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, 2005 or
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
---------- ----------
Commission File Number: 0-16109
A.P. PHARMA, INC.
(Exact name of registrant as specified in its charter)
Delaware 94-2875566
- ------------------------------- -----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
123 Saginaw Drive, Redwood City, California 94063
- ------------------------------------------- ---------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 366-2626
--------------
Securities registered pursuant to Section 12 (b) of the Act: None
----
Securities registered pursuant to Section 12 (g) of the Act:
Common Stock ($.01 par value)
-----------------------------
Indicate by check mark if the Registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Exchange Act.
Yes [ ] No [X ]
---- ----
Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Exchange Act.
Yes [ ] No [X ]
---- ----
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes [X] No [ ]
---- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
Yes [ ] No [X ]
---- ----
Indicate by check mark whether the registrant is a large accelerated filer,
an accelerated filer or a non-accelerated filer, as defined in Rule 12b-2 of
the Exchange Act).
Large accelerated filer [ ] Accelerated filer [ ]
---- ----
Non-accelerated filer [X ]
----
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X ]
---- ----
The aggregate market value of the voting stock of the registrant held by non-
affiliates of the registrant as of June 30, 2005, was $28,384,976(1)
As of February 28, 2006, 25,279,970 shares of registrant's Common Stock, $.01
par value, were outstanding.
- --------------------------------------------------------------------------
(1)Excludes 8,174,458 shares held by directors, officers and shareholders
whose ownership exceeds 5% of the outstanding shares at June 30, 2005.
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
- -------- ----
Definitive Proxy Statement to be used
in connection with the 2006 Annual Meeting
of Stockholders. III
TABLE OF CONTENTS
PART I
ITEM 1. Business
ITEM 1A. Risk Factors
ITEM 1B. Unresolved Staff Comments
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, Related
Stockholder Matters and Issuer Purchases of Equity Securities
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
ITEM 9A. Controls and Procedures
ITEM 9B. Other Information
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. Principal Accountant Fees and Services
PART IV
ITEM 15. Exhibits and Financial Statement Schedules
Signatures
Certifications
PART I
Item 1. BUSINESS
INTRODUCTION-FORWARD LOOKING STATEMENTS
- ---------------------------------------
Except for statements of historical fact, the statements herein are forward-
looking and are subject to a number of risks and uncertainties that could
cause actual results to differ materially from the statements made. These
include, among others, uncertainty associated with progress in research and
development programs, timely development, approval, launch and acceptance of
new products, establishment of new corporate alliances and other factors
described below under the headings "APP Technology", "Products", "Marketing",
"Government Regulation", "Patents and Trade Secrets" and "Competition". In
addition, such risks and uncertainties also include the matters discussed
under "Risk Factors" below and under Management's Discussion and Analysis of
Financial Condition and Results of Operations in Item 7 below.
COMPANY OVERVIEW
- ----------------
In this Annual Report on Form 10-K, the "Company", "A.P. Pharma", "APP",
"we", "us", and "our", refer to A.P. Pharma, Inc.
We are a specialty pharmaceutical company focused on the development of
pharmaceutical products utilizing our proprietary polymer-based drug delivery
systems. Our focus is the development and commercialization of bioerodible
injectable and implantable systems under the trade name Biochronomer(TM).
Our business strategy is twofold:
- - to develop selected proprietary products, funding them through the
preliminary phases of regulatory review before entering into 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 the prevention of both acute and delayed chemotherapy-induced nausea
and vomiting (CINV); post-surgical and chronic pain management; and anti-
inflammatories. Our product development programs have been funded by the
sale of common stock in June 2004, royalties from topical products previously
marketed by pharmaceutical partners (Retin-A Micro(R) and Carac(R)), proceeds
from the divestitures of our cosmeceutical and analytical standards product
lines and by fees we received from collaborative partners. In addition, in
January 2006, we sold the rights to royalties from sales of Retin-A Micro and
Carac. Proceeds of $25 million were received upon the closing of the
transaction and will be used primarily to fund pivotal clinical development
of APF530, our drug candidate for the prevention of both acute and delayed
chemotherapy-induced nausea and vomiting. The remaining $5 million will be
paid based on the satisfaction of certain predetermined milestones over the
next four years.
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. A major point of difference with other delivery
systems is our polymer's versatility and controlled erosion mechanism. Over
one hundred in vivo and in vitro studies have been completed to advance
understanding of this innovative drug delivery technology. Studies
demonstrate complete and controlled bioerosion of the polymers. Erosion
times can be varied from hours to days, weeks or months and mechanical
properties can be adjusted to produce materials as diverse as injectable
gels, coatings, strands, wafers, films or microspheres. Importantly,
toxicology and clinical data indicate that the technology is safe for use in
humans. In addition, the manufacturing is reproducible and the polymers are
stable, provided they are stored under appropriate 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/RNAI.
During 2005, we completed a Phase 2 human clinical trial using APF530, our
lead product candidate for the prevention of both acute and delayed
chemotherapy-induced nausea and vomiting in patients undergoing both
moderately and highly emetogenic chemotherapy for cancer.
APF530 contains the anti-nausea drug granisetron formulated with the
Company's proprietary Biochronomer bioerodible drug delivery system. The
Phase 2 study, which was completed in September 2005, achieved the primary
endpoints, which included an evaluation of safety, tolerability and
pharmacokinetics. In addition, efficacy endpoints were evaluated relating to
emetic events and the use of rescue medication.
Our second Biochronomer product candidate is APF112 for the treatment of
post-surgical pain. APF112 incorporates the well-known analgesic mepivacaine
in our Biochronomer system. It is designed to provide 24 to 36 hours of
post-surgical pain relief and to minimize the use of morphine-like drugs
(opioids) which are used extensively in post-surgical pain management.
Opioids are associated with a wide range of side effects, such as nausea,
sedation, dizziness, constipation, vomiting, urinary retention, and in some
situations, life-threatening respiratory depression. We completed a Phase 2
human clinical trial for APF112 in 2004, involving a total of approximately
100 patients undergoing surgery for repair of inguinal hernia. A protocol
for a further Phase 2 trial using APF112 has been developed, and we are
exploring corporate partnering opportunities before proceeding with this in
order to focus our limited resources on APF530.
We earned royalties on two pharmaceutical products: Retin-A Micro which was
licensed to Ortho Neutrogena, a member of the Johnson & Johnson family of
companies, and Carac, which was licensed to Dermik Laboratories, a sanofi-
aventis company. In January 2006, we sold the rights to the royalties on
sales of these products effective October 1, 2005 to an affiliate of the Paul
Royalty Fund for $25 million on closing and up to $5 million over the next
four years, based on the satisfaction of certain predetermined milestones.
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. Under the sale agreement, we retained the rights to our topical
prescription products, which were marketed by our corporate partners, Johnson
& Johnson and sanofi-aventis, and on which we received 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 five years
following the sale.
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. Our name was
changed to A.P. Pharma, Inc. in May 2001 to reflect the new pharmaceutical
focus of the Company.
APP TECHNOLOGY
- --------------
We have made significant investment and progress in the development of
bioerodible drug delivery systems. Specifically, we have developed two
families of polymers, each with unique attributes. The first family is known
collectively as poly(ortho esters) under the trade name Biochronomer;
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
patents have been issued and several more patent applications have been
filed.
The Biochronomer polymer is a poly(ortho ester) whose production is highly
reproducible and multi-kilo quantities of polymer have been produced
according to Good Manufacturing Practices (GMP).
Current product development work takes advantage of the versatility of these
materials, and is exemplified by forms that range from injectable gels into
which drugs can be incorporated by a simple mixing procedure, to solid
devices that can be fabricated at temperatures low enough to allow the
incorporation of materials such as proteins that require mild fabrication
conditions.
Our primary focus has been on advancing our Biochronomer technology, which is
designed to release drugs at selected implantation sites such as under the
skin, at the site of a surgical procedure, 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 as diverse as coatings, wafers, strands, microspheres and injectable
gels to enable various means of administration into the body.
PRODUCTS
- --------
Ethical Pharmaceutical Products
- -------------------------------
We define ethical pharmaceutical products as prescription products that are
promoted primarily through the medical profession. We are developing
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 commercial advantages in large, profitable markets.
Results from various preclinical and clinical studies confirm that this
technology offers the potential to maintain or improve therapeutic efficacy
and to reduce adverse drug side effects.
Products Under Development
- --------------------------
Our efforts in pharmaceutical markets include applications using our
Biochronomer technology that are under development, as noted below.
Our lead product candidate, APF530, which contains the anti-nausea drug
granisetron formulated with the Company's proprietary Biochronomer
bioerodible drug delivery system is designed to prevent both acute and
delayed chemotherapy-induced nausea and vomiting in patients undergoing
either moderately or highly emetogenic chemotherapy for cancer. During 2005,
we completed a Phase 2 human clinical trial using APF530.
The Phase 2 study, which was completed in September 2005, achieved the
primary endpoints, which included an evaluation of safety, tolerability and
pharmacokinetics. In addition, efficacy endpoints were evaluated relating to
emetic events and the use of rescue medication.
There were no serious adverse events attributed to the APF530 formulation,
and injections of APF530 were well tolerated. The pharmacokinetic evaluation
of granisetron in all three dose groups clearly indicated that measurable
plasma levels of granisetron were evident over a seven day period.
Analysis of the open label efficacy data from the Phase 2 patient groups
receiving either moderately or highly emetogenic chemotherapy indicated that
the percentage of complete responders in the moderately emetogenic group was
90% in the acute phase and 78% in the delayed phase. In the group receiving
highly emetogenic chemotherapy, the percentage of complete responders was 81%
in the acute phase and 80% in the delayed phase. "Complete response" was
defined as no emetic episodes and no use of rescue medication. Based on the
data generated from the Phase 2 study, two dose levels of APF530 have been
selected for a Phase 3 study, which is planned to begin in the second quarter
of 2006.
The proposed Phase 3 trial will compare the safety and efficacy of APF530
with palonosetron, currently marketed under the brand Aloxi(R), and will
include approximately 1,200 patients comprised of two groups, each with
roughly equal number of those receiving either moderately or highly
emetogenic chemotherapeutic agents. In each group, three sets of
approximately 200 patients will be treated with APF530 containing 5
milligrams or 10 milligrams of granisetron, compared with the currently
approved dose of palonosetron. The study's primary endpoint is to establish
the efficacy of APF530 for the prevention of acute onset (first 24 hours) and
delayed onset (4-5 days) CINV in patients receiving either moderately or
highly emetogenic chemotherapy. No other 5HT3 antagonist is currently
approved for the prevention of both acute and delayed CINV for both
moderately and highly emetogenic chemotherapy.
The first product candidate to incorporate the Biochronomer delivery system
was APF112, which targets the management of pain in patients following
surgery. The treatment goal 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 profile. APF112 is designed to prolong the
anesthetic effect of mepivacaine and thus to minimize or eliminate 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 despite
unpleasant side effects - nausea, disorientation, sedation, constipation,
vomiting, urinary retention and, in some situations, life-threatening
respiratory depression. If efficacy in treating post-surgical pain can be
demonstrated, 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.
Phase 2 clinical studies were conducted in surgeries for inguinal hernia
repair during 2004 and although the safety and tolerability of APF112 were
very good, the efficacy results were difficult to interpret with no
significant difference between the two formulations of APF112 and the current
standard of care. A second Phase 2 study protocol has been developed which,
with the financial support of a corporate partner, would evaluate a
combination therapy using bupivacaine for immediate pain relief following
surgery and APF112 for longer-term pain relief.
