ADVANCED POLYMER SYSTEMS INC /DE/, 10-K, 1999-03-30

ADVANCED POLYMER SYSTEMS INC /DE/
10-K, 1999-03-30
PLASTIC MATERIALS, SYNTH RESINS & NONVULCAN ELASTOMERS

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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 Securities
Exchange Act of 1934
For the fiscal year ended December 31, 1998 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

ADVANCED POLYMER SYSTEMS, 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 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 (ss.229.405 of this chapter) is not contained
herein, and will not be contained, to the best of the registrant's
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form 10-
K. [X]
---

The aggregate market value of the voting stock of the registrant held by
non-affiliates of the registrant as of February 28, 1999, was $64,091,712.
(1)

As of February 28, 1999, 19,993,311 shares of registrant's Common Stock,
$.01 par value, were outstanding.

- --------------------------------------------------------------------------
(1)Excludes 6,500,319 shares held by directors, officers and shareholders
whose ownership exceeds 5% of the outstanding shares at February 28,
1999. 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.

<PAGE>

DOCUMENTS INCORPORATED BY REFERENCE

Form
10-K
Document Part
- -------- ----

Definitive Proxy Statement to be used
in connection with the Annual Meeting
of Stockholders. III

<PAGE>
TABLE OF CONTENTS

PART I

ITEM 1. Business

ITEM 2. Properties

ITEM 3. Legal Proceedings

ITEM 4. Submission of Matters to a Vote of Security Holders

PART II

ITEM 5. Market for the Registrant's Common Equity and Related
Shareholder Matters

ITEM 6. Selected Financial Data

ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations

ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk

ITEM 8. Financial Statements and Supplementary Data

ITEM 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure

PART III

ITEM 10. Directors and Executive Officers of the Registrant

ITEM 11. Executive Compensation

ITEM 12. Security Ownership of Certain Beneficial Owners
and Management

ITEM 13. Certain Relationships and Related Transactions

PART IV

ITEM 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K

Signatures
<PAGE>

PART I

Item 1. BUSINESS

INTRODUCTION-FORWARD LOOKING STATEMENTS
- ---------------------------------------

To the extent that this report discusses future financial projections,
information or expectations about our products or markets, or otherwise
makes statements which are not historical fact, such statements 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
approval, launch and acceptance of new products, the costs associated with
new product introductions, as well as other factors described below under
the headings "APS Technology", "Products", "Manufacturing", "Marketing",
"Government Regulation", "Patents and Trade Secrets" and "Competition".
In addition, such risks and uncertainties also include the matters
discussed under Management's Discussion and Analysis of Financial
Condition and Results of Operations in Item 7 below.

THE COMPANY
- -----------

Advanced Polymer Systems, Inc. and subsidiaries ("APS" or the "Company")
is using its patented Microsponge(R) delivery systems and related
proprietary technologies to enhance the safety, effectiveness and
aesthetic quality of topical prescription, over-the-counter ("OTC") and
personal care products. The Company is currently manufacturing and
selling Microsponge systems for use by corporate customers in
approximately 100 different skin care products sold worldwide. APS holds
197 issued U.S. and foreign patents on its technology and has over 52
other patent applications pending.

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.

Products under development or in the marketplace utilize the Company's
Microsponge systems in three primary ways: 1) as reservoirs releasing
active ingredients over an extended period of time, 2) as receptacles for
absorbing undesirable substances, such as excess skin oils, or 3) as
closed containers holding ingredients away from the skin for therapeutic
action. The resulting benefits include extended efficacy, reduced skin
irritation, cosmetic elegance, formulation flexibility and improved
product stability.

In February 1997, the Company received FDA approval for the first ethical
pharmaceutical product based on its patented Microsponge technology Retin
A(R)-Micro(TM) which has been licensed to Ortho-McNeil Pharmaceutical
Corporation, a member of the Johnson & Johnson ("J&J") family of
companies. This product was launched in March 1997. In September 1994,
the Company submitted a New Drug Application ("NDA") for a melanin-
Microsponge sunscreen. The NDA was found to be non-approvable pending
additional information which the Company would need to generate.

