President and Chief Executive
Officer of ReSound Corporation from 1994 to 1998. He served as a director of
Caradon (Europe) plc from April 1994 until September 1998. He currently
serves as Chairman of the Board of OrthoClear Inc. and as a director of
Audimed Gmbh and The Resource Group (TRG).
Toby Rosenblatt -- director of A.P. Pharma since September 1983. Mr.
Rosenblatt is President of Founders Investments, Ltd., a private investment
limited partnership. Mr. Rosenblatt also serves as a director of the
BlackRock Funds and is a trustee of numerous civic and educational
institutions.
Gregory Turnbull -- director of A.P. Pharma since February 1986. Mr.
Turnbull is currently a business consultant. Previously, he was a general
partner of Cable & Howse Ventures, a venture capital firm, and also served as
an investment banker with Morgan Stanley & Co. and White, Weld & Co. Mr.
Turnbull serves as a director of Planar Systems, Inc.
Dennis Winger -- director of A.P. Pharma since February 1993. Mr. Winger
is Senior Vice President and Chief Financial Officer of Applera Corporation.
From 1989 to 1997, Mr. Winger was Senior Vice President, Finance and
Administration and Chief Financial Officer of Chiron Corporation. He
currently serves as a director of Cell Genesys and Cephalon, Inc.
Robert Zerbe, M.D. -- director of A.P. Pharma since December 2002. Dr.
Zerbe is the Chief Executive Officer and founder of QuatRx Pharmaceuticals
Company, a private biopharmaceutical company. Until 2000, Dr. Zerbe was
employed by Pfizer as the Senior Vice President of Global Research and
Development and Director of Development Operations. From 1993 to 2000, Dr.
Zerbe served at the Parke-Davis Pharmaceutical Research Division of Warner-
Lambert as Senior Vice President worldwide, clinical research and development.
Dr. Zerbe serves as a director of Maxim Pharmaceuticals, Inc.
Executive Officers
John Barr, Ph.D. -- Vice President, Research and Development, joined A.P.
Pharma in 1997 as director of Pharmaceutical Sciences. He was promoted to his
current position in August 2000. Prior to joining A.P. Pharma, he worked as
the director of Biopharmaceutics for Cortech, Inc. a Denver-based biotech firm
focused on the development of novel anti-inflammatory agents. In that
capacity, he was involved with both the research and development aspects of
the company's intravenous and oral programs. Dr. Barr received his Ph.D. in
pharmacology from the University of Glasgow in Scotland, after which he
pursued postdoctoral studies at the University of Arizona.
Gordon Sangster -- Chief Financial Officer, joined A.P. Pharma in 1993 as
corporate controller. He became Vice President of Finance in 1994 and Chief
Financial Officer in August 2000. Prior to joining A.P. Pharma, Mr. Sangster
spent five years in a variety of corporate and international financial roles
at Raychem, Inc. Previously, Mr. Sangster held financial positions at the
Cooper Companies and at CooperVision, where he was international controller.
Mr. Sangster is a member of the Institute of Chartered Accountants of England
and Wales.
There are no family relationships among any of the Company's directors or
executive officers.
DIRECTOR NOMINATION
Criteria for Nomination to the Board. The nominating and governance committee
considers the appropriate balance of experience, skills and characteristics
required of the Board of Directors, and seeks to insure that at least a
majority of the directors are independent under the rules of the NASDAQ Stock
Market, and that members of the Company's audit committee meet the
independence and financial literacy requirements under the rules of the NASDAQ
Stock Market. Nominees for director are selected on the basis of their depth
and breadth of experience, integrity, ability to make independent analytical
inquiries, understanding of the Company's business environment, and
willingness to devote adequate time to Board duties.
Stockholder Proposals for Nominees. The nominating and governance committee
will consider written proposals from stockholders for nominees for director.
Any such nominations should be submitted to the nominating and governance
committee c/o the Secretary of the Company and should include the following
information: (a) all information relating to such nominee that is required to
be disclosed pursuant to Regulation 14A under the Securities Exchange Act of
1934 (including such person's written consent to being named in the proxy
statement as a nominee and to serving as a director if elected); (b) the
name(s) and address(es) of the stockholder(s) making the nomination and the
number of shares of the Company's Common Stock which are owned beneficially
and of record by such stockholder(s); and (c) appropriate biographical
information and a statement as to the qualification of the nominee. Any such
nomination should be submitted no later than the date described under the
caption, "Stockholder Proposals for 2006 Annual Meeting" below.
Process for Identifying and Evaluating Nominees. The process for identifying
and evaluating nominees to the Board of Directors is initiated by identifying
a slate of candidates who meet the criteria for selection as a nominee and
have the specific qualities or skills being sought based on input from members
of the Board and, if the nominating committee deems appropriate, a third-party
search firm. These candidates are evaluated by the nominating committee by
reviewing the candidates' biographical information and qualification and
checking the candidates' references, and qualified nominees are interviewed by
at least one member of the nominating and governance committee. The committee
evaluates which of the prospective candidates is qualified to serve as a
director and whether the committee should recommend to the Board that the
Board nominate any of these final prospective candidates. Candidates
recommended by the nominating and governance committee are presented to the
Board for selection as nominees to be presented for the approval of the
stockholders or for election to fill a vacancy.
The nominating and governance committee expects that a similar process will be
used to evaluate nominees recommended by stockholders.
BOARD COMMITTEES
The Board of Directors has standing audit, finance, compensation and stock
option, and nominating and governance committees.
Audit Committee. The audit committee currently consists of Messrs. Drury,
Rosenblatt, Turnbull (chairman) and Winger. The Board has determined that all
members of the audit committee are independent directors under the rules of
the NASDAQ Stock Market and each of them is able to read and understand
fundamental financial statements. The Board has determined that Messrs.
Drury, Turnbull and Winger qualify as "audit committee financial experts" as
defined by the rules of the Securities and Exchange Commission ("SEC"). The
purpose of the audit committee is to oversee the accounting and financial
reporting processes of the Company and audits of its financial statements.
The responsibilities of the audit committee include appointing and providing
the compensation of the independent accountants to conduct the annual audit of
our accounts, reviewing the scope and results of the independent audits,
reviewing and evaluating internal accounting policies, and approving all
professional services to be provided to the Company by its independent
accountants. The audit committee operates under a written charter adopted by
the Board of Directors.