Other Products
- --------------
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.
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 following the sale at rates ranging from
5% to 15% of sales of analytical standards products.
MARKETING
- ---------
A key part of our business strategy is to form collaborations with
pharmaceutical partners.
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 concluded to-date have involved only the
Microsponge delivery system for prescription products and were as follows:
Johnson & Johnson Inc. In May 1992, we entered into a development and
license agreement with Ortho-McNeil Pharmaceutical Corporation, (a subsidiary
of J&J ("Ortho")) related to tretinoin-based products incorporating our
Microsponge technology. The license fees provided Ortho with exclusive
distribution or license rights for all Ortho tretinoin products utilizing our
Microsponge system through 2016.
Dermik. In March 1992, we restructured our 1989 joint venture agreement with
Dermik, a sanofi-aventis company. As part of the agreement sanofi-aventis
received certain exclusive marketing rights for the U.S. Product
applications included a 5-FU treatment for actinic keratoses (precancerous
skin lesions). In 2000 Dermik received FDA marketing clearance for the
product, which was launched under the trade name Carac. Dermik's exclusivity
relating to Carac will continue as long as annual minimum royalty payments
are made, governed by the life of the applicable patents until 2021.
In January 2006, we sold the rights to the royalties on sales of these
products effective October 1, 2005 to an affiliate of the Paul Royalty Fund
for $25 million on closing and up to $5 million over the next four years,
based on the satisfaction of certain predetermined milestones.
GOVERNMENT REGULATION
- ---------------------
Ethical Products
- ----------------
In order to clinically test, produce and sell products for human therapeutic
use, mandatory procedures and safety evaluations established by the FDA and
comparable agencies in foreign countries must be followed. The procedure for
seeking and obtaining the required governmental clearances for a new
therapeutic product includes preclinical animal testing to determine safety
and efficacy, followed by human clinical testing. This can take many years
and require substantial expenditures. In the case of third party agreements,
we expect that our corporate partners will partially fund the testing and the
approval process with guidance from us. We intend to seek the necessary
regulatory approvals for our proprietary products as they are being
developed.
PATENTS AND TRADE SECRETS
- -------------------------
As part of 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 the composition of a variety of
polymers, 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 19 issued United States patents and an additional 108
issued foreign patents. Currently, we have 42 pending patent applications
worldwide. 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 polymers have a number of important advantages. Among these are
ease of manufacturing, the ability to control both erosion times and
mechanical properties, and 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.
HUMAN RESOURCES
- ---------------
As of February 28, 2006, we had 36 full-time employees, 5 of whom hold PhDs.
There were 28 employees engaged in research and development and quality
control, and 8 working in finance, business development, human resources and
administration.
We consider our relations with employees to be good. None of our employees
is covered by a collective bargaining agreement.
Item 1A. Risk Factors
RISK FACTORS
- ------------
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 WILL NEED ADDITIONAL CAPITAL TO CONDUCT OUR OPERATIONS AND TO DEVELOP OUR
PRODUCTS AND OUR ABILITY TO OBTAIN THE NECESSARY FUNDING ON FAVORABLE TERMS
IN THE FUTURE IS UNCERTAIN.
We will require additional capital resources in order to conduct our
operations and develop our products. While we estimate that our existing
capital resources and interest income will be sufficient to fund our current
level of operations for at least the next year 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:
- scientific progress in our research and development programs;
- the magnitude and scope of our research and development programs;
- our ability to establish and maintain 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.
IF WE ARE UNABLE TO RECRUIT AND RETAIN SKILLED EMPLOYEES, WE MAY NOT BE ABLE
TO ACHIEVE OUR OBJECTIVES.
Retaining our current employees and recruiting qualified scientific personnel
to perform future research and development work will be critical to our
success. Competition is intense for experienced scientists, and we may not
be able to recruit or retain sufficient skilled personnel to allow us to
pursue collaborations and develop our products and core technologies to the
extent otherwise possible.
WE ARE RELIANT ON SINGLE SOURCE THIRD PARTY CONTRACTORS FOR THE MANUFACTURE
AND PRODUCTION OF RAW MATERIALS AND PRODUCT CANDIDATES.
We currently, and for the foreseeable future will, rely upon outside
contractors to manufacture, supply and package for us key intermediates,
active pharmaceutical ingredients and formulated drug product for our product
candidates. Our current dependence upon others for the manufacture of our
raw materials and product candidates and our anticipated dependence upon
others for the manufacture of any products that we may develop, may adversely
affect our ability to develop our product candidates in a timely manner and
may adversely affect future profit margins and our ability to commercialize
any products that we may develop on a timely and competitive basis.
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:
- we may be unsuccessful in finding partners willing to fund some or all of
our clinical trial expenditures;
- 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;
- - labeling;
- distributing;
- advertising and promoting; and
- selling and marketing.
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
and drug delivery 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.
IF WE FAIL TO CONTINUE TO MEET THE NASDAQ NATIONAL MARKET'S REQUIREMENTS FOR
CONTINUED LISTING, THE NASDAQ NATIONAL MARKET MAY DELIST OUR COMMON STOCK,
WHICH WOULD NEGATIVELY IMPACT THE PRICE OF OUR COMMON STOCK AND OUR ABILITY
TO SELL OUR COMMON STOCK.
Our common stock is listed on the Nasdaq National Market. The rules of the
Nasdaq National Market provide that issuers with stockholders' equity of less
than $10 million may be delisted from the Nasdaq National Market. As of the
end of the third fiscal quarter of 2005, we failed to meet that requirement,
though we regained compliance with the requirement in January 2006. In the
event that we fail to comply with all listing standards applicable to issuers
listed on the Nasdaq Stock Market, our common stock may be delisted from the
Nasdaq National Market. In that event, we may be required to list our common
stock on the Nasdaq Capital Market provided we meet the listing requirements
for the Nasdaq Capital Market. If we are delisted or required to list our
common stock on a market or exchange less liquid than the Nasdaq National
Market, it would be far more difficult for our stockholders to trade in our
securities and it may be more difficult to obtain accurate, current
information concerning market prices for our securities. The possibility
that our securities may be delisted may also adversely affect our ability to
raise additional financing.
Item 1B. Unresolved Staff comments
None.
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 annual rent expense for the Redwood City
facility is approximately $463,000.
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 "in-substance
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, 2004 was
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 STOCK RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Shares of the Company's common stock trade on the NASDAQ National Market,
under the symbol APPA. As of February 28, 2006, there were 431 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.
2005 High Low 2004 High Low
- ----------------------------------------------------------------------
First Quarter $2.73 $1.41 First Quarter $3.79 $2.15
Second Quarter 1.80 1.37 Second Quarter 4.45 2.85
Third Quarter 2.25 1.47 Third Quarter 3.50 1.11
Fourth Quarter 1.88 1.30 Fourth Quarter 2.35 1.15
See Note 8 "Stockholders' Equity" in the Notes to Financial Statements
contained in part II Item 8 of this Form 10-K concerning A.P. Pharma's equity
compensation plans.
Item 6. SELECTED FINANCIAL DATA
(in thousands, except per share data)
For the Year Ended and as of
December 31, 2005 2004 2003 2002 2001
- ----------------------------------------------------------------------------
Statements of Operations Data
- -----------------------------
Royalties $ 5,247 $ 4,972 $ 4,502 $ 4,026 $ 3,227
Contract revenues 144 432 346 407 38
License fees -- -- -- 237 --
------ ------ ------ ------ ------
Total revenues 5,391 5,404 4,848 4,670 3,265
Expenses
Research and development 10,299 11,495 8,421 6,414 7,107
General and administrative 3,565 3,225 3,039 3,309 3,488
------ ----- ------ ------ ------
Operating losses (8,473) (9,316) (6,612) (5,053) (7,330)
Interest and other income
income, net 290 224 404 658 1,192
------ ----- ------ ------ ------
Loss from continuing
operations (8,183) (9,092) (6,208) (4,395) (6,138)
Income (loss) from
discontinued operations(1) (89) (133) (57) 401 624
Gain on disposition of
discontinued operations(2) 62 4 1,902 216 3,000
------ ------ ------ ------ ------
Net loss $(8,210) $(9,221) $(4,363) $(3,778) $(2,514)
====== ====== ====== ====== ======
Basic and diluted loss per
common share:
Loss from continuing
operations $ (0.33) $ (0.40) $ (0.30) $ (0.22) $ (0.30)
Net loss $ (0.33) $ (0.40) $ (0.21) $ (0.19) $ (0.12)
Weighted average common
shares outstanding -
basic and diluted 25,118 22,909 20,553 20,409 20,276
<FN>
(1) Income (loss) from discontinued operations represents the income (loss)
attributable to our Analytical Standards division that was sold to GFS
Chemicals on February 13, 2003, and the income (loss) attributable to our
cosmeceutical and toiletries business that was sold to RP Scherer on July 25,
2000. See Note 10 "Discontinued Operations" in the Notes to Financial
Statements of Part II, Item 8 of this Form 10-K.
(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. The
gain on disposition of discontinued operations in 2003 represents the gain on
sale of our Analytical Standards division to GFS Chemicals on February 13,
2003. See Note 10 "Discontinued Operations" in the Notes to Financial
Statements of Part II, Item 8 of this Form 10-K.
</FN>
Balance Sheet Data
- ------------------
December 31,
----------------------------------------------
2005 2004 2003 2002 2001
------- ------- ------ ----- ------
Cash, cash equivalents and
marketable securities $5,809 $13,596 $ 9,484 $14,121 $19,494
Working capital 4,882 12,636 9,366 13,989 18,092
Total assets 8,969 17,014 13,155 17,781 23,483
Long-term liabilities -- -- -- 345 785
Stockholders' equity 6,203 14,154 11,263 15,459 19,173
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
- --------
We are a specialty pharmaceutical company focused on the development of
ethical (prescription) pharmaceuticals utilizing our proprietary polymer-
based drug delivery systems. Our primary focus is the development and
commercialization of our bioerodible injectable and implantable systems under
the trade name Biochronomer(TM). Initial target areas of application for our
drug delivery technology include anti-nausea, post-surgical and chronic pain
management and anti-inflammatories. Our product development programs have
been funded by the sale of common stock in June 2004, royalties from topical
products previously marketed by pharmaceutical partners, proceeds from the
divestitures of our cosmeceutical and analytical standards product lines and
by fees we received from collaborative partners. In addition, in January
2006, we sold the rights to royalties from sales of Retin-A Micro(R) and
Carac(R). Proceeds of $25 million were received upon the closing of the
transaction.
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.
Critical Accounting Policies and Estimates
- ------------------------------------------
The preparation of our financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in our financial statements and
accompanying notes. On an ongoing basis, we evaluate our estimates including
those related to the useful lives of fixed assets, valuation allowances,
impairment of assets, accrued clinical and preclinical expenses and
contingencies. Actual results could differ materially from those estimates.
The items in our financial statements requiring significant estimates and
judgments are as follows:
Revenue Recognition
- -------------------
Our revenue arrangements with multiple deliverables are divided into separate
units of accounting if certain criteria are met, including whether the
delivered item has stand-alone value to the customer and whether there is
objective and reliable evidence of the fair value of the undelivered items.