APS has established several alliances with multinational corporations
including J&J, Avon and Rhone-Poulenc Rorer for products which incorporate
Microsponge systems. The alliance partners receive certain marketing
rights to the products developed. In return, APS typically receives an
initial cash infusion in the form of license fees, future payments
contingent on the achievement of certain milestones, revenues from the
manufacture of Microsponge systems, and royalty payments based on third
party product sales or a share of partner revenues. For products
requiring FDA approval, these alliances provide for the partners to pay
the costs of product development, clinical testing, regulatory approval
and commercialization. J&J and Rhone-Poulenc Rorer also have made equity
investments in the Company.

Effective January 1997, the Company licensed certain of its consumer
products to Lander Company in the United States and Canada in return for
guaranteed minimum royalties and revenues from the sale of Microsponge
systems. Lander is responsible for all aspects of commercialization
including selling, marketing, manufacturing, distribution and customer
service.

To maintain quality control over manufacturing, APS has committed
significant resources to its production processes and polymer systems
development programs. The Company's manufacturing facility in Lafayette,
Louisiana, is responsible for large-scale production of Microsponge
systems and related technologies. All products are manufactured according
to Current Good Manufacturing Practices guidelines ("CGMPs") established
by the FDA. In addition, APS has a process development pilot plant in its
Louisiana facility. APS also has established relationships with contract
manufacturers, which provide second-source production capabilities to
handle growing product demand.

APS TECHNOLOGY
- --------------

The fundamental appeal of the Company's Microsponge technology stems from
the difficulty experienced with conventional formulations in releasing
active ingredients over an extended period of time. Cosmetics and skin
care preparations are intended to work only on the outer layers of the
skin. Yet, the typical active ingredient in conventional products is
present in a relatively high concentration and, when applied to the skin,
may be rapidly absorbed. The common result is over-medication, followed
by a period of under-medication until the next application. Rashes and
more serious side effects can occur when the active ingredients rapidly
penetrate below the skin's surface. APS' Microsponge technology is
designed to allow a prolonged rate of release of the active ingredients,
thereby offering potential reduction in the side effects while maintaining
the therapeutic efficacy.

Microsponge Systems. The Company's Microsponge systems are based on
microscopic, polymer-based microspheres that can bind, suspend or entrap a
wide variety of substances and then be incorporated into a formulated
product, such as a gel, cream, liquid or powder. A single Microsponge is
as tiny as a particle of talcum powder, measuring less than one-thousandth
of an inch in diameter. Like a true sponge, each microsphere consists of
a myriad of interconnecting voids within a non-collapsible structure that
can accept a wide variety of substances. The outer surface is typically
porous, allowing the controlled flow of substances into and out of the
sphere. Several primary characteristics, or parameters, of the
Microsponge system can be defined during the production phase to obtain
spheres that are tailored to specific product applications and vehicle
compatibility.

Polytrap(R) Systems. In January 1996, the Company signed a definitive
agreement with Dow Corning Corporation to acquire full rights to Dow
Corning's Polytrap technology and full responsibility for the continuing
commercialization of Polytrap systems in exchange for 200,000 shares of
APS common stock. Polytrap systems are designed to: 1) absorb skin oils
and eliminate shine, 2) provide a smooth and silky feel to product
formulation, 3) entrap and deliver various ingredients in personal care
products and 4) convert liquids into powders.

Microsponge and Polytrap systems are made of biologically inert polymers.
Extensive safety studies have demonstrated that the polymers are non-
irritating, non-mutagenic, non-allergenic, non-toxic and non-
biodegradable. As a result, the human body cannot convert them into other
substances or break them down. Furthermore, although they are microscopic
in size, these systems are too large to pass through the stratum corneum
(skin surface) when incorporated into topical products.

Colon-specific Systems. A Microsponge system offers the potential to hold
active ingredients in a protected environment and provide controlled
delivery of oral medication to the lower gastrointestinal ("GI") tract.
This approach, if successful, should open up entirely new opportunities
for APS.

Bioerodible Systems. The Company is also developing systems based on new
bioerodible polymers for the delivery of small and large molecule drugs,
including proteins and peptides, which, if successful, should open up new
fields of opportunity in systemic drug delivery arenas.