Finance Committee. The finance committee currently consists of Messrs. Drury,
Rosenblatt, Turnbull (chairman) and Winger. The Board has determined that all
members of the finance committee are independent directors under the rules of
the NASDAQ Stock Market. The finance committee is responsible for reviewing
the Company's plans for providing appropriate financial resources to sustain
the Company's operations including review of the Company's strategic plan and
annual operating budget.
Compensation and Stock Option Committee. The compensation and stock option
committee currently consists of Messrs. Riepenhausen, Rosenblatt (chairman)
and Turnbull. The Board has determined that all members of the compensation
and stock option committee are independent directors under the rules of the
NASDAQ Stock Market. The compensation and stock option committee administers
the Company's benefit plans, reviews and administers all compensation
arrangements for executive officers, and establishes and reviews general
policies relating to the compensation and benefits of our officers and
employees. The compensation and stock option committee operates under a
written charter adopted by the Board of Directors.
Nominating and Governance Committee. The nominating and governance committee
currently consists of Messrs. Riepenhausen, Rosenblatt (chairman) and
Turnbull, each of whom the Board has determined is an independent director
under the rules of the NASDAQ Stock Market. The nominating and governance
committee's responsibilities include recommending to the Board of Directors
nominees for possible election to the Board of Directors and providing
oversight with respect to corporate governance. The nominating and governance
committee operates under a written charter adopted by the Board of Directors,
a copy of which was attached to last year's proxy statement which was filed
with the SEC.
MEETINGS AND COMMITTEES OF THE BOARD
The Board of Directors met five times during 2004. The audit committee met
four times, the finance committee met four times, the compensation and stock
option committee met two times and the nominating and governance committee met
two times during fiscal 2004. All directors participated in at least 75% of
the total number of meetings of the Board and of the committees of the Board
on which each served.
COMMUNICATIONS WITH DIRECTORS
Stockholders who wish to communicate with our Directors may do so using the
procedures detailed on our website at www.appharma.com on the Corporate
Governance page of the Corporate Overview section.
The Company encourages its directors to attend its annual meetings. All eight
directors attended the Company's 2004 Annual Meeting.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists, or in the past fiscal year has existed,
between any member of our compensation committee and any member of any other
company's board of directors or compensation committee.
COMPENSATION OF DIRECTORS
Each nonemployee director of the Company annually has been granted an option
to acquire 10,000 shares of Common Stock, under the Company's 1992 and 2002
Stock Option Plans. In addition, each nonemployee director elected after the
Company's initial public offering in 1987 received a one-time grant to acquire
25,000 shares when first elected as a director. Nonemployee directors of the
Company also receive $12,000 per year, $1,000 for each meeting of the Board of
Directors attended and $500 for each committee meeting attended on a date
other than the date of a regularly scheduled Board or other committee meeting.
Since July 1, 2000, all compensation is payable in unregistered Common Stock
of the Company valued at the closing price of the Company's Common Stock on
the last trading date of each quarter.
During 2004, consulting fees totaling $1,750 were paid to Dr. Robert Zerbe.
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, as well as any holders of more than 10% of the
Company's Common Stock, to file with the SEC certain reports of ownership and
reports of changes in ownership of Common Stock and other equity securities of
the Company. Based solely on review of such reports and certain
representations furnished to it, the Company believes that during the fiscal
year ended December 31, 2004, all Section 16(a) filing requirements applicable
to its officers and directors were satisfied.
COMMON STOCK OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The following table sets forth beneficial Common Stock ownership as of March
30, 2005, by (i) each person who is known by the Company to own beneficially
more than 5% of the outstanding shares of Common Stock, (ii) each director,
including nominees, and each executive officer named in the Summary
Compensation Table included in the Proxy Statement, and (iii) all executive
officers and directors as a group. Each person has sole investment and voting
power with respect to the shares indicated, subject to community property laws
where applicable and except as otherwise set forth in the footnotes to the
table.
NUMBER PERCENT
OF OF
NAME SHARES(1) CLASS(1)
- ------------------------------------------- --------- --------
John Barr, Ph.D.(2) 205,887 *
Stephen Drury(3) 142,781 *
Paul Goddard, Ph.D.(4) 270,000 1.1
Michael O'Connell(5) 648,450 2.5
Peter Riepenhausen(6) 227,871 *
Toby Rosenblatt(7) 339,240 1.3
Gordon Sangster(8) 201,871 *
Gregory Turnbull(9) 201,285 *
Dennis Winger(10) 147,971 *
Robert Zerbe, M.D.(11) 43,559 *
Great Point Partners, LLC(12) 1,876,607 7.5
2 Pickwick Plaza, Suite 450
Greenwich, CT 06830
Heartland Advisors, Inc.(13) 1,556,500 6.2
789 North Water Street
Milwaukee, WI 53202
North Sound Capital LLC(14) 2,362,034 9.4
53 Forest Avenue, Suite 202
Old Greenwich, CT 06870
Wellington Management Company, LLP(15) 1,620,500 6.4
75 State Street
Boston, MA 02109
Officers and Directors as a group(10 persons) 2,428,915 9.7
(2)(3)(4)(5)(6)(7)(8)(9)(10)(11)
<FN>
- --------------
* Less than one percent.
(1) Assumes the exercise of all outstanding options to purchase
Common Stock held by such person or group to the extent
exercisable on or before May 30, 2005, and that no other
person has exercised any outstanding stock options.
(2) Includes 154,115 shares underlying exercisable stock options and
25,000 shares of restricted stock subject to the right of repurchase
which lapses on March 23, 2009.
(3) Includes 45,752 shares held in family trust and 75,000 shares
underlying exercisable stock options.
(4) Includes 205,000 shares underlying exercisable stock options.
(5) Includes 516,250 shares underlying exercisable stock options and
50,000 shares of restricted stock subject to the right of repurchase
which lapses on March 23, 2009.
(6) Includes 136,177 shares held in family trust and 70,000
shares underlying exercisable stock options.
(7) Includes 160,000 shares held in family partnership and 100,000
shares underlying exercisable stock options.
(8) Includes 196,719 shares underlying exercisable stock options.
(9) Includes 100,000 shares underlying exercisable stock options.
(10) Includes 100,000 shares underlying exercisable stock options.
(11) Includes 22,500 shares underlying exercisable stock options.
(12) Based solely on information contained in a Schedule 13G dated
April 27, 2004.
(13) Based solely on information contained in a Schedule 13G dated
December 31, 2004.
(14) Based solely on information contained in a Schedule 13G dated
December 31, 2004.
