**UNITED STATES****SECURITIES AND EXCHANGE COMMISSION**Washington, D.C. 20549

**FORM 10-K**

(Mark One)[**X**] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934

For the transition period from N/A to N/A

Commission file number 0-12984

 

ADVANCED TOBACCO PRODUCTS, INC.(Exact name of registrant as specified in its charter)

State of Texas                                                                                                                               74-2285214(State or other jurisdiction of                                                                                                     (I.R.S. Employerincorporation or organization)                                                                                                      Identification No.)

16607 Blanco Road, Suite 703                                                                                                          78232San Antonio, Texas                                                                                                                         (Zip Code)(Address of principal executive offices)

Registrant's telephone number, including area code: (210) 408-7077

Securities registered pursuant to Section 12(b) of the Act:

                                    Title of each class                                                 Name of each exchange                                                                                                                   on which registered                                          None                                                                       None           

Securities registered pursuant to Section 12(g) of the Act:

 

**Common Stock, $.01 par value**

(Title of Class)

     Indicate by check mark whether the registrant (1) has filed allreports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes   **X**_    No  ____   

     Indicate by check mark if disclosure or delinquent filespursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained,to the best of registrant's knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment to this Form10-K. [ **X** ] 

     As of November 29, 2002, the aggregate market value of thevoting and non-voting common equity held by non-affiliates of the registrant wasapproximately $3,617,740.

     As of November 29, 2002, the number of outstanding shares ofCommon Stock, $0.01 par value, of the registrant was 8,222,136. 

**PART I**

ITEM 1.BUSINESS AND CURRENT OPERATIONS

     **Advanced Tobacco Products, Inc., d/b/a AdvancedTherapeutic Products, Inc. ("ATP"), maintains a website at http://www.businesswire.com/cnn/avth.htm**

Forward-Looking Statements

     The forward-looking information contained in this report onForm 10-K is subject to change as the result of business, economic, competitive,regulatory, or other contingencies and uncertainties which cannot be predicted and whichare beyond the control of ATP and are subject to changes in the plans of PHA with regardto the Nicotrol/Nicorette Inhaler which are entirely at the discretion of PHA. 

History and Relationship with Pharmacia Corporation

     ATP, 16607 Blanco Road, Suite 703, San Antonio, Texas 78232,(210) 408-7077, is a Texas corporation formed in April 1983.

     In 1987, ATP sold patented nicotine technology, know how andrelated assets to what is now Pharmacia AB and Pharmacia & Upjohn Company("PHA"), subsidiaries of Pharmacia Corporation, a worldwide pharmaceuticalcompany that manufactures the Nicotrol/Nicorette ("Inhaler"), Nicorette ChewingGum, the Nicotrol/Nicorette Patch ("Patch") and the Nicotrol/Nicorette NasalSpray.

     The nicotine technology acquired from ATP forms the basis ofthe Inhaler developed by PHA for use in the nicotine replacement therapy market. ATPreceives product payments from sales of the Inhaler by PHA equal to 3% of PHA's net sales.See "Pharmacia Corporation Agreement."

     The Inhaler was launched nationwide in the U.S. as aprescription product in 1998. PHA has introduced the Inhaler, primarily as anover-the-counter product, in Australia, Austria, Belgium, Czech Republic, Denmark,Estonia, Finland, France, Hong Kong, Iceland, Ireland, Italy, Malasia, Malta, Mexico,Netherlands, New Zealand, Norway, Portugal, Russia, Singapore, South Africa, Sweden,Switzerland, Taiwan, and the United Kingdom

     The Inhaler is the only nicotine replacement product designedto help control a smoker's cravings for cigarettes while providing a key behavioralcomponent of smoking--the hand-to-mouth ritual. The Inhaler consists of a mouthpiece and acartridge containing nicotine. The user puffs on the mouthpiece, inhaling the nicotine,which is then absorbed through the lining of the mouth.

     ATP also has an agreement with PHA under which, among othermatters, ATP has the right to receive a royalty equal to .1% of net revenues received byPHA from the sale of any product using a nicotine impermeable copolymer technology.

     In addition, ATP has an exclusive worldwide license to certaindry powder nicotine inhaler technology from Duke University. ATP has obtained severalpatents covering this technology. ATP believes that a dry powder nicotine inhaler has thepotential to be a future generation nicotine replacement product.

Pharmacia Corporation Agreement

     ATP has the right to receive product payments from PHA withrespect to the Inhaler as follows:

Product payments of three percent (3%) of net sales (generally, sales by PHA towholesale distributors) payable on a country by country basis for the greater of 10 yearsfollowing the date of the first commercial sales or the expiration of all issued patentsenforceable in such countries. If the net sales to wholesale distributors cannot beobtained or are not disclosed, net sales are computed by multiplying the net sales of PHAto pre-wholesale distributors by 3.3. There are product payment limitations in the eventof the sale of a nicotine vapor product competitive with the Inhaler.

     The expiration date for applicable patents in most countriesis June 6, 2011. In the United States it is June 8, 2010.

     ATP has the right to receive product payments for othernicotine product applications, if any, both pharmaceutical and non-pharmaceutical. PHA isnot obligated to develop or sell any products using the technology developed by ATP.

ITEM 2.PROPERTIES

     ATP does not own any tangible fixed assets.

ITEM 3.LEGAL PROCEEDINGS

     ATP has no outstanding legal proceedings.