PRODUCTS
- --------

APS is currently focusing its efforts primarily on the ethical
dermatology, OTC skin care and personal care markets in which Microsponge
and Polytrap systems can provide substantial advantages. Certain
additional applications for the Company's technology are also under
development, as noted below.

Ethical Dermatology
- -------------------

APS defines "ethical dermatology" products as prescription and non-
prescription drugs that are promoted primarily through the medical
profession for the prevention and treatment of skin problems or diseases.
The Company is developing several ethical dermatology products which will
require approval of the FDA before they can be sold in the United States.
Although these pharmaceuticals are likely to take longer to reach the
marketplace than OTC and personal care products due to the regulatory
approval process, the Company believes that the benefits offered by
Microsponge delivery systems will allow valuable product differentiation
in this large and potentially profitable market. Results from various
human clinical studies reaffirm that this technology offers the potential
to reduce the drug side effects, maintain the therapeutic efficacy and
potentially increase patient compliance with the treatment regimen. The
following ethical dermatology products have been developed or are under
development by APS:

Tretinoin Acne Medication. In February 1997, the Company received FDA
approval for Microsponge-entrapped tretinoin for improved acne treatment.
This submission to the FDA represented the culmination of an intensive
research and clinical development program involving approximately 1,150
patients. Tretinoin has been marketed in the U.S. by Ortho
Dermatological, a Johnson & Johnson subsidiary, under the brand name
RETIN-A(R) since 1971. It has proven to be a highly effective topical
acne medication. However, skin irritation among sensitive individuals can
limit patient compliance with the prescribed therapy. The Company
believes its patented approach to drug delivery reduces the potentially
irritating side effects of tretinoin. Ortho Dermatological began marketing
this product in March 1997 under the brand name Retin-A(R) Micro (TM).

Melanin-Microsponge Sunscreen. APS has developed a sun protectant
designed to provide protection against the sun's UVA rays as well as
protection from the burning UVB rays. This unique APS product candidate
incorporates the Company's melanin-Microsponge system containing
genetically engineered melanin, a natural pigment found in skin.

The Company filed its NDA in September 1994 for marketing clearance. The
NDA was found to be non-approvable pending additional information which
the Company would need to generate. There can be no assurance that U.S.
FDA approval will be received. The Company has, however, begun to
commercialize melanin-Microsponge systems through strategic partners in
Europe and South America, where regulatory approval is not required for
the sale of sunscreen products.

5-Fluorouracil. Another ethical dermatology product candidate,
Microsponge-entrapped 5-Fluorouracil ("5-FU"), was the subject of an
Investigational New Drug ("IND") filing in early 1995. 5-FU is an
effective chemotherapeutic agent for treating actinic keratosis, a pre-
cancerous, hardened-skin condition caused by excessive exposure to
sunlight. However, patient compliance with the treatment regimen is poor,
due to significant, adverse side effects. Through a joint agreement with
Dermik, a subsidiary of Rhone-Poulenc Rorer, the Company is developing a
Microsponge-enhanced topical formulation that potentially offers a less
irritating solution for treating actinic keratosis. Phase III clinical
studies have been completed and Dermik is preparing for the filing of an
NDA in 1999.

Cosmeceutical Products
- ---------------------

Retinol. Retinol is a highly pure form of Vitamin A which has
demonstrated a remarkable ability to maintain the skin's youthful
appearance. However, it has been commercialized on only a limited basis
because it becomes unstable when mixed with other ingredients. APS has
been able to stabilize retinol in a formulation which is cosmetically
elegant and which has a low potential for skin irritation. The Company
has executed agreements with eight companies, each of which has marketing
strength in a particular channel of distribution. The channels for which
the Company has licensed retinol are direct marketing (Avon),
dermatologists (Medicis), salons and spas (Sothys), plastic surgery
(BioMedic), prestige (La Prairie), mass (Scott's Liquid Gold) and through
infomercials (Guthy Renker). The Company retains full rights to alternate
channels of distribution. Additionally, the Company formed an alliance
with R.P. Scherer to develop and commercialize unit-dose skin care
treatments for aging skin using retinol and possibly other vitamins.