(15) Based solely on information contained in a Schedule 13G dated
December 31, 2004.
</FN>
EXECUTIVE COMPENSATION
The following Summary Compensation Table shows the total compensation for
fiscal years 2004, 2003 and 2002 of the Chief Executive Officer and the other
most highly compensated executive officers whose salary exceeded $100,000 in
2004.
SUMMARY COMPENSATION TABLE
LONG-TERM
ANNUAL COMPENSATION
COMPENSATION AWARDS
------------ ------------
SECURITIES
UNDERLYING ALL
SALARY BONUS OPTIONS OTHER
NAME AND POSITION YEAR ($) ($) (#) COMPENSATION
- ----------------- ---- ------ ------- ------ ------------
Michael O'Connell 2004 320,000 36,389 50,000 6,150(1)
President and 2003 313,269 32,893 40,000 6,000(1)
Chief Executive 2002 303,269 29,190 100,000 5,500(1)
Officer
John Barr, Ph.D. 2004 213,000 24,221 25,000 6,150(1)
Vice President, 2003 207,615 21,800 7,500 4,332(1)
Research and 2002 198,269 19,083 12,500 5,500(1)
Development
Gordon Sangster 2004 204,500 19,933 -- 6,135(1)
Chief Financial 2003 204,500 18,405 7,500 6,000(1)
Officer, Vice 2002 198,500 16,376 12,500 5,500(1)
President of
Finance
<FN>
- ---------------
(1) The stated amounts are Company matching contributions to the A.P.
Pharma 401K Plan. The Company made matching cash
contributions equal to 50% of each participant's contribution
during the plan year up to a maximum amount equal to the lesser
of 3% of each participant's annual compensation or $6,150, $6,000 and
$5,500 for the years 2004, 2003 and 2002, respectively.
</FN>
The following table sets forth certain information with respect to options
granted during 2004 to the executive officers named in the Summary
Compensation Table.
STOCK OPTION GRANTS IN 2004
POTENTIAL
REALIZABLE VALUE
AT ASSUMED
ANNUAL RATES OF
STOCK PRICE
APPRECIATION FOR
INDIVIDUAL GRANTS OPTION TERM(1)
----------------------------------- ----------------
%
OF
TOTAL
OPTIONS
NUMBER OF GRANTED
SHARES TO
UNDERLYING EMPLOYEES
OPTIONS IN EXERCISE EXPIR-
GRANTED FISCAL PRICE ATION
NAME (#)(2) YEAR ($/SH) DATE 5%($) 10%($)
- -------------------- --------- ---- ------ -------- ------- ------
Michael O'Connell 50,000 15.0 $2.450 01/14/14 77,040 195,233
John Barr, Ph.D. 25,000 7.5 $2.450 01/14/14 38,520 97,617
<FN>
- ---------------
(1) Potential realizable value is based on an assumption that the price of
the Common Stock appreciates at the annual rate shown (compounded
annually) from the date of grant until the end of the ten year option
term. The numbers are calculated based on the requirements promulgated
by the SEC and do not reflect the Company's estimate of future stock price
growth.
(2) The options granted under the Company's 1992 Stock Plan and the 2002
Equity Incentive Plan typically vest over 4 years at 25% annually.
Payments on exercise, including any taxes the Company is required to
withhold, may be made in cash, by a full recourse promissory note or
by tender of shares. Options are granted at fair market value on the
date of grant.
</FN>
The following table sets forth certain information with respect to the value
of options held at fiscal year-end by the executive officers named in the
Summary Compensation Table. No options were exercised during 2004 by any of
the named executive officers.
AGGREGATED 2004 YEAR-END OPTION VALUES
VALUE OF UNEXERCISED
NUMBER OF UNEXERCISED IN-THE-MONEY OPTIONS
OPTIONS AT 2004 YEAR-END AT FISCAL YEAR-END (1)
------------------------- --------------------------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
NAME (#) (#) ($) ($)
- ------------------ ----------- ------------- ----------- -------------
Michael O'Connell 495,937 89,063 11,117 12,083
John Barr, Ph.D. 145,782 34,218 3,616 3,359
Gordon Sangster 192,553 12,447 3,616 3,359
<FN>
- ---------------
(1) Market value of underlying securities at fiscal year-end minus the
exercise price of "in-the-money" options.
</FN>
REPORT OF THE COMPENSATION AND STOCK OPTION COMMITTEE
The Compensation and Stock Option Committee of the Board of Directors (the
"Committee") is responsible for establishing compensation policies applicable
to the Company's executive officers and, pursuant to such policies,
determining the compensation payable to the Company's Chief Executive Officer
and other executive officers of the Company. The Committee consists of Peter
Riepenhausen, Toby Rosenblatt and Greg Turnbull, each of whom is a nonemployee
director of the Company and independent under the NASDAQ Stock Market rules.
In determining compensation policies, the Committee has access to compensation
surveys for companies which compete with the Company in the recruitment and
retention of senior executives as well as other executive compensation
information and data. The following report relates to compensation payable to
the Company's executive officers for the year ended December 31, 2004.
COMPONENTS OF COMPENSATION
There are three components of compensation payable to the Company's executive
officers: base salary, equity-based incentive compensation in the form of
stock options and restricted stock awards and annual incentive compensation in
the form of cash bonuses.
COMPENSATION POLICIES
The Company's compensation policies for all employees, including executive
officers, are designed to provide targeted compensation levels that are
competitive with those of companies of similar size, with whom the Company
must compete in the recruitment of senior personnel. The Committee also seeks
to tie incentive cash bonuses to the achievement of pre-established
performance objectives for the Company approved by the Committee and the Board
of Directors, and to use equity-based compensation to promote equity-ownership
in the Company at levels deemed appropriate by the Committee for executive
officers and employees. The goals of the Committee are to align compensation
with the Company's objectives and performance, and to enable the Company to
attract, retain and reward executives and employees who contribute to the
long-term success of the Company. The Company does not believe that
compensation payable by it will be subject to the limitations on deductibility
provided under Section 162(m) of the Internal Revenue Code.
BASE SALARIES
The salary component of executive compensation is based on the executive's
level of responsibility for meeting the Company's objectives and performance,
and comparison to similar positions in the Company and comparable companies.
Base salaries for executive officers are reviewed and adjusted annually based
on information regarding competitive salaries, including salary survey data
provided by third parties. Individual increases are established by the
Committee (taking into account recommendations of the chief executive officer
concerning the overall effectiveness of each executive).