ITEM 4.SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     NONE

**PART II**

ITEM 5.MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     a) Market Information

     The Common Stock trades in the over-the-counter market throughthe OTC Bulletin Board quotation system under the symbol "AVTH." The followingtable sets forth the high and low bid price of ATP's Common Stock reported for the fiscalperiods indicated. Bid prices represent prices between dealers, do not include retailmarkups, markdowns or commissions, and may not represent actual transactions. 

|  | **FIRSTQUARTER**    2001          2002 | **SECONDQUARTER**    2001          2002 | **THIRDQUARTER**    2001          2002 | **FOURTHQUARTER**    2001          2002 |
|--|--------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------------|

| HIGH | .39 | .36 | .32 | .36  | .34 | .37 | .36 | .43 |
|------|-----|-----|-----|------|-----|-----|-----|-----|
| LOW  | .19 | .26 | .20 | .305 | .29 | .35 | .30 | .34 |

     b) Holders

     There were approximately 1,750 shareholders of record of ATP'sCommon Stock at September 30, 2002.

     c) Dividends

     ATP anticipates declaring and paying dividends from time totime while substantial product payments are received from the sale of products under ATP'sagreements with PHA.

     On November 26, 2002, ATP declared a dividend of $.08 pershare payable on January 9, 2003, to shareholders of record as of December 20, 2002.

     On November 27, 2001, ATP declared a dividend of $.05 pershare payable on January 9, 2002, to shareholders of record as of December 21, 2001.

     On November 22, 2000, ATP declared a dividend of $.05 pershare payable on January 10, 2001, to shareholders of record as of December 22, 2000.

 

ITEM 6.SELECTED FINANCIAL DATA

     The following table sets forth for the indicated periods selectedhistorical financial information for ATP. Such information is derived from the financialstatements of ATP included under Item 8 and should be read in conjunction with suchfinancial statements, the related notes thereto and the information included under Item 7,"Management's Discussion and Analysis of Financial Condition and Results ofOperations."

|  |  | Three Months |  |  |  |
|--|--|--------------|--|--|--|

|  | Year Ended | Ended         |                         |  |
|--|------------|---------------|-------------------------|--|
|  | June 30    | September 30, | Year Ended September 30 |  |

|                                                                            | 1998      | 1998      | 1999      | 2000      | 2001      | 2002      |
|----------------------------------------------------------------------------|-----------|-----------|-----------|-----------|-----------|-----------|
|                                                                            |           |           |           |           |           |           |
| Revenues                                                                   | $ 516,600 | $ 352,000 | $ 964,582 | $ 496,516 | $ 643,399 | $ 826,771 |
|                                                                            |           |           |           |           |           |           |
| Net income                                                                 | 467,121   | 331,758   | 909,893   | 447,328   | 529,091   | 642,239   |
| Net income per share of common stock - basic                               | .06       | .04       | .11       | .05       | .06       | .08       |
| Net income per share of common stock - diluted                             | .06       | .04       | .11       | .05       | .06       | .08       |
| Weighted-average number of shares of common stock outstanding - basic      | 8,092,136 | 8,092,136 | 8,092,136 | 8,173,010 | 8,217,040 | 8,222,136 |
| Weighted-average number of shares of common stock outstanding -    diluted | 8,205,502 | 8,216,836 | 8,195,340 | 8,180,833 | 8,217,191 | 8,222,136 |
| Cash provided by (used in) operations                                      | 93,005    | 360,279   | 1,048,490 | 435,978   | 462,466   | 522,014   |
| Increase (decrease) in cash and cash equivalents                           | 52,554    | 356,791   | 241,579   | (566,055) | 69,752    | 154,924   |
| Balance sheet data to end of indicated periods                             |           |           |           |           |           |           |
| Working capital                                                            | 939,872   | 687,338   | 1,608,228 | 772,654   | 857,335   | 1,062,236 |
| Total assets                                                               | 2,063,651 | 2,411,756 | 2,750,124 | 2,022,345 | 2,164,881 | 2,399,723 |
| Total stockholders' equity                                                 | 2,060,849 | 1,826,157 | 2,736,050 | 1,998,308 | 2,124,731 | 2,355,863 |

ITEM 7.MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS

     a) Results of Operations

     Operating revenues were $496,516, $643,399, and $826,771 forthe twelve months ended September 30, 2000, 2001 and 2002, respectively.

     All revenues resulted from the recognition of product paymentsfrom PHA's sales of the Inhaler and the Patch. Product payments generated by the Patchwere $11,693, $18,104, and $36,151 in fiscal 2000, 2001 and 2002, respectively.

     General and administrative expenses were $140,735, $203,310,and $270,307 in fiscal 2000, 2001 and 2002, respectively. General and administrativeexpenses for fiscal 2002 decreased to $270,307 as compared to $278,310 for fiscal 2001,after adjusting general and administrative expenses for fiscal 2001 for non-recurringpayments totaling $75,000 which were credited against general and administrative expensesfor 2001. The noncurring payments were "stand still" fees paid by third-partiesfor review of ATP and its assets.

     Income from operations was $355,781, $440,089 and $556,464, infiscal 2000, 2001 and 2002, respectively. The increases in income from operations from2000 through 2002 were primarily due to the increases in product payments from PHA's salesof the Inhaler. ATP's net income for fiscal 2002 was $642,239, which included $85,775 ofinterest income. 

     b) Liquidity and Capital Resources

     Cash and investments available on September 30, 2002, wereapproximately $2,044,648. ATP believes that its cash and investment resources aresufficient to meet its foreseeable needs.

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The financial statements and other matters required by thisItem 8 are included on Pages F-1 and following.

ITEM 9.DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

     None

**PART III**

ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     ATP's entire Board of Directors acts as its audit committee.

     Mr. James E. Turner, age 54, has been a Director of ATP sinceNovember 1986 and a consultant to ATP since its inception. Mr. Turner was one of thefounders and the Business Manager of NCC Group, Ltd., a research and development limitedpartnership which was a predecessor of ATP. Mr. Turner was a consultant to PHA from Augustof 1987 until September of 2000.