The consideration we receive is allocated among the separate units based on
their respective fair values, and the applicable revenue recognition criteria
are considered separately for each of the separate units. Advance payments
received in excess of amounts earned are classified as deferred revenue until
earned.
* 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
-----------------
Generally, contract revenues 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 services are
rendered. These revenues approximate the costs incurred.
* License Fees
------------
Licensing agreements 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. 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 or the related
patents expire, whichever is earlier. Revenue recognized from deferred
license fees is classified as license fees in the accompanying statements of
operations. License fees received in connection with arrangements where we
have no continuing involvement are recognized 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 license fees
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.
Clinical Trial Accruals
- -----------------------
Our expenses related to clinical trials are based on estimates of the
services received and efforts expended pursuant to contracts with multiple
research institutions and clinical research organizations that conduct and
manage clinical trials on our behalf. Since the invoicing related to these
services does not always coincide with our financial statement close process,
we must estimate the level of services performed and fees incurred in
determining the accrued clinical trial costs. The financial terms of these
agreements are subject to negotiation and variation from contract to contract
and may result in uneven payment flows. Payments under the contracts depend
on factors such as the successful enrollment of patients or achievement of
certain events or the completion of portions of the clinical trial or similar
conditions. The Phase 3 clinical trials of APF530 will have a significant
effect on the Company's research and development expenses. Expenses related
to clinical trials generally are accrued based on the level of patient
enrollment and services performed by the clinical research organization or
related service provider according to the protocol. We monitor patient
enrollment levels and related activity to the extent possible and adjust our
estimates accordingly. Historically these estimates have been accurate and
no material adjustments have had to be made.
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 because stock option exercise prices have
historically equalled the per share fair values of the underlying common
stock on the date of grant. 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 the pro forma disclosures of the effect on
net loss and net loss per share as if FAS No. 123 had been applied in
measuring compensation expense for all periods presented (see Note 2 "Summary
of Significant Accounting Policies").
The preparation of the financial statement footnotes requires us to estimate
the fair value of stock options granted to employees. While fair value may
be readily determinable for awards of stock, market quotes are not available
for long-term, nontransferable stock options because these instruments are
not traded. We currently use the Black-Scholes option-pricing model to
estimate the fair value of employee stock options.
In December 2004, the Financial Accounting Standard Board ("FASB") issued
SFAS 123R, Statement No. 123R "Share-Based Payment", which is a revision of
FASB Statements No. 123 and 95. We will adopt SFAS 123R effective January 1,
2006. We are currently evaluating our option valuation methodologies and
assumptions in light of SFAS 123R. (See "Recent Accounting Pronouncements").
Results of Operations for the years ended December 31, 2005, 2004 and
- ---------------------------------------------------------------------
2003
- ----
The following sets forth the statement of operations data and percentage
changes as compared to the prior year (dollar amounts are presented in
thousands):
For the Year Ended December 31, Annual % Change
------------------------------- ---------------
2005 2004 2003 2005/2004 2004/2003
---- ---- ---- --------- ---------
Royalties $ 5,247 $ 4,972 $4,502 6% 10%
Contract revenues 144 432 346 (67%) 25%
------ ------ -----
Total revenues 5,391 5,404 4,848 0% 11%
Research and development 10,299 11,495 8,421 (10%) 37%
General and
administrative 3,565 3,225 3,039 (11%) 6%
Interest income 287 202 251 42% (20%)
Loss from discontinued
operations (89) (133) (57) (33%) 133%
Gain on disposition of
discontinued operations,
net of taxes 62 4 1,902 * *
<FN>
* Calculation not meaningful.
</FN>
Our revenues in 2005 are derived principally from royalties and, to a lesser
extent, contract revenues.
Royalties increased in 2005 by $275,000 or 6% to $5,247,000 from $4,972,000
in 2004. This increase was due mainly to a 20% increase in royalties on
sales of Carac, a topical prescription treatment for actinic keratoses which
was sold by our marketing partner, Dermik Laboratories, a sanofi-aventis
company. Royalties on sales of Retin-A Micro, a topical prescription
treatment for acne which is marketed by Ortho Neutrogena, a Johnson & Johnson
company,were essentially flat with the prior year. The increase in royalties
in 2004 from 2003 of $470,000 or 10%, to $4,972,000 related to a 10% increase
in royalties earned on sales of Retin-A Micro by Ortho Neutrogena, a Johnson
and Johnson company, as well as a 12% increase in royalties earned on sales
of Carac, by Dermik. We sold our rights to the royalty income from these
products in January 2006 (See previous discussion in Company Overview).
Contract revenues decreased in 2005 by $288,000 or 67% to $144,000 from
$432,000 in 2004 as a result of fewer collaborative research and development
programs as we focused our efforts on the development of APF530 for the
prevention of both acute and delayed chemotherapy-induced nausea and
vomiting. Contract revenues increased by $86,000 or 25% in 2004 compared
with 2003 mainly due to the initiation of a new collaborative research and
development arrangement in 2004.
Research and development expense in 2005 decreased by $1,196,000 or 10% to
$10,299,000 from $11,495,000 in 2004. During 2005, we successfully completed
a Phase 2 clinical trial in the U.S. involving 45 patients, using APF530 for
the prevention of both acute and delayed chemotherapy-induced nausea and
vomiting, and began preparations for a Phase 3 study. The decrease in
expense from 2005 to 2004 is due to the fact that in 2004 we incurred higher
expenses on toxicology studies and performed a Phase 2 study using APF112,
our product candidate for post-surgical pain management, as well as a Phase 1
study using APF530. Research and development expense increased in 2004
compared to 2003 by $3,074,000, or 37% to $11,495,000 due mainly to the
completion in 2004 of the Phase 2 clinical trial of APF112 and the Phase 1
study on APF530. Research and development expenses are expected to increase
in 2006 as we conduct our Phase 3 clinical trial using APF530.
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 1, 2 and 3 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,
human clinical trials, supplies, equipment, consultants, overhead allocation
and sponsored research at academic and research institutions.
Products in Development
- -----------------------
We have a number of product candidates in various stages of development. 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
Product Market Delivery
Portfolio Drug Size Duration Status
- --------- ---- ------ -------- ------
APF530 - Anti- Granisetron $1 billion Short-term Phase 3
nausea (chemo-
therapy)
APF112 - Acute Mepivacaine $2 billion Short-term Phase 2
pain relief
(surgical/
orthopedic)
APF328 - Anti- Meloxicam $1.5 billion Medium-term Pre-IND
inflammatory
(surgical/
orthopedic)
APF505 - Anti- Meloxicam $3.5 billion Long-term Pre-IND
inflammatory
(osteoarthritis)
The major components of research and development expenses for 2005, 2004 and
2003 were as follows (in thousands):
2005 2004 2003
------ ------ ------
Internal research and
development costs $ 5,197 $ 5,315 $ 4,869
APF530 3,551 2,739 229
APF112 -- 2,422 2,759
External raw material
supplies, polymer
manufacturing and
scale-up, and
miscellaneous costs 1,551 1,019 564
------ ------ ------
$10,299 $11,495 $ 8,421
====== ====== ======
Internal general research and development costs include employee salaries and
benefits, laboratory supplies, depreciation, and allocation of overhead.
External polymer development on clinical and preclinical programs includes
expenditures on technology and product development, preclinical and clinical
evaluations, regulatory and toxicology consultants, and polymer
manufacturing, all of which are performed on our behalf by third parties.
General and administrative expense increased by $340,000 or 11% in 2005 to
$3,565,000 from $3,225,000 in 2004 due primarily to expenses associated with
the financing activities which we completed in January 2006. General and
administrative expense increased in 2004 by $186,000 or 6% from 2003 due to
an increase in professional fees primarily as a result of the new audit
requirements under the Sarbanes Oxley Act of 2002. General and
administrative expense includes salaries and related expenses, professional
fees, directors' fees, investor relations costs, insurance expense and the
related overhead cost allocation. General and administrative expense for
2006 is expected to remain consistent with 2005.
Interest income consists primarily of income earned on our invested cash,
cash equivalents and marketable securities. Interest income increased by
$85,000 or 42% in 2005 to $287,000 compared with $202,000 in 2004 due to
higher interest rates. Interest income decreased in 2004 by $49,000 compared
to 2003 due to lower interest rates on investments in 2004.
On February 13, 2003, we completed the sale of certain assets of our
Analytical Standards division to GFS Chemicals, Inc. ("GFS"), a privately
held company based in Columbus, Ohio. In this transaction, we received $2.1
million on closing, and are entitled to receive royalties on sales of
Analytical Standards products for a period of five years following the sale
at rates ranging from 15% to 5%. The net present value of the guaranteed
minimum royalties is included in the gain on disposition of these assets.
On July 25, 2000, we completed the sale of certain technology rights for our
topical pharmaceutical and cosmeceutical product lines and associated assets
("cosmeceutical and toiletry business") to RP Scherer Corporation, a
subsidiary of Cardinal Health, Inc. We received $25 million on closing and
were entitled to receive further earnout amounts for the subsequent three
years, the amounts of which were dependent on the performance of the business
sold.
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.
Income (loss) from discontinued operations represents the income (loss)
attributable to our Analytical Standards division through the date of sale
and the income (loss) attributable to our Analytical Standards division and
our cosmeceutical and toiletries business. For the year 2005, the net loss
from discontinued operations of $89,000 primarily related to the gross profit
guarantee owed under the RP Scherer agreement compared to $133,000 in 2004
and $57,000 in 2003 which related to the gross profit guarantee offset by a
recovery of bad debt and a tax refund received.
The gain on disposition of discontinued operations recorded in 2003 of
$1,902,000 relates to the gain on the sale of our Analytical Standards
division.
Liquidity and Capital Resources
- -------------------------------
Cash, cash equivalents and marketable securities decreased by $7,787,000 to
$5,809,000 at December 31, 2005 from $13,596,000 at December 31, 2004.
Net cash used in continuing operating activities for the years ended December
31, 2005, 2004 and 2003 was $7,652,000, $7,526,000 and $5,919,000,
respectively. Net cash used in continuing operating activities relates
primarily to funding operations and changes in deferred revenue offset by
depreciation. The increase in net cash used in continuing operating
activities in 2005 was primarily due to the timing of payments on toxicology
studies and research and development expenses associated with the Phase 2
study on APF530 compared with payments for the cost of the Phase 2 study in
2004 on APF112 for the treatment of post-surgical pain and the Phase 1
clinical trial on APF530. The increase in net cash used in continuing
operating activities for 2004 compared with 2003 was primarily due to
increased research and development expenses resulting from the completion of
the Phase 2 human clinical studies for APF112 as well as the completion of
the Phase 1 clinical trial of APF530.
The cash provided by discontinued operations of $125,000 and $99,000 in 2005
and 2004, respectively, relates to the royalties received from GFS for sales
of Analytical Standards products. The cash used in discontinued operations
in 2003 of $413,000 relates to cash used in Analytical Standards division
operations, severance payments and payments of the gross profit guarantee to
RP Scherer, partially offset by royalties received from GFS.
Net cash provided by investing activities for the year ended December 31,
2005 was $5,088,000 compared with net cash used in investing activities for
the year ended December 31, 2004, of $1,572,000 and net cash provided by
investing activities of $3,064,000 in the year ended December 31, 2003. The
increase in net cash provided by investing activities in 2005 compared with
net cash used in investing activities in 2004 was primarily due to decreased
purchases of marketable securities and increased sales of marketable
securities. The proceeds received in 2003 of $2,142,000 related to the sale
of our Analytical Standards division.