CASH BONUSES
Cash bonuses for executive officers and all other employees are determined
under the Company's management by objectives program ("MBO"). The MBO plan
establishes annual corporate goals and a target bonus for all employees,
including each executive officer, which is a percentage of base salary. The
purpose of the plan is to facilitate the company's development and
commercialization of its product pipeline and to translate business goals into
individual accountabilities by linking performance to compensation. The
percentage of the target bonus that is paid to each officer is dependent upon
the percentage achievement of corporate goals. Achievement of corporate goals
is determined at the end of the year and approved by the Compensation
Committee. Related bonuses are paid in the subsequent year. Bonuses earned
by the executive officers for achieving a percentage of the 2004 corporate
goals were paid in January 2005.
EQUITY AWARDS
The Company's compensation policies recognize the importance of stock
ownership by senior executives and equity-based incentive compensation is an
integral part of each executive's compensation. The Committee believes that
the opportunity for stock appreciation through stock options which vest over
time promotes the relationship between long-term interests of executive
officers and stockholders. The size of specific options grants takes into
account the executive officer's salary, number of options previously granted,
as well as shares of Common Stock held, and the contributions to the Company's
success.
The Company's 2002 Equity Incentive Plan permits the awards of restricted
stock. No restricted stock awards were granted to executive officers in 2004.
COMPENSATION PAYABLE TO CHIEF EXECUTIVE OFFICER
The 2004 salary for Mr. O'Connell, the Company's President and Chief Executive
Officer, was determined principally by evaluating his performance in his
leadership role in the Company and his contributions in executing the
strategic and operating plan of the Company and taking into consideration
competitive compensation levels for comparable companies. The Compensation
Committee and Board of Directors decided to maintain his base salary of
$320,000 which has been effective since September 1, 2003. In 2004, the
Compensation Committee and Board of Directors approved the grant to Mr.
O'Connell of stock options to acquire an aggregate of 50,000 shares of Common
Stock. As of March 30, 2005, Mr. O'Connell held presently exercisable stock
options to purchase 508,335 shares and, including options, beneficially owns
as of that date 590,335 shares of the Company's Common Stock.
Compensation and Stock Option Committee
Peter Riepenhausen
Toby Rosenblatt
Gregory Turnbull
INDEMNIFICATION AGREEMENTS
We have entered into indemnification agreements with our directors and
executive officers. Such agreements require us, among other things, to
indemnify our officers and directors, other than for liabilities arising from
willful misconduct of a culpable nature, and to advance their expenses
incurred as a result of any proceedings against them as to which they could be
indemnified.
REPORT OF THE AUDIT COMMITTEE
The Audit Committee of the Board of Directors is comprised solely of
independent directors as defined under the listing standards of the NASDAQ
Stock Market and operates under a written charter adopted by the Board of
Directors. The Audit Committee, on behalf of the Board of the Directors,
provides general oversight of the Company's financial accounting and reporting
process, including the system of internal control. The Audit Committee also
oversees and evaluates the performance of the Company's independent auditors
and provides an open avenue of communication among the independent auditors,
financial and senior management and the Board of Directors.
The Company's management has primary responsibility for preparing the
Company's financial statements and for the Company's financial reporting
process including the system of internal control. The Company's independent
auditors are responsible for expressing an opinion on the conformity of the
Company's audited financial statements to accounting principles generally
accepted in the United States of America.
In this context and in connection with the audited financial statements
contained in the Company's 2004 Annual Report on Form 10-K, the Audit
Committee:
* reviewed the audited financial statements with the Company's management,
including a discussion of the quality of the accounting principles. In
addition, the Committee met with management and the Company's auditors on a
quarterly basis, to review the quarterly financial statements prior to
their release;
* discussed with the Company's independent auditors, their judgment as to the
quality of the Company's accounting principles, as well as certain matters
related to the conduct of the audit, as required by Statement of Auditing
Standards No. 61, as amended by Statement on Auditing Standards No. 90,
Communication with Audit Committees;
* met with the independent auditors, with and without management present, to
discuss the results of their audit and the overall quality of the Company's
financial reporting;
* reviewed the written disclosures and the letter from the independent
auditors required by Independence Standard Board Standard No. 1,
"Independence Discussions with Audit Committees," and discussed with the
auditors their independence from the Company, and concluded that the non-
audit services performed by the independent auditors are compatible with
maintaining their independence;
* instructed the independent auditors that the Committee expects to be
advised if there are any subjects that require special attention.
Based on the review and discussions described above, the Audit Committee
recommended to the Board of Directors that the Company's audited consolidated
financial statements for the fiscal year ended December 31, 2004 be included
in the Company's Annual Report on Form 10-K for the year ended December 31,
2004, for filing with the SEC, and the Board of Directors approved such
inclusion. The Audit Committee has also selected the Company's independent
auditors, subject to stockholder ratification. A representative from Ernst &
Young LLP will be present at the Annual Meeting.
Audit Committee
Stephen Drury
Toby Rosenblatt
Gregory Turnbull
Dennis Winger
AUDITOR FEES AND SERVICES
The aggregate fees paid for professional services relating to fiscal 2004 and
2003 for each of the following categories of services are as follows:
2004 2003
---- ----
Audit fees(1) $261,285 $149,745
Tax fees(2) 20,800 25,000
All other fees -- --
<FN>
- ------------
(1) Audit fees include fees for the audit of our consolidated financial
statements and interim reviews of our quarterly financial statements and
consents. For 2004, audit fees also include the audit of (a) management's
assessment of internal control over financial reporting and (b) the
effectiveness of internal control over financial reporting, as required
under Section 404 of the Sarbanes-Oxley Act of 2002.
(2) Tax fees consist of fees for tax compliance and tax advice.
</FN>
The Board has delegated to the Audit Committee the authority to pre-approve
audit-related and non-audit services not prohibited by law to be performed by
the Company's independent auditors and associated fees, provided that the
Audit Committee shall report any decision to pre-approve such audit-related or
non-audit services and fees to the full Board at its next regular meeting.
The Audit Committee has delegated to the Chair of the Audit Committee the
authority to pre-approve audit-related and non-audit services not prohibited
by law to be performed by the Company's independent auditors and associated
fees up to a maximum of $25,000 during 2005, provided that the Chair shall
report any decision to pre-approve such audit-related or non-audit services
and fees to the full Audit Committee at its next regular meeting.