     Mr. J. H. Uptmore, age 71, has been a Director of ATP sinceAugust 1987. Mr. Uptmore has been the President and Chairman of the Board of J. H. Uptmore& Associates, Inc., a construction contracting and development company, since 1974.

     Mr. J. W. Linehan, age 59, has been Director of ATP since June1991, and President, Chief Executive Officer, Chief Financial Officer and Secretary of ATPsince July 1, 1990. Since August 1, 1995, Mr. Linehan has been President and ChiefExecutive Officer of Linehan Engineering, Inc., an independent engineering company whollyowned by him.

     Ms. Brenda Ray, age 53, has been a Director of ATP since March1989. Ms. Ray assisted in the original research and development of ATP's nicotine vaporinhalation technology. She is a consultant and has been President of Brenda Ray, Inc.since 1985.

     Mr. David A. Monroe, age 50, has been a Director of ATP sinceMarch 1989. Mr. Monroe is President and CEO of PhotoTelesis Corporation, a governmentelectronics manufacturing company, and e-Watch, Inc., a commercial electronics company.Mr. Monroe's prior experience includes Division General Manager of Raytheon TI Systems,Inc., Founder & Chief Technical Officer of Image Data Corporation, a communicationstechnology company, and Vice-President of Datapoint Corporation, a computer equipmentmanufacturer.

ITEM 11.EXECUTIVE COMPENSATION

Cash Compensation

     Mr. Linehan, President and Chief Executive Officer of ATP andits sole executive officer, receives no salary or fees, but indirectly benefits frompayments made to Linehan Engineering, Inc. (See Item 13, "Certain Relationships andRelated Transactions"). Each Director is entitled to receive travel expenses incurredby them in order to attend Directors' meetings.

Non-Statutory Stock Options

     On October 1, 2000, ATP issued a non-statutory stock option toJames A. Turner ("Turner"), a director of ATP, for 100,000 shares of ATP'scommon stock at an exercise price of $0.2813 per share, the approximate market value of ashare of ATP common stock on October 1, 2000. 30,000 of the shares under option wereexercised and the balance of 70,000 shares under option become exercisable in the event ofa business combination or strategic alliance presented by Turner and approved by the Boardof Directors of ATP prior to September 30, 2003. The option expires on September 30, 2005.

Stock Option Exercises and 2002 Fiscal Year - End Option Values

     The following table details the number and value of commonstock underlying unexercised options held by directors as of September 30, 2002.

| Name | Common Stock 
Underlying OptionsValue of Unexercised 
In-the-Money OptionExercisableUnexercisableExercisableUnexercisableJames E. Turner-0-70,000-0-$ 9,709
     Mr. Turner exercised an option to purchase 30,000 shares ofcommon stock on December 1, 2000, at an exercise price of $0.2813 per share at anaggregate realized value of $0.00. On December 1, 2000, the approximate market value ofATP stock was $0.2813 per share.

ITEM 12.COMMON STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERSAND MANAGEMENT

     The following table sets forth certain information about theDirectors of ATP, and all persons known by ATP to own more than 5% of the Common Stock asof November 30, 2002, and all officers and Directors of ATP as a group as of September 30,2002. Except as indicated, ATP believes that each of the below named persons has solevoting and investment power with respect to the shares shown and owns the shares indicatedbeneficially and of record. All of the Common Stock held by the persons described in thefollowing table is available for sale under Rule 144 of the Securities and ExchangeCommission.
**Name****Director Since****Number of Shares****Percent of Class**Brenda Ray (1)     12544 Judson Road    San Antonio, TX 7823319891,397,46417.00%James E. Turner (3)     307 Wayside Drive    San Antonio, TX 782131986400,2214.87%J. H. Uptmore (2)     P.O. Box 29389    San Antonio, TX 782291987196,9212.40%David A. Monroe (3)     7800 I.H. 10 W    San Antonio, TX 78230198947,229.57%J.W. Linehan     16607 Blanco Road, Suite 703    San Antonio, TX 78232199190,0001.09%Officers and Directors          as a Group (5 persons)2,231,83627.14%Hummingbird Management, LLC (4)N/A427,7005.2%
(1)    Includes 420,104 shares of Common Stock owned by the Jon PhilipRay Family Trust of which Brenda Ray is a beneficiary.

(2)    Includes 46,921 shares of Common Stock owned by J. H. Uptmore& Associates, Inc., of which Mr. Uptmore is President and Chairman of the Board.

(3)    Does not include shares under outstanding stock options.

(4)    Hummingbird Management, LLC acts as investment manager to theHummingbird Value Fund, L.P. and to the Hummingbird Microcap Value Fund, L.P., which arethe holders of the 427,700 shares held in respective amounts unknown to the Company.

Compliance with Section 16(a) of the Exchange Act

     Section 16(a) of the Securities Exchange Act of 1934 requiresATP's directors, executive officers, and any persons holding more than ten percent (10%)of ATP's Common Stock to report their initial ownership of ATP's Common Stock and anysubsequent changes in that ownership to the Securities and Exchange Commission and toprovide copies of such reports to ATP. Based upon ATP's review of copies of such reportsreceived by ATP, ATP believes that during the year ended September 30, 2002, all Section16(a) filing requirements were satisfied.

ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTION

     Since August 1995, ATP has had an Administrative ServicesAgreement with Linehan Engineering, Inc. ("LEI"), a related-party entity ownedby ATP's president. In 2000, 2001 and 2002, ATP paid LEI $39,780, $40,980 and $44,420respectively.