Our financing activities provided us with $119,000, $12,012,000 and $83,000
for the years ended December 31, 2005, 2004 and 2003, respectively. The net
cash provided by financing activities in 2004 primarily relates to the
issuance of 4,153,335 shares of common stock at $3.00 per share in June 2004.
The net cash provided by financing activities in 2005 and 2003 was primarily
related to proceeds from issuances of shares under the Employee Stock
Purchase Plan and stock option plans.
To date, we have financed our operations including technology and product
research and development, primarily through royalties received on sales of
Retin-A Micro and Carac, income from collaborative research and development
fees, the proceeds received from the sales of our Analytical Standards
division and our cosmeceutical and toiletry business, the sale of common
stock in June 2004, and interest earned on short-term investments. In
January 2006, we sold the rights to our interest in the royalty income from
Retin-A Micro and Carac for $25 million plus additional payments totaling $5
million which will be made based on the satisfaction of certain pre-
determined milestones over the next four years. Our existing cash and cash
equivalents, marketable securities, collections of accounts receivable,
together with interest income and other revenue-producing activities
including license and option fees and research and development fees, are
expected to be sufficient to meet our cash needs for at least the next year.
It is possible that we will seek additional financing within this timeline
through debt or equity financing, the sale of certain assets and technology
rights, collaborative agreements or other arrangements.
Our future capital requirements will depend on numerous factors including,
among others, 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.
Our capital resources will be unable to meet our long term capital
requirements. We are actively seeking partners in the U.S. and abroad to
take over the funding of the Phase 3 clinical trial of APF530, and to
commercialize the product upon approval by the FDA. If we are unable to
reach terms with a partner, we will have to raise additional funds. We may
be unable to raise sufficient additional capital when we need it or to raise
capital on favorable terms. The sale of equity or convertible debt securities
in the future may be dilutive to our stockholders, and debt financing
arrangements may require us to pledge certain assets and enter into covenants
that could restrict certain business activities or our ability to incur
further indebtedness and may contain other terms that are not favorable to us
or our stockholders. If we are unable to obtain adequate funds on reasonable
terms, we may be required to curtail operations significantly or to obtain
funds by entering into financing, supply or collaboration agreements on
unattractive terms.
Below is a summary of fixed payments related to certain contractual
obligations (in thousands). This table excludes amounts already recorded on
our balance sheet as current liabilities at December 31, 2005.
Less More
Than 1-3 3-5 Than
Total 1 year years years 5 years
----- ------ ----- ----- -------
Operating Leases(1) $2,495 $ 474 $ 947 $ 990 $ 84
----- ----- ----- ----- -----
Total $2,495 $ 474 $ 947 $ 990 84
===== ===== ===== ===== =====
<FN>
(1) See Note 7 "Commitments" in the Notes to Financial Statements of Part II,
Item 8 of this Form 10-K for more information.
</FN>
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. The Gross
Profit Guaranty expense totaled $629,000 for the first five guaranty years
and in those years did not include two consecutive periods where the combined
gross profit on sales to Ortho and Dermik equaled or exceeded the guaranteed
gross profit. Therefore, we expect the Gross Profit Guaranty payments to
range from approximately $100,000 to $150,000 per year for the remainder of
the guaranty period.
Reclassifications
- -----------------
Certain reclassifications have been made to the prior year financial
statements to conform with the presentation in 2005. Amortization of
premium/discount and accretion of marketable securities in the prior years
have been reclassified from investing activities to operating activities on
the statement of cash flows.
Off-Balance-Sheet Arrangements
- ------------------------------
As of December 31, 2005, we did not have any off-balance-sheet arrangements,
as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Recent Accounting Pronouncements
- --------------------------------
In December 2004, the Financial Accounting Standard Board ("FASB") issued
SFAS 123R, Statement No. 123R "Share-Based Payment", which is a revision of
FASB Statements No. 123 and 95. SFAS 123R requires all share-based payments
to employees and directors, including employee stock options, to be
recognized as a cost in the financial statements based on their fair values.
SFAS 123R must be adopted effective the beginning of the first fiscal year
beginning after June 15, 2005. This statement permits public companies to
adopt its requirements using one of two methods; (i) the "modified-
prospective" method in which compensation cost is recognized beginning with
the effective date (a) based on the requirements of SFAS 123R for all share-
based payments granted after the effective date and (b) based on the
requirements of SFAS 123R for all awards granted to employees prior to the
effective date of SFAS 123R that remain unvested on the effective date; or
(ii) the "modified-retrospective" method which includes the requirements of
the modified-prospective method described above, but also permits entities to
restate based on the amounts previously recognized under SFAS 123 for
purposes of pro forma disclosures either (a) all prior periods presented or
(b) prior interim periods of the year of adoption. We will adopt SFAS 123R
effective January 1, 2006 using the modified-prospective method. We expect
the adoption of SFAS 123R will have a material adverse impact on our results
of operations, although it will have no impact on our overall liquidity. We
cannot reasonably estimate the impact of adoption because it will depend on
levels of share-based payments granted in the future as well as certain
assumptions that can materially affect the calculation of the value of share-
based payments to employees and directors. However, had we adopted SFAS 123R
in prior periods, the impact of the standard would have approximated the
impact of SFAS 123 as described in the disclosure of pro forma net loss and
pro forma loss per common share in Note 2 of Notes to Financial Statements
included under Item 8 of this Annual Report on Form 10-K.
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. The interest rates as of
December 31, 2005 and 2004 were 3.78% and 2.20%, respectively. At December
31, 2005 and 2004, respectively, our cash equivalents and marketable
securities include corporate and other debt securities as follows: (in
thousands)
December 31,
-------------------------
2005 2004
---- ----
Available-for-sale:
Effective maturity of less than
3 months $ 456 $ 2,228
Due after 3 months and less than
1 year 3,541 10,486
Due after 1 year and less than
5 years 1,478 --
----- ------
Total available-for-sale $5,475 $12,714
===== ======
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
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
A.P. Pharma, Inc.
We have audited the accompanying balance sheets of A.P. Pharma, Inc. as of
December 31, 2005 and 2004, and the related statements of operations,
stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 2005. Our audits also included the financial
statement schedule listed in the Index at Item 15(a)2. These financial
statements and schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. We were
not engaged to perform an audit of the Company's internal control over
financial reporting. Our audit included consideration of internal control
over financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
resonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of A.P. Pharma, Inc. at
December 31, 2005 and 2004, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2005, in
conformity with U.S. generally accepted accounting principles. Also, in our
opinion, the related financial statement schedule, when considered in
relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
/s/Ernst & Young LLP
Palo Alto, California
February 24, 2006
A.P. Pharma, Inc.
Balance Sheets
(in thousands except par value and shares)
- ------------------------------------------
December 31,
-------------------------
2005 2004
---- ----
Assets
Current Assets:
Cash and cash equivalents $ 790 $ 3,110
Marketable securities 5,019 10,486
Accounts receivable 1,519 1,506
Prepaid expenses and other current
assets, less allowance for doubtful
note receivable of $394 at December
31, 2005 and 2004 320 394
------- -------
Total current assets 7,648 15,496
Property and equipment, net 1,164 1,235
Other long-term assets 157 283
------- -------
Total Assets $ 8,969 $ 17,014
======= =======
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable $ 614 $ 697
Accrued expenses 1,904 2,003
Accrued disposition costs 248 160
------- -------
Total current liabilities 2,766 2,860
Commitments
Stockholders' Equity:
Preferred stock, 2,500,000 shares
authorized; none issued or
outstanding at December 31,
2005 and 2004 -- --
Common stock, $.01 par value,
50,000,000 shares authorized;
25,279,970 and 25,033,919 issued
and outstanding at December 31,
2005 and 2004, respectively 253 250
Additional paid-in capital 98,995 98,739
Accumulated other comprehensive
loss (16) (16)
Accumulated deficit (93,029) (84,819)
------- -------
Total Stockholders' Equity 6,203 14,154
------- -------
Total Liabilities and Stockholders'
Equity $ 8,969 $ 17,014
======= =======
<FN>
See accompanying notes to financial statements.
</FN>
A.P. Pharma, Inc.
Statements of Operations
(in thousands except per share data)
- -------------------------------------
Year Ended December 31,
-----------------------
2005 2004 2003
---- ---- ----
Revenues
Royalties $ 5,247 $ 4,972 $ 4,502
Contract revenues 144 432 346
------ ------ ------
Total revenues 5,391 5,404 4,848
Expenses
Research and development 10,299 11,495 8,421
General and administrative 3,565 3,225 3,039
------ ------ ------
Operating loss (8,473) (9,316) (6,612)
------ ------ ------
Interest income 287 202 251
Other income, net 3 22 153
------ ----- ------
Loss from continuing operations (8,183) (9,092) (6,208)
Loss from discontinued operations (89) (133) (57)
Gain on disposition of discontinued
operations, net of taxes 62 4 1,902
------ ------ ------
Net loss $(8,210) $(9,221) $(4,363)
====== ====== ======
Basic and diluted loss per share:
Loss from continuing operations $ (0.33) $ (0.40) $ (0.30)
====== ====== ======
Net loss $ (0.33) $ (0.40) $ (0.21)
====== ====== ======
Weighted average common shares
outstanding - basic and diluted 25,118 22,909 20,553
====== ====== ======
<FN>
See accompanying notes to financial statements.
</FN>
A.P. Pharma, Inc.
Statement of Stockholders' Equity
(in thousands)
- ---------------------------------
For the Years Ended December 31, 2005, 2004 and 2003
Accumulated
Other
Additional Compre-
Common Stock Paid-In Accumulated hensive Stockholders'
Shares Amount Capital Deficit Income(Loss) Equity
---------- -------- ----------- ----------- ------------ ------------
Balance, December
31, 2002 20,467 $205 $86,413 $(71,235) $ 76 $15,459
Comprehensive
loss:
Net loss -- -- -- (4,363) -- (4,363)
Net unrealized
loss on
marketable
securities -- -- -- -- (59) (59)
------
Comprehensive
loss (4,422)
------
Common stock
issued upon
exercise of
stock options 14 -- 22 -- -- 22
Fair value of
stock based
compensation
issued to
directors for
services and to
employees for
restricted stock
awards 86 1 112 -- -- 113
Stock based
compensation
related to stock
options granted to
non-employees -- -- 30 -- -- 30
Common stock issued
to employees under
the Employee Stock
Purchase Plan 75 -- 61 -- -- 61
------ --- ------ ------- ---- ------
Balance, December
31, 2003 20,642 $206 $86,638 $(75,598) $ 17 $11,263
====== === ====== ======= ==== ======
Comprehensive
loss:
Net loss -- -- -- (9,221) -- (9,221)
Net unrealized
loss on
marketable
securities -- -- -- -- (33) (33)
------
Comprehensive
loss (9,254)
------
Common stock
issuance, net of
issuance costs 4,153 41 11,715 -- -- 11,756
Common stock
issued upon
exercise of
stock options 69 1 150 -- -- 151
Fair value of
stock based
compensation
issued to
directors for
services and to
employees for
restricted stock
awards 52 1 116 -- -- 117
Expenses associated
with stock options
granted to
non-employees -- -- 16 -- -- 16
Common stock issued
to employees under
the Employee Stock
Purchase Plan 118 1 104 -- -- 105
------ --- ------ ------- ---- ------
Balance, December
31, 2004 25,034 $250 $98,739 $(84,819) $ (16) $14,154
====== === ====== ======= ==== ======
Net loss and
comprehensive loss -- -- -- (8,210) -- (8,210)
------
Common stock issued
upon exercise of
stock options 15 -- 22 -- -- 22
Fair value of
stock based
compensation
issued to
directors
for services and
to employees for
restricted stock
awards 145 2 135 -- -- 137
Stock based
compensation related
to stock options
granted to
non-employees -- -- 4 -- -- 4
Common stock issued
to employees under
the Employee Stock
Purchase Plan 86 1 95 -- -- 96
------ --- ------ ------- ---- ------
Balance, December
31, 2005 25,280 $253 $98,995 $(93,029) $ (16) $ 6,203
====== === ====== ======= ==== ======
<FN>
See accompanying notes to financial statements.