PERFORMANCE GRAPH
The rules of the SEC require APP to include in this Proxy Statement a line
graph presentation comparing cumulative five year stockholder returns, on a
dividend reinvested basis, with a broad based equity index and a published
industry index. The Company selected the S&P 500 Stock Index and Russell 2000
for purposes of the comparison which appears below. The graph assumes that
$100 was invested in APP stock and each index on December 31, 1999, with all
dividends reinvested. Past stock performance is not necessarily indicative of
future results.
[The following descriptive data is supplied in accordance with Rule 304(d) of
Regulation S-T]
12/99 12/00 12/01 12/02 12/03 12/04
----- ----- ----- ------ ----- -----
A.P. PHARMA, INC. . 100 69 81 29 71 48
S&P 500 100 91 80 62 80 89
RUSSELL 2000 100 97 99 79 116 138
CERTAIN TRANSACTIONS
In 2000, the Company approved a Retention Incentive Plan ("Retention Plan")
for Mr. O'Connell. The purpose of the Retention Plan was to encourage Mr.
O'Connell to continue his employment with the Company, enhance his ability to
perform effectively and provide the Company with the benefit of his continued
service. Under the Retention Plan, the Company entered into a retention
agreement with Mr. O'Connell providing that he will be eligible for certain
benefits if his employment is terminated under specified circumstances. If
Mr. O'Connell's full-time employment with the Company is terminated by the
Company (other than for cause) or by the executive for good reason (due to
material reduction in the executive's authority or responsibility, base salary
or other compensation or employee benefits), he will be retained as a part-
time employee for a period ranging from a minimum of 12 months to a maximum of
24 months (the "Retention Period"). During the Retention Period, Mr.
O'Connell will receive continuation of salary, payable one-half in a lump sum
following termination of full-time employment and the remainder ratably over
the Retention Period and an annual bonus equal to the bonus paid during the
immediately preceding 12-month period. On March 23, 2005, the Board of
Directors approved an amendment to its Retention and Non-Competition Agreement
with Mr. O'Connell. The principal changes to Mr. O'Connell resulting from the
amendment include adding (a) full accelerated vesting of options granted to
him should his employment be terminated by the Company without cause or by him
for good reason after a change of control and (b) the lapse of restrictions on
restricted stock held by him upon a change of control.
In 2000, the Company approved an agreement with Dr. Goddard under which he
received a stock option grant to acquire 75,000 shares of the Company's Common
Stock. Twenty-five percent of the options vested at the end of twelve months
and the balance vests in equal monthly installments for the next 36 months.
The agreement provided that Dr. Goddard would receive additional option grants
each year of 20,000 shares while he serves as chairman.
In September 2004, Dr. Goddard entered into an additional agreement with the
Company to increase his involvement in the Company's activities. As
compensation for his increased involvement, he received a stock option grant
in September 2004 to acquire 120,000 shares of the Company's Common Stock.
The option will vest 25% after the first year and then monthly over a period
of three years and fully vest on September 15, 2008. Under this new
agreement, he will not be entitled to receive the additional annual option
grants of 20,000 shares for the years 2005 and 2006. Additionally, Dr.
Goddard's cash compensation was increased from $150,000 to $200,000 per year
beginning September 1, 2004. This was subsequently reduced to $150,000
effective March 6, 2005.
On November 1, 2003, the Company entered into a Change of Control Agreement
with Dr. Barr which provides that if his employment is terminated by the
Company without good cause within 12 months after a change of control of the
Company, he will receive for a period of 12 months, his base salary together
with an average of any bonus paid during each of the three 12-month periods
prior to termination, payable in 12 equal monthly installments.
On March 23, 2005, the Board of Directors approved an amendment to its change
of Control Agreement with Dr. Barr. The principal changes to Dr. Barr
resulting from the amendment include adding (a) full accelerated vesting of
options granted to him should his employment be terminated by the Company
without cause or by him for good reason after a change of control and (b) the
lapse of restrictions on restricted stock held by him upon a change of
control.
Also on March 23, 2005, the Board of Directors approved a Change of Control
Agreement for Mr. Sangster, Chief Financial Officer. Mr. Sangster's Agreement
provides that if his employment is terminated by the Company without good
cause within 12 months after a change of control of the Company, he will
receive (a) for a period of 12 months, his base salary together with an
average of any bonus paid during each of the three 12-month periods prior to
termination, payable in 12 equal monthly installments, and (b) full
accelerated vesting of options granted to him prior to termination without
good cause or by him for good reason following a change of control.
PROPOSAL TWO
AMENDMENT TO THE 1997 EMPLOYEE STOCK PURCHASE PLAN
The Board of Directors has approved an amendment, subject to stockholder
approval, to the 1997 Employee Stock Purchase Plan ("Purchase Plan"). The
following description of the Purchase Plan is a summary and so qualified by
reference to the complete text of the purchase plan. The Purchase Plan permits
the Company's employees to purchase the Company's Common Stock at a discounted
price. This plan is designed to encourage and assist employees of the Company
to acquire an equity interest in the Company through the purchase of shares of
Company Common Stock. Approximately 38 employees of the Company are eligible
to participate in the Purchase Plan. You can request a copy of the 1997
Employee Stock Purchase Plan by writing to the Company to the attention of
Marea Fabrique, Investor Relations.
Subject to stockholder approval, the Board of Directors has approved an
increase of 150,000 shares from 500,000 to 650,000 shares, under the Purchase
Plan. Management expects these shares to be sufficient for all stock purchases
under the plan for approximately two years. As of March 31, 2005, 425,469
shares have been issued under the Purchase Plan.
DESCRIPTION OF THE 1997 PLAN
All employees, including executive officers, customarily employed more than 20
hours per week and more than five months per year by the Company are eligible
to participate in the Employee Stock Purchase Plan as of the first semi-annual
enrollment date following employment. However, employees who hold, directly or
through options, five percent or more of the stock of the Company are not
eligible to participate. Participants may elect to make contributions up to a
maximum of 10% of base earnings. On the last trading date of April and
October, the Company applies the funds then in each participant's account to
the purchase of shares. The cost of each share purchased is 85% of the lower
of the closing prices for Common Stock on: (i) the first trading day in the
enrollment period in which the purchase is made; and (ii) the purchase date.
The length of the enrollment period may not exceed a maximum of 24 months.