     Since October, 2000, ATP has had a Consulting ServicesAgreement with James E. Turner ("Turner"), a director of ATP. In 2001 and 2002,ATP paid Turner $66,000 and $84,000, respectively. Under the Consulting ServicesAgreement, Turner was granted an option to purchase up to 100,000 shares of Common Stock,exercisable as to 30,000 shares immediately and an additional 70,000 shares becomingexercisable in the event of a business combination or strategic alliance presented byTurner and approved by the Board of Directors of ATP prior to September 30, 2003. Theoption includes an exercise price of $0.2813 per share and the option expires September30, 2005. In addition, ATP can terminate the Consulting Services Agreement upon 30 day'swritten notice to Turner and payment to Turner of $21,000; however, if ATP terminates theConsulting Services Agreement prior to June 30, 2003, as the result of the completion of abusiness combination or strategic alliance generated by Turner, ATP shall pay Turner$42,000.

     Since October 1996, ATP has had a Consulting ServicesAgreement with Brenda Ray, Inc. ("Ray"), a related-party entity owned by adirector of ATP. In 2000, 2001 and 2002, ATP paid Ray $12,000, $12,000, and $12,000,respectively.

 

**PART IV**

ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ONFORM 8-K

     (a) The following documents are filed as part of this AnnualReport on Form 10-K:

          1. Financial Statements andIndependent Auditors' Report

             The financialstatements listed in the index to financial statements follows the signature page of thisreport.

          2. Financial Statement Schedules

             ATP did notmeet any of the requirements to provide financial statement schedules for any of thefiscal             years ended 2002,2001, or 2000.

          3. Exhibits

             99.1.1Certification of Chief Executive and Chief Financial Officer pursuant to Section 906 ofthe Sarbanes Oxley             Act of 2002.

     (b)   ATP filed two Current Reports on Form 8-Ksince the filing of ATP's last 10-K; one in August 5, 2002 disclosing a change in theCompany's accountants from Arthur Anderson LLP to The Hanke Group P.C. and the other onAugust 15, 2002, attaching a Certificate of the Chief Executive and Financial Officer ofATP.

SIGNATURES

     Pursuant to the requirements of the Section 13 or 15(d) of theSecurities Exchange Act of 1934, the Registrant has duly caused this report to be signedon behalf by the undersigned, there unto duly authorized, in the City of San Antonio,State of Texas, as of December 22, 2002.

                                                                                                              ADVANCED TOBACCO PRODUCTS, INC.

 

Date: December 22, 2002                                                                        By /s/   J.W. Linehan                                                                                                                                                    J. W. Linehan, President,                                                                                                                    Chief Executive Officer and                                                                                                                    Chief Accounting and Financial Officer

     I, J. W. Linehan, Chief Executive Officer and Chief FinancialOfficer of Advanced Tobacco Products, Inc. ("Company"), certify that:

     1. I have reviewed this Form 10-K of the Company;

     2. Based on my knowledge, this annual report does not containany untrue statement of a material fact or omit to state a material fact necessary to makethe statements made, in light of the circumstances under which such statements were made,not misleading with respect to the period covered by this annual report;

     3. Based on my knowledge, the financial statements, and otherfinancial information included in this annual report, fairly present in all materialrespects the financial condition, results of operations and cash flows of the Company asof, and for, the periods presented in this annual report;

     4. I am responsible for establishing and maintainingdisclosure controls and Procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)for the registrant and have designed such disclosure controls and procedures to ensurethat material information relating to the Company is made known to me by others,particularly during the period in which this annual report is being prepared;

     5. I have evaluated the effectiveness of the issuer'sdisclosure controls and procedures as of a date within 90 days prior to the filing date ofthe report and have presented in the report their conclusions about the effectiveness ofthe disclosure controls and procedures based on the required evaluation as of that date;

     6. I have disclosed, based on my most recent evaluation, tothe Company's auditors and the audit committee of our board of directors (or personsperforming the equivalent functions):

          a. All significant deficienciesin the design or operation of internal controls which could adversely affect the Company'sability to record, process, summarize and report financial data and have identified forthe Company's auditors any material weakness in internal controls, and

          b. Any fraud, whether or notmaterial, that involves management or other employees who have a significant role in theCompany's internal controls; and

     7. I have indicated in this annual report whether or not therewere significant changes in internal controls or in other factors that could significantlyaffect internal controls subsequent to the date of my most recent evaluation, includingany corrective actions with regard to significant deficiencies and material weaknesses.

SIGNATURES:

     Pursuant to the requirements of the Securities Exchange Act of1934, this report has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

Date: December 22, 2002                                                                        By: /s/ J.W. Linehan                                                                                                                                 J. W. Linehan, President,                                                                                                                     Chief Executive Officer and                                                                                                                     Chief Accounting and Financial Officer

 

Date: December 22, 2002                                                                       By: /s/  James E. Turner                                                                                                                                    James E. Turner, Director

Date: December 22, 2002                                                                       By: /s/  J.H. Uptmore                                                                                                                                       J.H. Uptmore, Director

Date: December 22, 2002                                                                       By: /s/  Brenda Ray                                                                                                                                           Brenda Ray, Director

Date: December 22, 2002                                                                        By: /s/  David A. Monore                                                                                                                                     David A. Monroe, Director

**ADVANCED TOBACCO PRODUCTS, INC.**

**d/b/a ADVANCED THERAPEUTIC PRODUCTS, INC.**

ITEM 8. Financial Statements

The following financial statements are included in response to Item 14 (a):

                                                                                                                                          Page 

Index to Financial Statements                                                                                              F-1

Report of Independent Public Accountants                                                                          F-2

Balance Sheets - - September 30, 2002 and 2001                                                              F-3

Statements of Income for the Years EndedSeptember 30, 2002, 2001 and 2000                                                                                 F-4

Statements of Stockholders' Equity for the YearsEnded September 30, 2002, 2001, 2000 and 1999                                                             F-5