</FN>
A.P. Pharma, Inc.
Statements of Cash Flows (in thousands)
- ---------------------------------------
For the Year Ended December 31,
-------------------------------------
2005 2004 2003
--------- --------- ---------
Cash flows from operating activities:
Net loss $ (8,210) $ (9,221) $ (4,363)
Adjustments to reconcile net loss to net
cash used in operating activities:
Loss from discontinued operations 89 133 57
Gain on disposition of discontinued
operations (62) (4) (1,902)
Loss (Gain) on sale of marketable
securities 4 (2) (1)
Depreciation and amortization 387 381 432
Recovery of note receivable -- (18) (24)
Stock-based compensation 140 133 143
Amortization of premium/discount and
accretion of marketable securities 59 249 221
Loss on retirements and disposals of fixed
assets -- 7 16
Changes in operating assets and liabilities:
Accounts receivable (83) (287) (122)
Prepaid expenses and other current assets 74 58 (130)
Other long-term assets 132 184 (277)
Accounts payable (83) 221 209
Accrued expenses (99) 830 227
Deferred revenue -- (190) (405)
------ ------- ------
Net cash used in continuing operating
activities (7,652) (7,526) (5,919)
Cash provided by (used in) discontinued
operations 125 99 (413)
------ ------- -------
Net cash used in operating activities (7,527) (7,427) (6,332)
------ ------- -------
Cash flows from investing activities:
Proceeds from disposition of discontinued
operations -- -- 2,142
Purchases of property and equipment (316) (193) (251)
Purchases of marketable securities (8,126) (12,838) (6,720)
Maturities of marketable securities 7,935 9,577 6,650
Sales of marketable securities 5,595 1,882 1,243
------ ------- -------
Net cash provided by (used in) investing
activities 5,088 (1,572) 3,064
------ ------- -------
Cash flows from financing activities:
Proceeds from the issuance of common
stock, net of issuance costs -- 11,756 --
Proceeds from the exercise of common
stock options 22 151 22
Proceeds from issuance of shares under
the Employee Stock Purchase Plan 96 105 61
Proceeds from issuance of restricted
stock 1 -- --
------ ------- -------
Net cash provided by financing activities 119 12,012 83
------ ------- -------
Net decrease (increase) in cash and cash
equivalents (2,320) 3,013 (3,185)
Cash and cash equivalents at the beginning
of the year 3,110 97 3,282
------ ------ -------
Cash and cash equivalents at the end of
the year $ 790 $ 3,110 $ 97
====== ====== ======
Supplemental Cash Flow Data:
Cash paid for interest $ 4 $ 5 $ 4
====== ====== ======
<FN>
See accompanying notes to financial statements.
</FN>
NOTES TO FINANCIAL STATEMENTS
- -----------------------------
DECEMBER 31, 2005, 2004 AND 2003
- --------------------------------
Note 1 Business
A.P. Pharma, Inc. (APP, the Company, we, our, or us) is developing patented
polymer-based delivery systems to enhance the safety and effectiveness of
pharmaceutical compounds. New products and technologies under development
include bioerodible polymers for injectable and implantable drug delivery.
Projects have also been conducted under feasibility and development
arrangements with pharmaceutical and biotechnology companies.
On July 25, 2000, we completed the sale of certain technology rights for our
topical pharmaceutical and cosmeceutical product lines and other assets
("cosmeceutical and toiletry business") to RP Scherer Corporation, a
subsidiary of Cardinal Health, Inc. As a result of this transaction, our
Statements of Operations reflect the receipt of certain earnout payments and
the payment of certain contractual obligations in the gain from disposition
of discontinued operations (see Note 10).
On February 13, 2003, we completed the sale of our Analytical Standard
division to GFS Chemicals, Inc. ("GFS"), a privately held company based in
Columbus, Ohio. In this transaction, we received $2.1 million and are
entitled to receive royalties on sales of Analytical Standards products of
15% for the first year, 10% for the second through fourth years, and 5% for
the fifth year. The net present value of the guaranteed minimum royalties is
included in the gain on disposition of discontinued operations (see Note 10).
On January 18, 2006 we sold our rights to royalties on sales of Retin-A
Micro(R) and Carac (R) for up to $30 million, of which $25 million was
received at closing. See Note 15 "Subsequent Event".
Note 2 Summary of Significant Accounting Policies
Cash Equivalents and Marketable Securities
- ------------------------------------------
We consider all marketable securities that have original maturities, from the
date of purchase, of less than three months to be cash equivalents.
Investments with maturities of three months and longer from the date of
purchase are classified as marketable securities. Investments consist
primarily of commercial paper, bankers' acceptances, master notes and
corporate debt securities. We have classified all our investments in certain
debt securities as "available-for-sale", and, therefore, they are recorded at
fair value with unrealized gains and losses reported as a separate component
of stockholders' equity. If the estimated fair value of a security is below
its carrying value, we evaluate whether we have the intent and ability to
retain our investment for a period of time sufficient to allow for any
anticipated recovery in market value and whether evidence indicating that the
cost of the investment is recoverable within a reasonable period of time
outweighs evidence to the contrary. If the impairment is considered to be
other-than-temporary, the security is written down to its estimated fair
value. Other-than-temporary declines in estimated fair value of all
marketable securities are charged to "other income, net." The cost of all
securities sold is based on the specific identification method.
Financial Instruments
- ---------------------
The carrying values of the Company's financial instruments, including
marketable securities, accounts receivable and accrued liabilities,
approximate their respective fair values due to their short maturities.
Allowance for Note Receivable
- -----------------------------
An allowance was recorded for a note receivable at such time as management
determined that collection was not reasonably assured. Interest income under
the terms of note receivable agreement is recorded when cash is received or
collectibility is reasonably assured. The note receivable, net of the
related allowance, is included in prepaid expenses and other current assets
in the accompanying balance sheet.
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, 12 years, which
is 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 us to consider whether those assets have been impaired.
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.
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 because stock option exercise prices have
historically equalled the per share fair values of the underlying common
stock. 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 loss and net loss per share as if FAS No. 123 had been applied
in measuring compensation expense for all periods presented (in thousands)
(see Note 8 "Stockholders' Equity"):
2005 2004 2003
----------- ----------- ---------
Net loss - as reported $(8,210) $(9,221) $(4,363)
Add:
Stock-based employee
compensation expense
for restricted stock
awards 24 -- --
Deduct:
Stock-based employee
compensation expense
determined under FAS 123 (360) (400) (397)
------- ------ ------
Net loss - pro-forma $(8,546) $(9,621) $(4,760)
====== ====== ======
Basic and diluted net
loss per common share
- as reported $ (0.33) $ (0.40) $ (0.21)
Basic and diluted net
loss per common share
- pro-forma $ (0.34) $ (0.42) $ (0.23)
Recent Accounting Pronouncements
- --------------------------------
In December 2004, the Financial Accounting Standard Board ("FASB") issued
SFAS 123R, Statement No. 123R "Share-Based Payment", which is a revision of
FASB Statements No. 123 and 95". SFAS 123R requires all share-based payments
to employees, including employee stock options, to be recognized as a cost in
the financial statements based on their fair values. SFAS 123R must be
adopted effective the beginning of the first fiscal year beginning after June
15, 2005. This statement permits public companies to adopt its requirements
using one of two methods; (i) the "modified-prospective" method in which
compensation cost is recognized beginning with the effective date (a) based
on the requirements of SFAS 123R for all share-based payments granted after
the effective date and (b) based on the requirements of SFAS 123R for all
awards granted to employees prior to the effective date of SFAS 123R that
remain unvested on the effective date; or the "modified-retrospective" method
which includes the requirements of the modified-prospective method described
above, but also permits entities to restate based on the amounts previously
recognized under SFAS 123 for purposes of pro forma disclosures either (a)
all prior periods presented or (b) prior interim periods of the year of
adoption. We will adopt SFAS 123R effective January 1, 2006 using the
modified-prospective method. We expect the adoption of SFAS 123R will have a
material adverse impact on our results of operations, although it will have
no impact on our overall liquidity. We cannot reasonably estimate the impact
of adoption because it will depend on levels of share-based payments granted
in the future as well as certain assumptions that can materially affect the
calculation of the value of share-based payments to employees and directors.
However, had we adopted SFAS 123R in prior periods, the impact of the
standard would have approximated the impact of SFAS 123 as described in the
disclosure of pro forma net loss and pro forma loss per common share in the
Stock-Based Compensation section above.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the 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
- -------------------
Our revenue arrangements with multiple deliverables are divided into separate
units of accounting if certain criteria are met, including whether the
delivered item has stand-alone value to the customer and whether there is
objective and reliable evidence of the fair value of the undelivered items.
The consideration we receive is allocated among the separate units based on
their respective fair values, and the applicable revenue recognition criteria
are considered separately for each of the separate units. Advance payments
received in excess of amounts earned are classified as deferred revenue until
earned.
Royalties
- ---------
Royalties from licenses are based on third-party sales of licensed products
or technologies and recorded as earned in accordance with contract terms when
third-party results can be reliably determined and collectibility is
reasonably assured.
Generally, 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
- -----------------
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 services are rendered.
These revenues approximate the costs incurred.
License Fees
- ------------
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 or the
related patents expire, whichever is earlier. Revenue recognized from
deferred license fees is classified as license fees in the accompanying
statements of operations. License fees received in connection with
arrangements where we have no continuing involvement are recognized as
license fees when the amounts are received or when collectibility is assured,
whichever is earlier. No such fees were recorded during the years ended
December 31, 2005, 2004 and 2003.
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 license fees
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. No such fees were recorded during the years ended December 31,
2005, 2004 and 2003.
Research and Development
- ------------------------
Research and development consists of costs incurred for Company-sponsored and
collaborative research and development expenses. These costs consist
primarily of employee salaries and other personnel-related expenses,
facility-related expenses, lab consumables, polymer development
manufacturing, clinical and pre-clinical related services performed by
clinical research organizations, research institutions and other outside
service providers.
Expenses related to clinical trials generally are accrued based on the level
of patient enrollment and services performed by the clinical research
organization or related service provider according to the protocol. The
Company monitors patient enrollment levels and related activity to the extent
possible and adjusts estimates accordingly.
Research and development expenses under collaborative agreements approximate
the revenue recognized, excluding milestone and up-front payments received
under such arrangements.