Enrollment dates are the first business day of May and November. The Board may
limit the maximum number of shares that may be purchased by a participant
during any enrollment period, and no participant's right to acquire shares may
accrue at a rate exceeding $25,000 of fair market value of Common Stock
(determined as the lower of the fair market value on the first trading day in
an enrollment period or the fair market value on the purchase date) in any
calendar year.
The Board of Directors may administer the Purchase Plan or the Board may
delegate its authority to a committee of the Board. The Board of Directors may
amend or terminate the Purchase Plan at any time and may provide for an
adjustment in the purchase price and the number and kind of securities
available under the plan in the event of a reorganization, recapitalization,
stock split, or other similar event. However, amendments that would increase
the number of shares reserved for purchase, or would otherwise require
stockholder approval in order to comply with certain federal tax laws, require
stockholder approval. Shares available under the plan may be either
outstanding shares repurchased by the Company or newly issued shares.
The following table shows the "Dollar Value" and number of shares applicable to
the named individuals and groups under the 1997 Employee Stock Purchase Plan
during the year ended December 31, 2004, purchased on the April and October
2004 purchase dates under the Purchase Plan at a purchase price of $0.80 and
$0.94, respectively. These amounts represent 85% of the closing price on the
first trading date of the enrollment period of November, 2002 or May, 2003.
The "Dollar Value" is the difference between the fair market value of the
Common Stock on the purchase date of April 30, 2004 or October 29, 2004 and the
participant's purchase price of $0.80 or $0.94 per share.
Since purchase rights are subject to discretion, including an employee's
decision not to participate in the Purchase Plan, awards under the Purchase
Plan for the current fiscal year are not determinable. No purchase rights have
been granted with respect to the additional 150,000 shares for which approval
is requested.
PLAN BENEFITS
1997 EMPLOYEE STOCK PURCHASE PLAN
Dollar Number
Name and Position Value ($) of Shares
- ----------------- --------- ---------
Michael O'Connell 37,895 26,033
President and Chief Executive Officer
John Barr, Ph.D. 13,885 7,998
Vice President, Research and Development
Executive Officers as a Group 51,780 34,031
Non-Executive Director Group (1) -- --
Non-Executive Officer Employee Group 122,816 84,031
<FN>
- ---------------
(1) Members of the Board of Directors are ineligible to participate in this
plan, unless they are also an employee of the Company.
</FN>
FEDERAL INCOME TAX CONSEQUENCES
In general, participants will not have taxable income or loss under the
Purchase Plan until they sell or otherwise dispose of shares acquired under the
plan (or die holding such shares). If the shares are held, as of the date of
sale or disposition, for longer than both: (i) two years after the beginning of
the enrollment period during which the shares were purchased; and (ii) one year
following purchase, a participant will have taxable ordinary income equal to
15% of the fair market value of the shares on the first day of the enrollment
period (but not in excess of the fair market value of the shares at the time of
sale over the purchase price). Any additional gain (or loss) from the sale
will be long-term capital gain (or loss). The Company is not entitled to an
income tax deduction if the holding periods are satisfied.
If the shares are sold or disposed of before the expiration of either of the
foregoing holding periods (a "disqualifying disposition"), a participant will
have taxable ordinary income equal to the excess of the fair market value of
the shares on the purchase date over the purchase price. In addition, the
participant will have a taxable capital gain (or loss) measured by the
difference between the sale price and the participant's purchase price which
gain (or loss) will be long-term if the shares have been held as of the date of
sale for more than one year. The Company is entitled to an income tax
deduction equal to the amount of ordinary income recognized by a participant in
a disqualifying disposition.
PROPOSAL
At the Annual Meeting, the Company's stockholders will be asked to approve the
increase to the 1997 Employee Stock Purchase Plan. Such approval will require
the affirmative vote of a majority of the shares present and voting at the
Annual Meeting. The Board of Directors recommends a vote "FOR" the proposal.
PROPOSAL THREE
APPROVAL OF AMENDMENT TO THE
COMPANY'S 2002 EQUITY INCENTIVE PLAN
The Company's 2002 Equity Incentive Plan is intended to strengthen the Company
by providing added incentive to officers, directors, employees and consultants
for high levels of performance and unusual efforts to increase the earnings of
the Company through the opportunity for stock ownership. Subject to
stockholder approval, the Board has approved to increase by 400,000 shares the
number of shares of Common Stock reserved for issuance under the Plan. The
following description of the 2002 Equity Incentive Plan is a summary and so
qualified by reference to the complete text of the purchase plan. You can
request a copy of the 2002 Equity Incentive Plan by writing to the Company to
the attention of Marea Fabrique, Investor Relations.
The Board of Directors believes it would be in the best interest of the Company
to approve the amendment to the 2002 Equity Incentive Plan to increase the
number of shares by 400,000. The 2002 Equity Incentive Plan, currently the
only plan pursuant to which the Company grants options, has only 66,971 shares
available for grant as of March 31, 2005. As a consequence, without approval
of an increase in the number of shares of Common Stock reserved for issuance
under the 2002 Equity Incentive Plan, the Company anticipates it will no longer
have shares available for grant after 2005. The grant of stock options or
restricted stock has been an important component of the compensation of Company
directors, officers and other key employees and an important means of providing
an opportunity for stock ownership to such personnel. As of March 31, 2005,
directors, officers, employees and consultants held unexercised options under
the 2002 Equity Incentive Plan covering 721,327 shares of Common Stock with an
average exercise price of $1.77. Also, on March 23, 2005, the Company issued
75,000 shares of restricted stock to two of its officers at $0.01.
DESCRIPTION OF THE 2002 EQUITY INCENTIVE PLAN
The following is a general summary of the principal provisions of the 2002
Equity Incentive Plan. The 2002 Equity Incentive Plan authorizes the granting
of Incentive Stock Options ("ISOs") to employees (including employees who are
officers and directors) and Nonstatutory Options ("NSOs") to officers,
directors, employees and consultants to purchase authorized, but unissued
shares of the Company's Common Stock. The 2002 Equity Incentive Plan also
provides for grants of restricted stock awards and, subject to stockholder
approval the number of shares reserved for issuance under the 2002 Equity
Incentive Plan will be 1,300,000. The 2002 Equity Incentive Plan is
administered by the Administrator which determines the terms of options granted
under the 2002 Equity Incentive Plan, including the exercise price, number of
shares subject to the option, whether the option is an ISO or an NSO, and the
schedule pursuant to which the option shall become exercisable. No option may
be granted under the 2002 Equity Incentive Plan after April, 2012, but
outstanding options may extend beyond that date.