Statements of Cash Flows for the Years EndedSeptember 30, 2002, 2001 and 2000                                                                                   F-6

Notes to Financial Statements                                                                                               F-7

                                                                                F-1

 

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors and Stockholders ofAdvanced Tobacco Products, Inc., d/b/aAdvanced Therapeutic Products, Inc.:

     We have audited the accompanying balance sheet of AdvancedTobacco Products, Inc. (a Texas corporation), d/b/a Advanced Therapeutic Products, Inc.,as of September 30, 2002, and the related statement of income, stockholders' equityand cash flows for the year ended September 30, 2002. These financial statements are theresponsibility of the Company's management. Our responsibility is to express an opinion onthese financial statements based on our audit. The financial statements of AdvancedTobacco Products, Inc., d/b/a Advanced Therapeutic Products, Inc., as of September 30,2001 and 2000, were audited by other auditors whose report dated November 27, 2001,expressed an unqualified opinion on those statements.

     We conducted our audit in accordance with auditing standardsgenerally accepted in the United States of America. Those standards require that we planand perform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statement presentation. Webelieve that our audit provides a reasonable basis for our opinion.

     In our opinion, the 2002 financial statements referred toabove present fairly, in all material respects, the financial position of Advanced TobaccoProducts, Inc., d/b/a Advanced Therapeutic Products, Inc., as of September 30, 2002,and the results of its operations and its cash flows for the year ended September 30,2002, in conformity with accounting principles generally accepted in the United States ofAmerica.

The Hanke Group, P.C.

San Antonio, TexasNovember 25, 2002

                                                                                 F-2

ADVANCED TOBACCO PRODUCTS, INC.

d/b/a ADVANCED THERAPEUTIC PRODUCTS, INC.

BALANCE SHEETS - - SEPTEMBER 30, 2002 AND 2001
2002 2001 ASSETSCURRENT ASSETS:Cash and cash equivalents$ 348,422$ 193,498Product payments receivable187,385142,095Other receivables2,0772,436Investments568,212559,456Total current assets1,106,096897,485LICENSE AGREEMENTS, less accumulated amortization        of $108,613 and $90,359 as of 2002 and 2001, respectively    144,098    162,352LONG-TERM INVESTMENTS1,149,5291,105,044Total assets$ 2,399,723$ 2,164,881LIABILITIES AND STOCKHOLDERS' EQUITYLIABILITIES:Book overdraft$ 21,515$ - Accrued liabilities22,34540,150Total liabilities43,86040,150STOCKHOLDERS' EQUITY:Preferred stock, $100 par value; 500,000 shares authorized; none issued-  -  Common stock, $.01 par value; 30,000,000 shares authorized; 8,222,136 issued and    outstanding    82,222    82,222Additional paid-in capital12,595,76712,595,767Accumulated deficit(10,322,126)(10,553,258)Total stockholders' equity2,355,8632,124,731Total liabilities and stockholders' equity$ 2,399,723$ 2,164,881
The accompanying notes are an integral part of these financialstatements.

                                                                                   F-3

 

ADVANCED TOBACCO PRODUCTS, INC.

d/b/a ADVANCED THERAPEUTIC PRODUCTS, INC.

STATEMENTS OF INCOME

 
For the Year Ended September 30200220012000REVENUES:Product payments$ 826,771$ 643,399$ 496,516Total operating revenues826,771643,399496,516EXPENSES:General and administrative270,307203,310140,735Total operating expenses270,307203,310140,735INCOME FROM OPERATIONS556,464440,089355,781OTHER INCOME:Interest income85,77589,00291,547Total other income85,77589,00291,547INCOME BEFORE INCOME TAXES642,239529,091447,328INCOME TAX EXPENSE-  -  -  NET INCOME$ 642,239$ 529,091$ 447,328INCOME PER COMMON SHARE - BASIC$.08$.06$.05WEIGHTED-AVERAGE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING - BASIC    8,222,136    8,217,040    8,173,010INCOME PER COMMON SHARE - DILUTED$.08$.06$.05WEIGHTED-AVERAGE NUMBER OF SHARES OF COMMON STOCK OUTSTANDING - DILUTED    8,222,136    8,217,191    8,180,833CASH DIVIDENDS DECLARED PER SHARE OF COMMON STOCK$.05$.05$.15
The accompanying notes are an integral part of these financialstatements.

                                                                                       F-4

 

 

ADVANCED TOBACCO PRODUCTS, INC.

d/b/a ADVANCED THERAPEUTIC PRODUCTS, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY

Common StockAdditional    Paid-In
AccumulatedSharesAmountCapitalDeficitTotalBALANCE, September 30, 19998,092,136$ 80,922$ 12,544,878$ (9,889,750)$ 2,736,050Net income-  -  -  447,328447,328Exercise of stock options100,0001,00042,750-  43,750Dividends declared-  -  -  (1,228,820)(1,228,820)BALANCE, September 30, 20008,192,13681,92212,587,628(10,671,242)1,998,308Net income-  -  -  529,091529,091Exercise of stock options30,0003008,139-  8,439Dividends declared-  -  -  (411,107)(411,107)BALANCE, September 30, 20018,222,13682,22212,595,767(10,553,258)2,124,731Net income-  -  -  642,239642,239Dividends declared-  -  -  (411,107)(411,107)BALANCE, September 30, 20028,222,136$ 82,222$ 12,595,767$ (10,322,126)$ 2,355,863
The accompanying notes are an integral part of these financialstatements.

                                                                                     F-5

 

ADVANCED TOBACCO PRODUCTS, INC.

d/b/a ADVANCED THERAPEUTIC PRODUCTS, INC.