In May 1997, the Company entered into an agreement under which it licensed
exclusive rights to broad-based patents covering the topical use of
Vitamin K. The Company has developed various Vitamin K formulations that
it is planning to license to marketing partners in a variety of
distribution channels.

Personal Care and OTC Products
- ------------------------------

APS technologies are ideal for skin and personal care products. They can
retain several times their weight in liquids, respond to a variety of
release stimuli, and absorb large amounts of excess skin oil, all while
retaining an elegant feel on the skin's surface. In fact, APS
technologies are currently employed in approximately 100 products sold by
major cosmetic and toiletry companies worldwide. Among these products are
skin cleansers, conditioners, oil control lotions, moisturizers,
deodorants, razors, lipsticks, makeup, powders, and eye shadows.

Entrapping cosmetic ingredients in APS' proprietary Microsponge delivery
systems offers several advantages, including improved physical and
chemical stability, greater available concentrations, controlled release
of the active ingredients, reduced skin irritation and sensitization, and
unique tactile qualities.

Other Product Applications
- --------------------------

While not the principal focus of APS development efforts, other products
could benefit from the value-added application of the Company's polymer
technology. To date, the Company has applied its technology to its
analytical standards business.

Analytical Standards. APS initially developed microsphere precursors to
the Microsponge for use as a testing standard for gauging the purity of
municipal drinking water. Marketed by APS nationwide, these microspheres
are suspended in pure water to form an accurate, stable, reproducible
turbidity standard for the calibration of turbidimeters used to test water
purity.

APS believes its analytical standards technology has much broader
application than testing the turbidity of water. The Company has begun to
develop standards for industrial use for the calibration of
spectrophotometers and colorimeters.

MANUFACTURING
- -------------

Polymer Raw Material. Raw materials for the Company's polymers are
petroleum-based monomers which are widely available at low cost. The
monomers have not been subject to unavailability or significant price
fluctuations.

Process Engineering and Development. The Company employs chemical
engineers and operates a pilot-plant facility for developing production
processes. The equipment used for manufacturing and process development
is commercially available in industrial sizes and is installed in the
Company's production facility in Lafayette, Louisiana.

Microsponge Production. APS has committed significant resources to the
production process and polymer systems development required to
commercialize its products. The Company has to date manufactured most
Microsponge systems in company-owned and operated facilities.

The Company's manufacturing facility in Lafayette, Louisiana, is
responsible for large-scale production of Microsponge systems and related
technologies. The Company initiated a plant expansion project during 1997
in anticipation of higher volume requirements. This was completed during
1998. APS also has established relationships with contract manufacturers
which provide second-source production capabilities. The Company's
objective is to utilize these third parties selectively, so that it can
maintain its flexibility and direct the bulk of APS' capital resources to
other areas, such as product development and marketing. All products are
manufactured according to CGMP. In addition, APS has a process
development pilot plant in its Louisiana facility.

MARKETING
- ---------

A key part of APS' business strategy is to ally the Company with major
marketing partners. The Company has therefore negotiated several
agreements covering Microsponge delivery systems, the supply of entrapped
ingredients, and the marketing of formulated products. To create an
incentive for APS to develop products as quickly as possible, these
development and license agreements provide, in some cases, for substantial
payments by the client companies during the period of product development
and test marketing. Additionally, some agreements provide for non-
refundable payments on the achievement of certain key milestones,
royalties on sales of formulated products, and minimum annual payments to
maintain exclusivity.

In general, APS grants limited marketing exclusivity in defined markets to
client companies, while retaining the right to manufacture the Microsponge
delivery systems it develops for these clients. However, after
development is completed and a client commercializes a formulated product
utilizing the Company's delivery systems, APS can exert only limited
influence over the manner and extent of the client's marketing efforts.