The Company pays directors for services in Company stock, and uses NSOs as a
way to compensate nonemployee directors and to provide incentives to them
through an equity interest in the Company. A 10 year NSO to purchase 25,000
shares of the Company's Common Stock will be granted to each person who is
neither an officer nor an employee of the Company when such person is first
elected or appointed director. Each such option vests at the rate of 25% per
year, so long as the individual is serving as a director, with full vesting
over four years. A nonemployee director also receives a grant of a ten year
NSO to purchase 10,000 shares of Common Stock on the date of each annual
meeting of stockholders of the Company held more than 12 months after a
nonemployee director is first elected or appointed to the Board of Directors.
These options fully vest one year after the date of grant.
The exercise price of each option granted under the 2002 Equity Incentive Plan
must be at least equal to 100% of the fair market value of the underlying
shares of Common Stock on the date of grant. The 2002 Equity Incentive Plan
provides that the maximum term of an option is ten years. With respect to any
participant then owning stock possessing more than ten percent (10%) of the
voting power of the Company's outstanding capital stock, the exercise price of
any ISO must be at least 110% of fair market value of the underlying shares of
Common Stock on the date of grant, and the term may be no longer than five
years. The 2002 Equity Incentive Plan permits the exercise of options for
cash, a check, or with the approval of the Administrator, tender to the Company
of shares of the Company's Common Stock owned by the optionee and having a fair
market value not less than the option exercise price or delivery of full
recourse promissory notes.
The 2002 Equity Incentive Plan limits to $100,000 the value of option stock
(measured at the time of the option grant) with respect to which ISOs granted
to any one employee after 1986 under any Company plan may vest in any calendar
year.
At the time an option is exercised, in whole or in part, or at any time
thereafter as requested by the Company, the optionee is required to make
adequate provision for federal and state income and employment tax withholding
obligations of the Company, if any, resulting from the exercise. Subject to
certain limitations, an optionee may elect, subject to the terms of the 2002
Equity Incentive Plan and the approval of the Administrator, to have shares of
Common Stock issuable on exercise of the options withheld or to tender shares
then owned by the optionee to provide for these taxes.
Generally, options are exercisable not upon grant, but in cumulative increments
over time, typically 25% per year over four years. Options may be exercised
for ninety days after the optionee leaves the Company and, if the optionee's
employment is terminated by reason of death or permanent disability, for one
year after the optionee's death or disability, but in either case not beyond
the original term of the option.
In the event of a merger of the Company, sale of substantially all of its
assets or similar transaction, the Administrator may, among other things,
accelerate the expiration date and the exercisability of all options
outstanding under the 2002 Equity Incentive Plan.
Under the 2002 Equity Incentive Plan, the Administrator also may grant to
participants a direct right to purchase shares by notifying the grantee of the
terms, conditions and restrictions relating to the purchase right.
The 2002 Equity Incentive Plan also provides for the grants of restricted stock
awards. A restricted stock award is an award of shares of Common Stock which
are subject to restrictions on transfer for a period of time specified by the
Administrator (the "Restriction Period") provided, that the Restriction Period
may not exceed 10 years and may not be less than three years. During the
Restriction Period, the recipient of the restricted stock award may not sell,
assign, transfer, pledge or otherwise encumber shares of restricted stock.
Within these limits, the Administrator may provide for the lapse of such
restrictions in installments, but other than in the case of acquisition of the
Company, may not waive or accelerate the restrictions.
The recipient of the restricted stock award must pay a purchase price
determined by the Administrator, which shall not be less than the par value
($.01 per share) for all shares of restricted stock awarded. In the event the
holder of the restricted stock ceases to be employed by (or to act as a
director of or consultant to) the Company prior to the end of the Restriction
Period, all shares still subject to restriction are forfeited and repurchased
by the Company for the price paid by the participant. Before the Restriction
Period expires, unless otherwise determined by the Administrator, cash
dividends, if any with respect to the restricted stock awards will be
automatically reinvested in additional restricted stock, and dividends payable
in stock will be in the form of restricted stock.
The 2002 Plan expires in February, 2012, unless terminated earlier by the Board
of Directors. The Board may at any time terminate or amend the 2002 Equity
Incentive Plan, provided that without approval of stockholders there will be no
increase in the total number of shares covered by the 2002 Equity Incentive
Plan. In any case, no amendment may adversely affect any then-outstanding
option or unexercised portion thereof without the optionee's consent unless
such amendment is required to enable the option to qualify as an ISO.
The following table shows the number of options granted to the named
individuals and groups under the 2002 Equity Incentive Plan during 2004.
Because the grants under the 2002 Equity Incentive Plan are discretionary,
benefits for the current fiscal year are not determinable. No awards have been
granted with respect to the additional 400,000 shares for which approval is
requested.
PLAN BENEFITS
2002 EQUITY INCENTIVE PLAN
Name and Position Number of Options (1)
- ----------------- ---------------------
Michael O'Connell 50,000
President and Chief Executive Officer
John Barr, Ph.D. 25,000
Vice President, Research and Development
Executive Officers as a Group 75,000
Non-Executive Director Group 200,000
Non-Executive Officer Employee Group 78,500
<FN>
- ---------------
(1) All options granted at fair market value on the date of the grant.
</FN>
FEDERAL INCOME TAX CONSEQUENCES OF STOCK AWARDS
The following general description of federal income tax consequences is based
upon current statutes, regulations and interpretations thereof. Because the
applicable rules are complex and because income tax consequences may vary
depending upon the individual circumstances of each participant, participants
should consult their personal tax advisors concerning federal, state, local and
foreign income tax consequences associated with their participation in the 2002
Equity Incentive Plan.
ISOs granted under the 2002 Equity Incentive Plan are intended to constitute
"incentive stock options" within the meaning of the Section 422 of the Code.
ISOs may be granted only to employees of the Company (including directors who
are also employees). An optionee does not recognize taxable income upon either
the grant or exercise of an ISO. However, the excess of the fair market value
of the shares purchased upon exercise over the option exercise price (the
"Option Spread") is includible in the optionee's "alternative minimum tax
income" ("AMTI"), used to calculate the "alternative minimum tax". The Option
Spread is measured on the date of exercise and is generally includible in AMTI
in the year of exercise.