STATEMENTS OF CASH FLOWS
For the Year Ended September 302002 2001 2000 CASH FLOWS FROM OPERATING ACTIVITIES:Net income$ 642,239$ 529,091$ 447,328Adjustments to reconcile net income to net cash provided by operating activities-Amortization of license agreements18,25427,50415,860Amortization of discount on investments(75,743)(73,503)(71,046)(Increase) decrease in product payments receivable(45,290)(34,303)32,286(Increase) decrease in other receivables359(2,436)1,587(Decrease) increase in accrued liabilities(17,805)16,1139,963Net cash provided by operating activities522,014462,466435,978CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of license agreements-  -  (31,273)Purchase of investments(542,498)(565,046)(585,690)Maturity of investments565,000575,000800,000Net cash provided by investing activities22,5029,954183,037CASH FLOWS FROM FINANCING ACTIVITIES:Increase in book overdraft21,515-  -  Exercise of stock options-  8,43943,750Dividends declared(411,107)(411,107)(1,228,820)Net cash used in financing activities(389,592)(402,668)(1,185,070)NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS154,92469,752(566,055)CASH AND CASH EQUIVALENTS, beginning of year193,498123,746689,801CASH AND CASH EQUIVALENTS, end of year$ 348,422$ 193,498$ 123,746
The accompanying notes are an integral part of these financialstatements.

 

F-6

 

                                                          ADVANCED TOBACCO PRODUCTS, INC.

d/b/a ADVANCED THERAPEUTIC PRODUCTS, INC.

NOTES TO FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Organization and Basis of Presentation

     Advanced Tobacco Products, Inc. (a Texas corporation), d/b/aAdvanced Therapeutic Products, Inc. (ATP or the Company), was formed in April 1983. In1987, ATP sold certain nicotine technology and related assets to what is now PharmaciaCorporation (PHA), a worldwide pharmaceutical company, for $3.6 million and the rightto future product payments.

Revenue Recognition and Current Operations

     The nicotine technology acquired from ATP forms the basis ofthe Nicotrol/Nicorette Inhaler (Inhaler) developed by PHA for use in the nicotinereplacement therapy market. Product payments from sales of the Inhaler, outside the U.S.,are 3 percent of PHA's net sales to pharmacy distributors. Until June 30, 2000,payments from U.S. sales of the Inhaler were 9.9 percent of PHA's net sales to McNeilConsumer Health Care (McNeil), a Johnson & Johnson Company, which marketed the Inhalerto pharmacies. Effective July 1, 2000, PHA reacquired, from McNeil, the rights tomarket the Inhaler in the U.S. Payments from the U.S. sales of the Inhaler are now3 percent of PHA's net sales. PHA is under no obligation to market these products.The agreement with PHA provides for quarterly product payments. The agreement alsoprovides for certain reduction of product payments paid to ATP if these payments exceed$1,000,000 in a given year. ATP recognized revenues from PHA at the time PHA has sales ofits related product.

     In addition, ATP has an agreement with PHA under which, amongother matters, ATP has the right to receive a royalty equal to 0.1 percent of netrevenues received by PHA from the sale of any product using a nicotine impermeablecopolymer technology. 

     ATP also has an exclusive worldwide license to certain drypowder nicotine inhaler technology from Duke University. ATP has obtained several patentscovering this technology. ATP believes that a dry powder nicotine inhaler has thepotential to be a future generation nicotine replacement product.

Concentration of Credit Risk

     ATP's product payments and payments receivable are derivedsolely from PHA. At September 30, 2002, ATP had cash deposits at financial institutionsexceeding federally insured limits by approximately $348,000, without regard toreconciling items. No allowance for doubtful accounts is considered necessary atSeptember 30, 2002 or 2001. 

Use of Estimates

     The preparation of financial statements in conformity withaccounting principles generally accepted in the United States of America requires ATP tomake estimates and assumptions that affect the reported amounts of assets and liabilitiesand disclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

                                                                                F-7Net Income Per Share

     Statement of Financial Accounting Standards (SFAS)No. 128, "Earnings Per Share," requires presentation of basic earnings pershare and diluted earnings per share, simplifies computational guidelines and increasesthe comparability of earnings per share on an international basis. Basic earnings percommon share is based on the weighted-average number of common shares outstanding duringthe respective years. Diluted earnings per share is based on the weighted-average numberof common shares outstanding and dilutive common stock equivalents.

     The following is a reconciliation of the denominators of thebasic and diluted per-share computations for net income:
    Weighted-average     Number of Shares of    Common StockOutstanding - Basic    Effect of     DilutiveStock OptionsWeighted-average     Number of Shares of    Common StockOutstanding - DilutedFor the year ended September 30-20028,222,136-8,222,13620018,217,0401508,217,19120008,173,0107,8238,180,833
Cash and Cash Equivalents

     ATP considers all investments with original maturities of lessthan three months to be cash equivalents.

License Agreement

     In fiscal year 1993, ATP entered into a license agreement fornicotine technology with Duke University. The term of the license agreement is for anyperiod such nicotine technology is under patent. ATP capitalized the direct costs incurredin obtaining the license agreement plus patent prosecution costs. These costs are beingamortized on a straight-line basis over 20 years.

Non-Statutory Stock Options

     ATP accounts for non-statutory stock options using the"intrinsic value" method of accounting set forth in APB Opinion No. 25,"Accounting for Stock Issued to Employees," and related interpretations.Accordingly, compensation cost for options is measured as the excess, if any, of thequoted market price of ATP's common stock at the date of the grant over the amount anemployee must pay to acquire the stock. SFAS No. 123, "Accounting forStock-Based Compensation," encourages, but does not require companies to measure andrecognize in their financial statements a compensation cost for stock-based compensationbased on the "fair value" method of accounting set forth in the statement.