Net Loss Per Share
- ------------------
Basic and diluted net loss per share is computed based on the weighted-
average number of common shares outstanding. Diluted net loss per share is
not presented separately as the Company is in a net loss position and
including potentially dilutive securities in the net loss per share
computation would be anti-dilutive. See Note 9 "Net Loss Per Share".
Concentrations of Credit Risk
- -----------------------------
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.
Approximately 95% and 96% of the accounts receivables were concentrated with
two customers in the pharmaceutical industry as of December 31, 2005 and
2004, respectively. Approximately 97%, 92% and 93% of total revenue were
concentrated with two customers for the years ended December 31, 2005, 2004
and 2003. To reduce credit risk, we perform ongoing credit evaluations of
our customers' financial condition. We do not generally require collateral
for customers with accounts receivable balances. As we sold our rights to
royalties on sales of Retin-A Micro and Carac on January 18, 2006 (see Note
15 "Subsequent Event"), we will not have royalty revenue receivables in the
future.
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.
Reclassifications
- -----------------
Certain reclassifications have been made to the prior year financial
statements to conform with the presentation in 2005. Amortization of
premium/discount and accretion of marketable securities in the prior years
have been reclassified from investing activities to operating activities on
the Statements of Cash Flows.
Note 3 Cash Equivalents and Marketable Securities
We consider all of our investments in debt securities as available-for-sale
and, accordingly, we have recorded these investments at fair value. Realized
losses totaled $4,000 for the year ended December 31, 2005. Realized gains
totaled $2,000 and $1,000 for the years ended December 31, 2004 and 2003,
respectively.
At December 31, 2005 and 2004, the amortized cost and estimated market value
of investments in debt securities and cash equivalents are set forth in the
tables below:
December 31, 2005
(in thousands)
------------------------------------------------
Unrealized Unrealized Estimated
Cost Gains Losses Market Value
------ ---------- ---------- ------------
Available-for-sale:
Corporate debt
securities $ 1,809 $-- $ (6) $ 1,803
Asset-backed
securities 1,484 -- (5) 1,479
Government debt
securities 996 -- (4) 992
Other debt securities 1,202 -- (1) 1,201
------ -- --- ------
Total available-for-
sale $ 5,491 $-- $(16) $ 5,475
====== == === ======
December 31, 2004
(in thousands)
------------------------------------------------
Unrealized Unrealized Estimated
Cost Gains Losses Market Value
------ ---------- ---------- ------------
Available-for-sale:
Corporate debt
securities $ 2,955 $ -- $ (7) $ 2,948
Asset-backed
securities 94 -- -- 94
Government debt
securities 7,750 -- (9) 7,741
Other debt securities 1,931 -- -- 1,931
------ --- --- ------
Total available-for-
sale $12,730 $ -- $(16) $12,714
====== === === ======
The table below summarizes fair value disclosures at December 31 (in
thousands):
2005 2004
----------------------- ----------------------
Fair Fair
Cost Value Cost Value
---- ---------- --------- ----------
Cash equivalents $ 456 $ 456 $ 2,228 $ 2,228
Marketable securities 5,035 5,019 10,502 10,486
------ ------ ------ ------
Totals $ 5,491 $ 5,475 $12,730 $12,714
====== ====== ====== ======
The cost and estimated fair value of available-for-sale debt securities as of
December 31, 2005, by contractual maturity, consisted of the following (in
thousands):
Estimated
Cost Market Value
----------- ------------
Available-for-sale:
Due in one year or less $4,008 $3,997
Due in more than one year
but less than 5 years 1,483 1,478
----- -----
Total available-for
sale $5,491 $5,475
===== =====
Note 4 Property and Equipment
Property and equipment consist of the following:
December 31,
(in thousands)
---------------------------
2005 2004
---------- ----------
Leasehold improvements $ 1,359 $ 1,359
Furniture and equipment 2,641 2,373
------ ------
Total property and equipment 4,000 3,732
Accumulated depreciation
and amortization (2,836) (2,497)
------ ------
Property and equipment, net $ 1,164 $ 1,235
====== ======
Depreciation expense amounted to $387,000, $381,000 and $432,000 for the
years ended December 31, 2005, 2004 and 2003, respectively.
Note 5 Accrued Expenses
Accrued expenses consist of the following:
December 31,
(in thousands)
------------------
2005 2004
---- ----
Professional fees $ 230 $ 126
Accrued salaries 226 198
Accrued bonus 378 232
Clinical studies 892 1,318
Other 178 129
----- -----
Total $1,904 $2,003
===== =====
Note 6 Long-Term Debt
In September 1995, we extinguished $2.5 million of Industrial Revenue Bonds
through an "in-substance defeasance" transaction by placing approximately
$2.5 million of United States government securities in an irrevocable trust
to fund all future interest and principal payments. In accordance with the
agreement, the investments held in the irrevocable trust shall be the
exclusive source of all principal and interest payments and we have no
liability for any shortfall in payments due. In addition, we have
relinquished all rights with respect to the amounts held in the trust. The
defeased debt balance outstanding of $2.5 million as of December 31, 2004 was
repaid on January 15, 2005 using the proceeds from the maturities of the
United States government securities held in the irrevocable trust. The bond
liability and related assets held in trust are not reflected in the
accompanying balance sheets.
Note 7 Commitments
We lease office and laboratory space and certain office equipment under
operating lease arrangments. Our office and laboratory space leases expire
in 2011. Our future minimum lease payments under these noncancelable
operating leases for facilities and equipment are as follows (in thousands):
Year Ending Minimum
December 31, Payments
------------ -----------
2006 $ 474
2007 474
2008 473
2009 488
2010 502
Thereafter 84
------
$2,495
======
Total rental expense for facilities and equipment was $492,000, $501,000 and
$667,000 for 2005, 2004 and 2003, respectively.
As part of the sale of our cosmeceutical and toiletry business to RP Scherer
Corporation in July 2000, we guaranteed a minimum gross profit percentage on
RP Scherer's sales of products to Ortho Neutrogena and Dermik (See Note 10
"Discontinued Operations").
Note 8 Stockholders' Equity
Shareholders' Rights Plan
- ------------------------
On August 19, 1996, the Board of Directors approved a Shareholders' Rights
Plan under which shareholders of record on September 3, 1996 received a
dividend of one Preferred Stock purchase right ("Rights") for each share of
common stock outstanding. The Rights were not exercisable until 10 business
days after a person or group acquired 20% or more of the outstanding shares
of common stock or announced a tender offer that could have resulted in a
person or group beneficially owning 20% or more of the outstanding shares of
common stock (an "Acquisition") of the Company. The Board of Directors
approved an increase in threshold to 30% in December 1997. Each Right,
should it become exercisable, will entitle the holder (other than acquirer)
to purchase company stock at a discount. The Board of Directors may
terminate the Rights plan or, under certain circumstances, redeem the rights.
In the event of an Acquisition without the approval of the Board, each Right
will entitle the registered holder, other than an acquirer and certain
related parties, to buy at the Right's then current exercise price a number
of shares of common stock with a market value equal to twice the exercise
price.
In addition, if at the time when there was a 30% shareholder, we were to be
acquired by merger, shareholders with unexercised Rights could purchase
common stock of the acquirer with a value of twice the exercise price of the
Rights.
The Board may redeem the Rights for $0.01 per Right at any time prior to
Acquisition. Unless earlier redeemed, the Rights will expire on August 19,
2006.
In June 2004, we sold 4,153,335 shares of common stock at a price of $3.00
per share, for net proceeds of approximately $11.8 million, after deducting
placement fees and costs associated with the offering. The shares were
offered under our shelf registration statement on Form S-3.
Stock-Based Compensation Plans
- ------------------------------
We have two types of stock-based compensation plans, which consist of a stock
purchase plan and two stock option plans.
In 1997, our stockholders approved our 1997 Employee Stock Purchase Plan (the
"Plan"). In May 2005 the stockholders authorized the increase in shares
reserved for issuance under the Plan by 150,000 to 650,000 to our employees,
nearly all of whom are eligible to participate. Under the terms of the Plan,
employees can elect to have up to a maximum of 10 percent of their base
earnings withheld to purchase our common stock. The purchase price of the
stock is 85 percent of the lower of the closing prices for our common stock
on: (i) the first trading day in the enrollment period, as defined in the
Plan, in which the purchase is made, or (ii) the purchase date. The length
of the enrollment period may not exceed a maximum of 24 months. Enrollment
dates are the first business day of May and November and the first enrollment
date was April 30, 1997. Approximately 57 percent of eligible employees
participated in the Plan in 2005. Under the Plan, we issued 86,449 shares in
2005, 118,062 shares in 2004 and 74,746 shares in 2003. The weighted average
fair value of purchase rights granted during 2005, 2004 and 2003 was $0.70,
$0.51 and $0.50, respectively. The weighted average exercise price of the
purchase rights exercised during 2005, 2004 and 2003 was $1.11, $0.89 and
$0.82, respectively. We had 138,082, 74,531 and 92,593 shares reserved for
issuance under the Plan at December 31, 2005, 2004 and 2003, respectively.
We have two current stock option plans for employees, officers, directors and
consultants. We grant stock options under the 2002 Stock Incentive Plan
("2002 Plan") and the Non-Qualified Stock Plan. The Company is authorized to
issue up to 1,300,000 shares under the 2002 Plan, 400,000 of which were
approved in May 2005, and 250,000 shares under the Non-Qualified Stock Plan.
The options to purchase our common stock are granted with an exercise price
which equals fair market value of the underlying common stock on the grant
dates, and expire no later than ten years from the date of grant. The
options are exercisable in accordance with vesting schedules that generally
provide for them to be fully vested and exercisable four years after the date
of grant. Any shares that are issuable upon exercise of options granted
under the 2002 Plan and the Non-Qualified Stock Plan that expire or become
unexercisable for any reason without having been exercised in full are
available for future grant and issuance under the same stock option plan.
We granted options to purchase common stock to consultants from time to time
in exchange for services rendered and these options vest over a period of two
to four years. No options were granted to consultants in 2005. We recorded
compensation expense related to option grants to consultants of approximately
$4,000, $16,000 and $30,000 in 2005, 2004 and 2003, respectively, which
represents the fair market value of the portion of the awards that vested
during 2005, 2004 and 2003. The unvested shares held by consultants have
been and will be revalued using the Black-Scholes option pricing model at the
end of each accounting period.