If an optionee holds shares which result from the exercise of an ISO for at
least two years from the date the ISO was granted, and for at least one year
from the date the ISO was exercised, any gain from a sale of the shares should
be taxable as long-term capital gain. Under these circumstances, the Company
would not be entitled to a tax deduction at the time the ISO is exercised or at
the time the stock is sold. If an optionee were to dispose of stock acquired
pursuant to an ISO before the end of the required holding periods (a
"Disqualifying Disposition"), the amount by which the market value of the stock
at the time the ISO was exercised exceeds the exercise price (or, if less, the
amount of gain realized on the sale) would be taxable as ordinary income, and
the Company should be entitled to a corresponding tax deduction. A gain
recognized in connection with a Disqualifying Disposition, in excess of the
amount required to be recognized as ordinary income would be a capital gain
(which will be long-term capital gain if the shares have been held more than
one year after the date of exercise of the option).
An optionee is not taxed upon the grant of an NSO. Generally, the optionee
will recognize as ordinary income the Option Spread on the date of exercise.
The Company is entitled to a deduction equal to the amount of ordinary income
recognized by an optionee who is an employee and such income recognized by an
employee is subject to income tax withholding by the Company. Upon the
disposition of stock acquired upon exercise of an NSO, an optionee will
recognize either long-term or short-term capital gain or loss, depending on how
long such stock was held, on any difference between the sale price and the
exercise price, to the extent not recognized as taxable income on the date of
exercise.
Generally, a participant should not have taxable income upon the grant of
restricted stock but would have taxable income upon the lapse of any
restrictions in an amount equal to the difference between the fair market value
of the restricted stock when the restrictions lapse and the amount paid for the
restricted stock, if any. A participant receiving restricted stock may,
however, make an election pursuant to Section 83(b) of the code (within 30 days
of grant of the restricted stock) to be taxed at grant on any excess of fair
market value over the amount paid, in which case the lapse of any restrictions
will not be a taxable event. If shares are held at least one year after the
date the optionee recognizes taxable income with respect to such shares, or
from filing an 83(b) election with respect to the shares, then upon sale of the
shares the employee will have long-term capital gain or loss equal to the
difference between the sale price and the fair market value of the shares of
the date income is recognized.
EQUITY COMPENSATION PLAN INFORMATION
The table below discloses the following information as of December 31, 2004
with respect to A.P. Pharma's equity compensation plans that have been
approved by stockholders and plans that have not been approved by
stockholders.
(c) Number of securities
remaining available for
future issuance under
(a)Number of (b)Weighted- equity compensation
securities to be average exercise plans (excluding
issued upon exercise price of outstanding securities reflected in
Plan Category of outstanding options options column (a))
- ------------- ---------------------- -------------------- ------------------------
Equity compensation plans
approved by security holders 2,027,719 $3.74 253,461
Equity compensation plans
not approved by security holders 177,917 1.95 67,500
Total 2,205,636 3.60 320,961
In October 2000, the Company adopted the Non-Qualified Stock Plan, which has
not been approved by A.P. Pharma's stockholders. The Non-Qualified Stock Plan
will expire in 2010. Under the Non-Qualified Stock Plan, awards may be
granted as a material inducement to any person accepting employment or
consultancy with the Company or an employee of the Company who is not an
officer or director of the Company at the time of the award. The Non-
Qualified Stock Plan provides for the discretionary award of options,
restricted stock and stock purchase rights or any combination of these awards
to an eligible person, provided, however, that only NQOs may be granted under
the plan. Under the Non-Qualified Stock Plan, the term of any NQO granted may
not exceed 10 years, and the exercise price of any such NQO must be at least
85% of the fair market value of the Common Stock at the date of grant.
Options generally vest on a monthly basis over a period of four years.
PROPOSAL
At the Annual Meeting, stockholders will be asked to approve amendments to the
Company's 2002 Equity Incentive Plan to increase by 400,000 the number of
shares of common stock reserved for issuance under the Plan. Such approval
will require the affirmative vote of a majority of shares present and voting at
the Annual Meeting. The Board of Directors recommends a vote "FOR" the
proposal.
PROPOSAL FOUR
RATIFICATION OF INDEPENDENT REGISTERED PUBLIC ACCOUNTANTS
Subject to stockholder ratification, the Audit Committee has selected Ernst &
Young LLP as independent registered public accountants to audit the financial
statements of the Company for the fiscal year ending December 31, 2005.
At the Annual Meeting, the stockholders will be asked to ratify the appointment
of Ernst & Young LLP as the Company's independent registered public accountants
for the fiscal year ending December 31, 2005. Representatives of Ernst & Young
LLP are expected to be present at the Annual Meeting and will have the
opportunity to make statements if they desire to do so. Such representatives
are also expected to be available to respond to appropriate questions.
The Board of Directors recommends a vote "FOR" the ratification of the
appointment of Ernst & Young LLP as the Company's independent registered public
accountants for the fiscal year ending December 31, 2005.
FINANCIAL STATEMENTS
The Company's annual report to stockholders for the fiscal year ended December
31, 2004, containing audited consolidated balance sheets as of the end of each
of the past two fiscal years and audited consolidated statements of
operations, shareholders' equity and cash flows for each of the last three
fiscal years, is being mailed with this Proxy Statement to Stockholders
entitled to notice of the Annual Meeting.
STOCKHOLDER PROPOSALS FOR 2006 ANNUAL MEETING
Under the applicable rules of the SEC, a stockholder who wishes to submit a
proposal for inclusion in the Proxy Statement of the Board of Directors for
the Annual Meeting of Stockholders to be held in the spring of 2006 must
submit such proposal in writing to the Secretary of the Company at the
Company's principal executive offices no later than December 23, 2005. The
applicable rules of the SEC impose certain limitations on the content of
proposals and also contain certain eligibility and other requirements
(including the requirement that the proponent must have continuously held at
least $2,000 in market value or 1% of the Company's Common Stock for at least
one year before the proposal is submitted).
OTHER MATTERS
As of the date of this Proxy Statement, the Board does not intend to bring any
other business before the Annual Meeting, and so far as is known to the Board,
no other matters will be presented to the Annual Meeting. If, however, any
other matter is properly presented at the Annual Meeting, it is intended that
proxies in the form enclosed with this Proxy Statement will be voted on such
matter in accordance with the judgment of the person or persons voting such
proxies, unless the proxy otherwise provides.
BY ORDER OF THE BOARD OF DIRECTORS,
Julian N. Stern, Secretary
Redwood City, California
April 20, 2005
You Are Cordially Invited To Attend The Meeting In Person.
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