The Company's key relationships are set forth below:

Johnson & Johnson Inc. In May 1992, APS and Ortho-McNeil Pharmaceutical
Corporation ("Ortho"), a subsidiary of J&J, entered into a development and
license agreement related to tretinoin-based products incorporating APS'
Microsponge technology. As part of the agreement, certain license fees
and milestone payments were paid by Ortho to APS. The license fees
provided Ortho with exclusive distribution or license rights for all Ortho
tretinoin products utilizing the APS Microsponge system. Ortho's
exclusivity will continue as long as certain annual minimum royalty
payments are made.

In February 1997, APS received FDA approval for the first product covered
by this agreement, Microsponge-entrapped tretinoin. This product is being
marketed by Ortho Dermatological beginning March 1997 as Retin-A(R) Micro
(TM). APS received a payment of $3,000,000 from Ortho upon receipt of the
FDA approval, of which half is a milestone payment which was recognized as
revenue in 1997 and half is prepaid royalties which was recorded as
deferred revenues.

Rhone-Poulenc Rorer. In March 1992, APS and Rhone-Poulenc Rorer ("RPR")
restructured their 1989 joint venture agreement. Under the new terms, RPR
received 705,041 shares of APS stock. Furthermore, RPR agreed to continue
funding the exploration and development of certain dermatology
applications of APS' technology. Product applications include a 5-FU
treatment for pre-cancerous actinic keratosis. In 1995, RPR filed an IND
application to begin human clinical testing of 5-FU. Phase III clinical
trials have been completed and RPR is preparing for the filing of an NDA
in 1999.

Lander Company. Effective January 1997, APS established a strategic
alliance with Lander under which Lander was granted full marketing rights
in the United States and Canada to Microsponge-based Exact(R) acne
medications, Take-Off facial cleansers, Everystep(R) Foot Powder, as well
as in-licensed consumer products. Under terms of the agreement, Lander is
responsible for all aspects of commercialization including selling,
marketing, manufacturing, distribution and customer service. APS receives
guaranteed minimum royalties and revenues from the sale of Microsponge
systems.

Avon. In August 1996, APS signed a license and supply agreement with Avon
under which APS is providing Avon with a formulation incorporating
Microsponge delivery systems and retinol, an ingredient developed to
improve the appearance of aging skin. Under terms of the agreement, APS
received upfront, non-refundable licensing fees and will receive
manufacturing revenues on supply of product. In 1998, the Company
announced that Avon had launched a second product using the Company's
Microsponge systems technology.

Medicis. In October 1996, APS entered into an agreement with Medicis
Pharmaceutical Corporation for the commercialization of certain
dermatology products. Medicis is responsible for marketing two APS
developed products in the United States. In return, APS received upfront,
non-refundable licensing fees and a share of revenues, with guaranteed
minimums. In November 1997, the Company licensed Vitamin K to Medicis for
sale in the U.S. to dermatologists.

La Prairie. In October 1997, APS signed an agreement with La Prairie, a
subsidiary of Beiersdorf AG for the supply of certain Microsponge-based
formulations for the prestige high-end channel of distribution. La
Prairie also provided funding for research and development for new
products. Products subject to this agreement were shipped in the first
quarter of 1998.

Pharmacia and Upjohn. In January 1998, the Company announced an agreement
with Pharmacia and Upjohn to develop and commercialize a new product for a
major global category in return for R&D fees and reimbursement of
expenses. Advanced Polymer's Microsponge system technology will be
utilized to deliver a proprietary Pharmacia and Upjohn therapeutic agent
topically.

Scott's Liquid Gold. In June 1998, APS signed an agreement with Scott's
Liquid Gold under which APS provides Scott's with products incorporating a
Microsponge-based retinol formulation for the mass channel. Under terms
of the agreement, APS received an upfront, non-refundable license fee and
receives manufacturing revenues on the supply of product, which commenced
in the third quarter of 1998.

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 pre-clinical animal
testing to determine safety and efficacy, followed by human clinical
testing, and can take many years and require substantial expenditures. In
the case of third-party agreements, APS expects that the corporate client
will fund the testing and the approval process with guidance from APS.
The Company intends to seek the necessary regulatory approvals for its
proprietary dermatology products as they are being developed.

APS' facilities, utilized to manufacture pharmaceutical raw materials, are
subject to periodic governmental inspections. If violations of applicable
regulations are noted during these inspections, significant problems may
arise affecting the continued marketing of any products manufactured by
the Company.