The following table summarizes option activity for 2005, 2004 and 2003:
2005 2004 2003
----------------- ------------------ --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------------- ------------------ --------------------
Outstanding at beginning
of year 2,205,636 $3.60 2,108,605 $3.97 2,901,512 $4.54
Granted 182,000 1.61 383,500 2.04 182,500 1.26
Exercised (15,057) 1.45 (68,448) 2.20 (13,570) 1.62
Expired or Forfeited (206,613) 4.08 (218,021) 4.93 (961,837) 5.21
--------- --------- ---------
Outstanding at end of year 2,165,966 3.40 2,205,636 3.60 2,108,605 3.97
========= ========= =========
Options exercisable at
year end 1,828,833 1,712,166 1,674,704
Shares available for future
grant at year end 538,741 320,961 286,669
Weighted-average fair
value of stock options
granted during the year $1.05 $1.12 $0.79
The following table summarizes information about stock options outstanding at
December 31, 2005:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------- -------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life Price Exercisable Price
- ----------- ----------- ----------- --------- ----------- ---------
$1.00-$1.60 440,869 7.9 years $ 1.29 248,933 $ 1.25
$1.63-$2.45 523,322 7.1 2.15 378,125 2.19
$2.50-$3.13 494,733 5.4 2.87 494,733 2.87
$3.34-$6.38 440,500 3.2 4.73 440,500 4.73
$6.81-$10.25 266,542 1.3 $ 8.11 266,542 8.11
--------- ---------
$1.00-$10.25 2,165,966 5.4 $ 3.40 1,828,833 $ 3.72
========= =========
We have adopted the disclosure only provisions of FAS 123 "Accounting for
Stock-Based Compensation." Accordingly, except for stock options issued to
non-employees and restricted stock awards to employees, no compensation cost
has been recognized for the various stock option plans and stock purchase
plan. In March 2005, we granted 75,000 shares of restricted stock awards
under the 2002 Plan to employees. The compensation cost that has been
expensed in the statements of operations for the restricted stock awards
issued to employees was $24,000 for 2005.
The table regarding the net loss and net loss per share included in Note 2,
"Summary of Significant Accounting Policies," prepared in accordance with FAS
123 has been determined as if we had accounted for our employee stock options
and employee stock purchase plan under the fair value method prescribed by
FAS 123.
Fair values of awards granted under the stock option plans and employee stock
purchase plan were estimated at grant or purchase dates using a Black-Scholes
option pricing model. For pro forma disclosure, the estimated fair value of
the options is amortized to expense over the vesting period of the options
using the straight line method. The multiple option approach is used to
value the purchase rights granted under the employee stock purchase plan. We
used the following assumptions:
Year Ended December 31,
-----------------------
2005 2004 2003
---- ---- ----
Expected life in years (from vesting
date):
Stock options 5 5 5
Employee Stock Purchase Plan 0.5 - 2 1.5 - 2 1.5 - 2
Discount rate:
Stock options 4.0% 3.2% 3.2%
Employee Stock Purchase Plan 3.15%-3.63% 1.47%-2.55% 1.47%-1.82%
Volatility
Stock options 78% 69% 85%
Employee Stock Purchase Plan 94%-105% 65%-147% 65%-68%
Expected dividend yield 0% 0% 0%
Also in 2001, we modified the 1992 Stock Option Plan to extend the exercise
period of vested stock options upon employee termination, from up to 30 days
after the date of termination to up to 90 days after the date of termination.
We did not record compensation expense associated with this modification in
2005, 2004 and 2003, as the expense associated with the affected options
exercised in 2005, 2004 and 2003 was $0. The number of stock options that
may be affected in future periods was not estimable on the date of
modification.
Note 9 Net Loss Per Share
The following options and restricted stock awards were outstanding as of
December 31, 2005, 2004 and 2003, but were not included in the computation of
diluted net loss per share since inclusion of these potentially dilutive
securities would have been anti-dilutive for the periods presented (in
thousands):
2005 2004 2003
---- ---- ----
Number of options
outstanding 2,166 2,206 2,109
Number of restricted stock
awards outstanding 75 -- --
Note 10 Discontinued Operations
We completed the sale of certain assets of our Analytical Standards division
as well as certain technology rights for our topical pharmaceutical and
cosmeceutical product lines and other assets ("cosmeceutical and toiletry
business") in February 2003 and July 2000, respectively.
The Analytical Standards division and cosmeceutical and toiletry business are
reported as discontinued operations for all periods presented in the
accompanying Statements of Operations.
Income (loss) from discontinued operations represents the income (loss)
attributable to our Analytical Standards division that was sold to GFS
Chemicals on February 13, 2003 and changes in estimates of our cosmeceutical
and toiletry business that was sold to RP Scherer on July 25, 2000, as follows
(in thousands):
For the year ended
December 31,
---------------------------
2005 2004 2003
---- ---- ----
Analytical Standards Division
- -----------------------------
Income from Analytical Standards
division $ -- $ -- $ 8
---- ---- ----
-- 8
Cosmeceutical and Toiletry Business
- -----------------------------------
Recovery of doubtful account
receivable -- -- 28
Change in estimates for
professional fees, severance
costs and guarantees (89) (133) (103)
Change in estimate of
provision for income
taxes and tax refunds -- -- 10
----- ---- ---
(89) (133) (65)
----- ---- ---
Total loss from discontinued
operations $ (89) $(133) $(57)
===== ==== ===
Revenues relating to the discontinued operations totaled $0, $0 and $127,000
for the years ended December 31, 2005, 2004 and 2003, respectively.
Gain on disposition of discontinued operations in the accompanying Statement
of Operations for the year ended December 31, 2003 represents the gain on the
sale of certain assets of our Analytical Standards division in February 2003.
The following table sets forth the Company's basic and diluted income (loss)
per common share from discontinued operations excluding the gain on sale for
the years ended December 31, 2005, 2004 and 2003:
For the year ended December 31,
-------------------------------
2005 2004 2003
---- ---- ----
Basic income (loss) per common
share from discontinued
operations $ * $(0.01) $ *
Diluted income (loss) per common
share from discontinued
operations $ * $(0.01) $ *
<FN>
* Less than ($0.00) per share
</FN>
As of December 31, 2005, liabilities related to the discontinued operation in
the amount of $248,000 include severance costs and accruals for gross profit
guarantees. These liabilities are reported as accrued disposition costs in
the accompanying balance sheets.
The cash provided by discontinued operations of $125,000 and $99,000 in 2005
and 2004, respectively, relates to the royalties received from GFS from sales
of Analytical Standards products, partially offset by severance payments made
to former employees who were terminated as a result of the sale of the
Analtyical Standards division. The cash used in discontinued operations in
2003 of $413,000 relates to cash used in Analytical Standards division
operations, severance payments and payments of the gross profit guarantee to
RP Scherer, partially offset by royalties received from GFS.
Analytical Standards Division
- -----------------------------
On February 13, 2003, we completed the sale of our Analytical Standards
division to GFS Chemicals, Inc. ("GFS"), a privately held company based in
Columbus, Ohio. In this transaction, we received $2.1 million on closing and
are entitled to receive royalties on sales of Analytical Standards products
for a period of five years following the sale at rates ranging from 5% to
15%. The net present value of the guaranteed minimum royalties is included
in the gain on disposition of discontinued operations.
As a result of the sale of the Analytical Standards division, we recorded
severance charges of $210,000 in the year ended December 31, 2003 as a
partial offset to the gain on disposition of the Analytical Standards
division. An increase to the estimated severance charges of $1,000 was
recorded in 2005. Approximately $223,000 of these severance charges has been
paid through December 31, 2005.
Cosmeceutical and Toiletry Business
- -----------------------------------
On July 25, 2000, we completed the sale of certain technology rights for our
topical pharmaceutical and cosmeceutical product lines and other assets
("cosmeceutical and toiletry business") to RP Scherer Corporation, a
subsidiary of Cardinal Health, Inc.
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. The Gross
Profit Guaranty expense totaled $629,000 for the first five 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.
As there is no minimum amount of Gross Profit Guaranty due, no accrual for
the guaranty is estimable for future years. A liability of $242,000 related
to the current amount due under the gross profit guarantees is included in
accrued disposition costs as of December 31, 2005.
Note 11 Defined Contribution Plan
We have a defined contribution plan covering substantially all of our
employees. In the past three calendar years, we 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 $6,300, $6,150 and $6,000 for 2005, 2004 and 2003 ,
respectively, and such amounts were recorded as expense in the corresponding
years. We may also contribute additional discretionary amounts to the
defined contribution plan as we may determine. For the years ended December
31, 2005, 2004 and 2003, we contributed to the plan approximately $73,000,
$86,000 and $64,000, respectively. No discretionary contributions have been
made to the plan since its inception.
Note 12 Income Taxes
There is no provision for income taxes because we have incurred operating
losses. Deferred income taxes reflect the net tax effects of net operating
loss and tax credit carryovers and temporary differences between the carrying
amounts of assets and liabilities for financial reporting purposes and the
amounts used for income tax purposes. Significant components of our deferred
tax assets are as follows (in thousands):
December 31,
------------------------
2005 2004
---- ----
Deferred Tax Assets:
Net operating loss carryforwards $ 26,500 $ 26,100
Research credits 2,300 2,000
Capitalized research expenses 100 200
Other 400 400
------- -------
Total deferred tax assets 29,300 28,700
Valuation allowance (29,300) (28,700)
------- ------
Net deferred tax assets -- --
======= ======
Realization of deferred tax assets is dependent upon future earnings, if any,
the timing and amount of which are uncertain. Accordingly, the net deferred
tax assets have been fully offset by a valuation allowance. The valuation
allowance increased by $600,000 and $1,500,000 and decreased by $100,000
during 2005, 2004, and 2003, respectively.
Deferred tax assets related to carryforwards at December 31, 2005 include
approximately $2,900,000 associated with stock option activity related to
nonqualified stock options for which any subsequently recognized tax benefits
will be credited directly to stockholders' equity.
As of December 31, 2005, we had net operating loss carryforwards for federal
income tax purposes of approximately $73,300,000 which expire in the years
2006 through 2025 and federal research and development tax credits of
approximately $1,300,000 which expire in the years 2006 through 2025.
As of December 31, 2005, we had net operating loss carryforwards for state
income tax purposes of approximately $26,000,000 which expire in the years
2012 through 2015 and state research and development tax credits of
approximately $1,400,000 which do not expire.
Utilization of our net operating loss and credit carryforwards may be subject
to substantial annual limitation due to the ownership change limitations
provided by the Internal Revenue Code and similar state provisions. Such an
annual limitation could result in the expiration of the net operating loss
and credits before utilization.
Note 13 Significant Agreements
Ortho Neutrogena Corporation
- ----------------------------
In May 1992, we entered into development and licensing and investment
agreements with Ortho Neutrogena (formerly Ortho-McNeil Pharmaceutical
Corporation) ("Ortho") for the development of retinoid products. The first
product is a Microsponge(R) system entrapment of tretinoin (trans-retinoic
acid or "t-RA"), a prescription acne drug product for which FDA approval was
received in February 1997. A second product licensed to Ortho is a
Microsponge entrapment of a retinoid to be used for the treatment of
photodamaged skin.
In February 1995, we received $750,000 in prepaid royalties and an additional
$750,000 as a milestone payment on the submission to the FDA of our New Drug
Application ("NDA") for the tretinoin prescription acne treatment. The
milestone payment was recognized as revenue upon receipt. The prepaid
royalties of $750,000 were recorded as deferred revenue. In February 1997,
upon receipt of approval from the FDA to market Retin-A Micro (tretinoin gel)
microsphere for the treatment of acne, we received $3 million from Ortho,
$1.5 million of which was a milestone payment that was recognized as revenue
in 1997 and $1.5 million of which was prepaid royalties that was recorded as
deferred revenue. As of December 31, 2005 and 2004, there were no amounts
remaining in deferred revenue.