Investments in Securities

     ATP accounts for investments in debt securities asheld-to-maturity securities, as set forth in SFAS No. 115, "Accounting forCertain Investments in Debt and Equity Securities." These securities are stated inthe accompanying financial statements at historical cost plus accretion of relateddiscount (for U.S. Treasury and Agency Bonds). Debt securities with a maturity of lessthan one year are classified in the balance sheet as current assets, while debt securitieswith a maturity of greater than one year are classified as long-term assets.

2. ACCOUNTING PRONOUNCEMENTS:

*FASB Statement No. 144*

     On January 1, 2002, SFAS No. 144, "Accounting for theImpairment or Disposal of Long-Lived Assets," became effective. It provides guidanceon the accounting for the impairment or disposal of long-lived assets. For long-livedassets to be held and used, the new rules are similar to previous guidance which requiredthe recognition of an impairment when the undiscounted cash flows would not recover itscarrying amount. The impairment to be recognized will continue to be measured as thedifference between the carrying amount and fair value of the asset. The computation offair value now removes goodwill from consideration and incorporates a probability-weightedcash flow estimation approach as an alternative to the traditional present value method.The previous guidance provided in SFAS No. 121 is to be applied to assets that are to bedisposed of by sale. Additionally, assets qualifying for discontinued operations treatmenthave been expanded beyond the former major line of business or class of customer approach.Long-lived assets to be disposed of by other than sale are now considered assets to beheld and used until the disposal date. The Company has reviewed the requirements ofStatement No. 144 and does not expect to be impacted by this Statement.

*FASB Statement No. 145*

     In April 2002, the Financial Accounting Standards Board (FASB)issued Statement No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendmentof FASB Statement No. 13, and Technical Corrections." This statement:

rescinds Statement No. 4, "Reporting Gains and Losses from Extinguishment ofDebt,"rescinds Statement No. 64, "Extinguishments of Debt Made to Satisfy Sinking-FundRequirements,"rescinds Statement No. 44, "Accounting for Intangible Assets of Motor Carriers,"andamends Statement No. 13, "Accounting for Leases," to eliminate an inconsistencybetween the required accounting for sale-leaseback transactions and the requiredaccounting for certain lease modifications that have economic effects that are similar tosale-leaseback transactions.

This statement also amends other existing authoritative pronouncements to make varioustechnical corrections, clarify meanings, or describe their applicability under changedconditions. The Company has reviewed the requirements of Statement No. 145 and does notexpect to be impacted by this Statement.

*FASB Statement No. 146*

In June 2002, the FASB issued Statement of Financial Accounting Standard No. 146,"Accounting for Costs Associated with Exit or Disposal Activities," whichaddresses accounting for restructuring and similar costs. Such costs include leasetermination costs and certain employee severance costs that are associated with arestructuring, discontinued operations, plant closings or other exit or disposalactivities. Statement No. 146 supercedes previous accounting guidance, principallyEmerging Issues Task Force (EITF) Issue No. 94-3. Statement No. 146 requires that theliability for costs associated with an exit or disposal activity be recognized, at fairvalue, when the liability is incurred. Under EITF No. 94-3, a liability for an exit costwas recognized at the date of the entity's commitment to an exit or disposal plan. TheCompany has reviewed the requirements of Statement No. 146 and does not expect to beimpacted by this Statement.

3. INVESTMENTS:

     ATP's investments consist of U.S. Treasury and Agency zerocoupon bonds which were purchased at a discount from their face value and certificates ofdeposit. ATP intends to hold all investments held at September 30, 2002, to theirrespective maturities, which range from November 2002 to December 2006.

     Investments classified as current assets at September 30,2002, include the following:

 
Book ValueFair ValueUnited States Treasury Bonds$568,212$ 581,198
     Investments classified as long-term assets atSeptember 30, 2002, include the following:

 
Book ValueFair ValueUnited States Treasury and Agency Bonds$ 969,529$ 1,019,243Certificates of Deposit180,000180,000$1,149,529$1,199,243
     Investments classified as current assets at September 30,2001, include the following:

 
Book ValueFair ValueUnited States Treasury Bonds$559,456$ 562,065
     Investments classified as long-term assets atSeptember 30, 2001, include the following:
Book ValueFair ValueUnited States Treasury and Agency Bonds$925,044$959,962Certificates of Deposit180,000180,000$1,105,044$1,139,962
     The difference between cost and fair value for the investmentsdiscussed above represent unrealized holding gains and losses. Fair value was obtainedfrom ATP's securities broker using quoted market prices.

     Investment income by asset classification is as follows:
September 302002 2001 2000 United States Treasury and Agency Bonds$ 75,743$ 75,933$ 72,771Certificates of Deposits6,2634,8913,043Money Market Mutual Funds3,7698,17815,733Total$ 85,775$ 89,002$ 91,547
4. FEDERAL INCOME TAXES:

     Income taxes are recognized for (a) amounts payable orrefundable in the current year and (b) deferred tax assets and liabilities for thefuture tax consequences of events that have been recognized in the Company's financialstatements. Deferred tax assets and liabilities are determined by applying the statutoryrate in effect at the balance sheet date to differences between the book and tax basis ofassets and liabilities. 

     As of September 30, 2002, ATP had remaining tax netoperating loss carryforwards of $1,233,209 which may be used to reduce taxes againstfuture earnings. The Company files its tax return on a fiscal year starting June 30. Thenet operating loss carryforwards expire between 2003 and 2011 as follows: $988,839 onJune 30, 2003, $118,883 on June 30, 2004, $91,380 on June 30, 2005, and$34,107 on June 30, 2011. ATP believes that it is "more likely than not"that the Company will not realize its deferred tax assets, accordingly, a valuationallowance equivalent to the deferred tax assets has been established.

The tax effects of net operating loss carryforwards are as follows:
September 3020022001Deferred income tax assets-Net operating loss carryforwards$ 419,291$ 1,079,550Less- Valuation allowance(419,291)(1,079,550)Net deferred tax assets$ -  $ -  
5. NON-STATUTORY STOCK OPTIONS:

     No options were granted, exercised, or expired during the yearended September 30, 2002. The following table summarizes the activity in ATP'snon-statutory stock options for the year ended September 30, 2002:
    Stock OptionsWeighted Average Exercise Price    Per ShareOutstanding at September 30, 2000--Exercised100,000.2813Expired30,000.2813Granted100,000.3350Outstanding at September 30, 2001170,000.3129Expired100,000.3350Outstanding at September 30, 200270,000.2813
     On October 1, 2000, ATP granted James E. Turner30,000 stock options at $.2813 per share with an additional 70,000 optionsexercisable upon certain conditions being met (see Note 5 for further discussion).The 30,000 stock options available to Mr. Turner were exercised on December 1,2000, at $.2813 per share. On June 15, 2001, ATP granted David A. Monroe, a directorof ATP, 100,000 options at $.335 per share which expired on June 15, 2002.

     If the Company had adopted fair value accounting method forits options under SFAS 123, the Company's net income would not have been affected in2002. Net income would have been reduced in 2001 by approximately $5,000. However, therewould be no change to either basic or diluted earnings per share for 2001. The fair valueof these options was estimated in 2001 using a Black-Scholes option pricing model with arisk-free interest rate of 2.38 percent, a volatility factor of .713, a dividendyield of 29 percent and a remaining option term of nine months.

6. RELATED-PARTY TRANSACTIONS:

     Since October, 2000, ATP has had a Consulting ServicesAgreement with James E. Turner ("Turner"), a director of ATP. Under theConsulting Services Agreement, ATP is required to pay $7,000 per month for Turner'sconsulting services. During the year ended September 30, 2002 and 2001 ATP paid Turner$84,000, and $66,000, respectively, for consulting services. Under the agreement, Turnerwas granted an option to purchase up to 100,000 shares of Common Stock, exercisable as to30,000 shares immediately and an additional 70,000 shares becoming exercisable in theevent of a business combination or strategic alliance presented by Turner and approved bythe Board of Directors of ATP prior to September 30, 2003. The options include an exerciseprice of $0.2813 per share and exercisable options expire September 30, 2005. In addition,ATP can terminate the Consulting Services Agreement upon 30 day's written notice to Turnerand payment to Turner of $21,000; however, if ATP terminates the Consulting ServicesAgreement prior to June 30, 2003, as the result of the completion of a businesscombination or strategic alliance generated by Turner, ATP shall pay Turner $42,000.

     Since October 1996, ATP has had a Consulting ServicesAgreement with Brenda Ray, Inc. (Ray), a related-party entity owned by a director of ATP.During the years ended September 30, 2002, 2001 and 2000, ATP paid Ray $12,000,$12,000 and $12,000, respectively, for consulting services. Under the Consulting ServicesAgreement**,**ATP is required to pay $1,000 per month for Ray's consultingservices. ATP can terminate the agreement upon 30 day's written notice to Ray and paymentto Ray of $3,000; however, if ATP terminates the Consulting Services Agreement prior toJune 30, 2003, as the result of the completion of a business combination or strategicalliance generated by Ray, ATP shall pay Ray $6,000.

     Since August 1995, ATP has had an administrative servicesagreement with Linehan Engineering, Inc. (LEI), a related-party entity owned by ATP'spresident. During the years ended September 30, 2002, 2001 and 2000, ATP paid LEI$44,420, $40,980 and $39,780, respectively, for administrative services. Under theConsulting Services Agreement**,**ATP is required to pay $3,300 per monthfor Linehan's administrative services. ATP can terminate the agreement upon 30 day'swritten notice to LEI and payment to LEI of $9,900; however, if ATP terminates theConsulting Services Agreement prior to June 30, 2003, as the result of the completion of abusiness combination or strategic alliance generated by LEI, ATP shall pay LEI $19,800.

7. QUARTERLY FINANCIAL DATA (UNAUDITED):

 
First QuarterSecond QuarterThird QuarterFourth Quarter2002-Operating revenues$198,808$163,680$276,898$187,385Operating income123,101109,035211,648112,680Net income145,430129,048233,963133,798Basic and diluted income per share    .02    .02    .03    .022001-Operating revenues$193,719$163,063$144,522$142,095Operating income158,619111,96975,84493,657Net income182,999132,24196,294117,557Basic and diluted income per share    .02    .02    .01    .01
8. SUBSEQUENT EVENT:

     On November 26, 2002, ATP declared a dividend of $0.08 pershare payable on January 9, 2003, to stockholders of record as of December 20,2002.

EXHIBIT 99.1.1

**Certification Pursuant toSection 906 of the Sarbanes-Oxley Act of 2002(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code)**

     Pursuant to section 906 of the Sarbanes-Oxley Act of 2002(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code), I,J. W. Linehan, Chief Executive Officer and Chief Financial Officer of Advanced TobaccoProducts, Inc., a Texas corporation (the "Company"), hereby certify, to myknowledge, that:

(1) the Company's Annual Report on Form 10-K for the year ended September 30, 2002 (the"Report") fully complies with the requirements of section 13(a) or 15(d) of theSecurities Exchange Act of 1934; and

(2) the information contained in the Report fairly presents, in all material respects,the financial condition and result of operations of the Company.
Dated: December 22, 2002/s/ J. W. Linehan    J. W. Linehan    Chief Executive Officer and Chief Financial Officer
     The foregoing certification is being furnished solely pursuantto Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350,Chapter 63 of Title 18, United States Code) and is not being filed as part of the Reportor as a separate disclosure document. |
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