Dermik
- ------
In March 1992, we restructured a 1989 joint venture agreement with Dermik, a
sanofi-aventis company. As part of the agreement, sanofi-aventis received
certain exclusive marketing rights. Product applications included a 5-FU
treatment for actinic keratoses. In 1998, this agreement was amended to give
Dermik an exclusive worldwide license to Microsponge-entrapped 5-FU and to
increase the royalty payable to us from 5% to 10%. In 1999, Dermik filed an
NDA for this product and in 2000, received FDA marketing clearance for the
product, which was launched under the trade name Carac in 2001. In 2003,
A.P. Pharma regained rights to Carac from Dermik for all regions outside the
U.S. and Canada. Dermik's exclusivity relating to Carac will continue as
long as annual minimum royalty payments are made, governed by the life of our
applicable patents, which continue until 2021.
On January 18, 2006 we sold our rights to royalties on sales of Retin-A Micro
and Carac for up to $30 million, of which $25 million was received at
closing. See Note 15 "Subsequent Event".
Note 14 Quarterly Results of Operations (Unaudited)
The following table presents summarized results of operations for each of our
quarters in the years ended December 31, 2005 and 2004. These quarterly
results are unaudited; however, in the opinion of management, such results
have been prepared on the same basis as our audited financial information and
include all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the information set forth therein.
QUARTERLY RESULTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
First Second Third Fourth
Year Ended December 31, 2005 Quarter Quarter Quarter Quarter
- ---------------------------- ------- ------- ------- -------
Total revenues $ 1,360 $ 1,250 $ 1,337 $ 1,444
Operating expenses 2,671 3,901 3,174 4,118
Interest income and other income, net 61 87 73 69
Loss from continuing operations (1,250) (2,564) (1,764) (2,605)
Discontinued operations (6) (44) 20 3
Net loss (1,256) (2,608) (1,744) (2,602)
Basic and diluted loss per common share:
Loss from continuing operations (0.05) (0.10) (0.07) (0.10)
Net loss (0.05) (0.10) (0.07) (0.10)
First Second Third Fourth
Year Ended December 31, 2004 Quarter Quarter Quarter Quarter
- ---------------------------- ------- ------- ------- -------
Total revenues $ 1,180 $ 1,284 $ 1,458 $ 1,482
Operating expenses 3,759 3,725 3,416 3,820
Interest and other, net 29 49 71 75
Loss from continuing operations (2,550) (2,392) (1,887) (2,263)
Discontinued operations (49) (52) (34) 6
Net loss (2,599) (2,444) (1,921) (2,257)
Basic and diluted loss per common share:
Loss from continuing operations (0.12) (0.11) (0.08) (0.09)
Net loss (0.13) (0.12) (0.08) (0.09)
Note 15 Subsequent Event
On January 18, 2006, we announced that we had sold our rights to royalties on
sales of Retin-A Micro and Carac effective October 1, 2005 to an affiliate of
the Paul Royalty Fund for up to $30 million.
Proceeds of $25 million were received upon the closing of the transaction and
will be used primarily to fund pivotal clinical development of APF530, our
drug candidate for the prevention of both acute and delayed chemotherapy-
induced nausea and vomiting. The remaining $5 million will be paid based on
the satisfaction of certain predetermined milestones over the next four
years.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
Item 9A. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures: We carried out an
evaluation, under the supervision and with the participation of our
management, including the Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the design and operations of our disclosure
controls and procedures pursuant to Rule 13a-15(e) and 15(d)-15(e) of the
Exchange Act. Based upon that evaluation, the Chief Executive Officer and
Chief Financial Officer concluded that as of December 31, 2005, the end of
the period covered by this report, our disclosure controls and procedures
were effective at the reasonable assurance level to timely alert them to
material information relating to the Company required to be included in our
Exchange Act filings.
(b) Changes in internal controls: During the quarter ended December 31,
2005, there have been no significant changes in our internal control over
financial reporting that materially affected, or are reasonable likely to
materially affect, our internal control over financial reporting.
Item 9B. OTHER INFORMATION
None.
Part III
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
APP incorporates by reference the information set forth under the caption
"Information Concerning the Board of Directors and Executive Officers" of the
Company's Proxy Statement (the "Proxy Statement") for the annual meeting of
shareholders to be held on May 31, 2006.
Code of Ethics
We have adopted a Code of Ethics that applies to all of our directors,
officers and employees. The Code of Ethics is posted on our website at
http://www.appharma.com under the caption Investor Relations.
Item 11. EXECUTIVE COMPENSATION
We have incorporated by reference the information set forth under the caption
"Executive Compensation" of the Proxy Statement.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The Company incorporates by reference the information set forth under the
caption "Common Stock Ownership of Certain Beneficial Owners and Management"
of the Proxy Statement.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company incorporates by reference the information set forth under the
caption "Certain Transactions" of the Proxy Statement.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The Company incorporates by reference the information set forth under the
captions "Report of the Audit Committee," "Ratification of Selection of
Independent Registered Public Accounting Firm" and "Fees Paid to Ernst &
Young LLP" of the Proxy Statement.
Part IV
Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 1. Financial Statements
The financial statements and supplementary data set forth in Part II
of the 10-K Annual Report are included herein.
2. Financial Statement Schedules
Schedule II Valuation Accounts
All other schedules have been omitted because the information is not
required or is not so material as to require submission of the
schedule, or because the information is included in the financial
statements or the notes thereto.
3. Exhibits
2.1-Copy of Asset Purchase Agreement between Registrant and RP
Scherer South, Inc. dated June 21, 2000. (1)
3-A-Copy of Registrant's Certificate of Incorporation. (2)
3-B-Copy of Registrant's Bylaws. (2)
10-C-Registrant's 1992 Stock Plan dated August 11, 1992. (3)*
10-D-Registrant's 1997 Employee Stock Purchase Plan dated March 5,
1997. (4)*
10-E-Lease Agreement between Registrant and Metropolitan Life
Insurance Company for lease of Registrant's executive offices
in Redwood City dated as of November 17, 1997. (5)
10-N-Agreement with Johnson & Johnson dated April 14, 1992. (6)
10-X-Registrant's Non-Qualified Plan
23.1-Consent of Independent Registered Public Accounting Firm.
31.1-Certification of Chief Executive Officer pursuant to Rules
13A-15(e) Promulgated under the Securities Exchange Act of
1934 as amended.
31.2-Certification of Chief Financial Officer pursuant to Rules
13A-15(e) Promulgated under the Securities Exchange Act of
1934 as amended.
32-Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
(c) Exhibits
The Company hereby files as part of this Form 10-K the exhibits listed
in Item 15(a)3 as set forth above.
- --------------------------------------------------------------------------
(1)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Form 8-K dated July 25, 2000, and incorporated herein by reference.
(2)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Registration Statement on Form S-1 (Registration No. 33-15429) and
incorporated herein by reference.
(3)Filed as Exhibit No. 28.1 to Registrant's Registration Statement on
Form S-8 (Registration No. 33-50640), and incorporated herein by
reference.
(4)Filed as an Exhibit No. 99.1 to Registrant's Registration Statement on
Form S-8 (Registration No. 333-35151), and incorporated herein by
reference.
(5)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1997, and
incorporated herein by reference.
(6)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1992, and
incorporated herein by reference.
(d) Financial Statement Schedules
See Item 15(a)2 of this Form 10-K.
* Management Contract or Compensatory plans.
SIGNATURES
Pursuant to the requirement of Section 13 or 15 (d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
A.P. PHARMA, INC.
By: /S/Michael O'Connell
----------------------------------------------
Michael O'Connell
President and Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature appears
below constitutes and appoints Michael O'Connell and Gordon Sangster, jointly
and severally, his or her attorneys-in-fact, each with the power of
substitution, for him or her in any and all capacities, to sign any
amendments to this Annual Report on Form 10-K and to file the same, with
exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his substitute or substitutes, may do or
cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
Signature Title Date
- --------------------------------------------------------------------------
/S/ Michael O'Connell President and Chief March 31, 2006
- ------------------------- Executive Officer --------------
Michael O'Connell (Principal Executive Officer)
/S/ Gordon Sangster Chief Financial Officer March 31, 2006
- ------------------------- (Principal Financial and --------------
Gordon Sangster Accounting Officer)
/S/ Paul Goddard Chairman of the Board of March 31, 2006
- ------------------------- Directors --------------
Paul Goddard
/S/ Stephen Drury Director March 31, 2006
- ------------------------- --------------
Stephen Drury
/S/ Peter Riepenhausen Director March 31, 2006
- ------------------------- --------------
Peter Riepenhausen
/S/ Toby Rosenblatt Director March 31, 2006
- ------------------------- --------------
Toby Rosenblatt
/S/ Gregory Turnbull Director March 31, 2006
- ------------------------- --------------
Gregory Turnbull
/S/ Dennis Winger Director March 31, 2006
- ------------------------- --------------
Dennis Winger
/S/ Robert Zerbe Director March 31, 2006
- ------------------------- --------------
Robert Zerbe
EXHIBIT INDEX
Form 10-K Annual Report
2.1-Copy of Asset Purchase Agreement between Registrant and RP Scherer
South, Inc. dated June 21, 2000. (1)
3-A-Copy of Registrant's Certificate of Incorporation. (2)
3-B-Copy of Registrant's Bylaws. (2)
10-C-Registrant's 1992 Stock Plan dated August 11, 1992. (3)*
10-D-Registrant's 1997 Employee Stock Purchase Plan dated March 5, 1997. (4)*
10-E-Lease Agreement between Registrant and Metropolitan Life Insurance
Company for lease of Registrant's executive offices in Redwood City
dated as of November 17, 1997. (5)
10-N-Agreement with Johnson & Johnson dated April 14, 1992. (6)
10-X-Registrant's Non-Qualified Stock Plan.
21-Proxy Statement for the Annual Meeting of Shareholders. (7)
23.1-Consent of Independent Registered Public Accounting Firm.
31.1-Certification of Chief Executive Officer pursuant to Rules
13A-15(e) Promulgated under the Securities Exchange Act of 1934 as
amended.
31.2-Certification of Chief Financial Officer pursuant to Rules 13A-15(e)
Promulgated under the Securities Exchange Act of 1934 as amended.
32-Certifications of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
- --------------------------------------------------------------------------
(1)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Form 8-K dated July 25, 2000, and incorporated herein by reference.
(2)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Registration Statement on Form S-1 (Registration No. 33-15429) and
incorporated herein by reference.
(3)Filed as Exhibit No. 28.1 to Registrant's Registration Statement on Form
S-8 (Registration No. 33-50640), and incorporated herein by reference.
(4)Filed as an Exhibit No. 99.1 to Registrant's Registration Statement on
Form
S-8 (Registration No. 333-35151), and incorporated herein by reference.
(5)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1997, and
incorporated herein by reference.
(6)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1992, and
incorporated herein by reference.
(7)To be filed supplementally.
* Management Contract or Compensatory plans.
Schedule II
Valuation and Qualifying Accounts (in thousands)
Additions Deductions,
Charged to write-offs
Beginning Cost and and Ending
Balance Expense Recoveries Balance
- ---------------------------------------------------------------------------
December 31, 2005
- -----------------
Accounts receivable, allowance
for bad debt $ -- $ -- $ -- $ --
Note receivable, allowance
for doubtful note $394 $ -- $ -- $394
December 31, 2004
- -----------------
Accounts receivable, allowance
for bad debt $ -- $ -- $ -- $ --
Note receivable, allowance
for doubtful note $413 $ -- $19 $394
December 31, 2003
- -----------------
Accounts receivable, allowance
for bad debt $28 $ -- $28 $ --
Note receivable, allowance
for doubtful note $437 $ -- $24 $413