The Company's plant in Lafayette, Louisiana operates according to CGMP
prescribed by the FDA. This compliance has entailed modifying certain
manufacturing equipment, as well as implementing certain record keeping
and other practices and procedures which are required of all
pharmaceutical manufacturers. The Company believes it is in compliance
with federal and state laws regarding occupational safety, laboratory
practices, environmental protection and hazardous substance control.

Personal Care Products
- ----------------------

Under current regulations, the market introduction of non-medicated
cosmetics, toiletries and skin care products does not require prior formal
registration or approval by the FDA or regulatory agencies in foreign
countries, although this situation could change in the future. The
cosmetics industry has established self-regulating procedures and the
Company, like most companies, performs its own toxicity and consumer
tests.

PATENTS AND TRADE SECRETS
- -------------------------

As part of the Company's strategy to protect its current products and to
provide a foundation for future products, APS has filed a number of United
States patent applications on inventions relating to specific products,
product groups, and processing technology. The Company also has filed
foreign patent applications on its polymer technology with the European
Union, Japan, Australia, South Africa, Canada, Korea and Taiwan. The
Company received U.S. patent protection for its basic Microsponge system
in 1987 and now has a total of 43 issued U.S. patents and an additional
154 issued foreign patents. The Company has over 52 pending patent
applications worldwide.

Although the Company believes the bases for these patents and patent
applications are sound, they are untested, and there is no assurance that
they will not be successfully challenged. There can be no assurance that
any patent already issued will be of commercial value, or that any patent
applications will result in issued patents of commercial value, or that
APS' technology will not be held to infringe on patents held by others.

APS relies on unpatented trade secrets and know-how to protect certain
aspects of its production technologies. APS' employees, consultants,
advisors and corporate clients have entered into confidentiality
agreements with the Company. These agreements, however, may not
necessarily provide meaningful protection for the Company's trade secrets
or proprietary know-how in the event of unauthorized use or disclosure.
In addition, others may obtain access to, or independently develop, these
trade secrets or know-how.

COMPETITION
- -----------

Although Microsponge and Polytrap systems, by virtue of their highly
porous structure, are unique delivery systems, there are many alternate
delivery systems available. However, in the cosmetic and cosmeceutical
fields, Microsponge and Polytrap systems are particularly versatile at
allowing the entrapment of active agents and controlled release by simple
changes in vehicles.

Other delivery systems based on microparticulate materials could compete
with Microsponge and Polytrap systems. Among these are liposomes,
microcapsules and microspheres. Liposomes are small phospholipid vesicles
capable of entrapping and releasing active agents. However, they are
significantly more expensive to manufacture, less versatile and their
stability is a concern. While they are primarily used in systemic
applications, they are also used in the cosmetic arena.

The most closely related systems are microcapsules and microspheres.
Microcapsules are spherical particles containing an active agent in the
core, surrounded by a polymeric membrane. Microspheres are spherical
particles containing the active agent dispersed in a polymeric matrix.
The major distinguishing feature between Microsponge and Polytrap systems
and microcapsules, or microspheres is that the structure of Microsponge
and Polytrap systems is highly porous, while microspheres or microcapsules
are solid particles with no internal voids.

Thus, while one type of Microsponge system can be used to entrap a variety
of active agents and release these at desired rates by vehicle changes,
different active agents and different release profiles can only be
achieved with microcapsules or microspheres by a complete change in
polymer and fabrication methods.

HUMAN RESOURCES
- ---------------

As of February 28, 1999, the Company had 90 full-time employees, 5 of whom
hold PhDs. There were 31 employees engaged in research and development
and quality control, 34 in manufacturing and production activities and 25
working in customer service, finance, marketing, human resources and
administration.

The Company considers its relations with employees to be satisfactory.
None of the Company's employees is covered by a collective bargaining
agreement.

Item 2. PROPERTIES

The Company occupies 26,067 square feet of laboratory, office and
warehouse space in Redwood City, California and 2,800 square feet of
office space in Greenwich, Connecticut. The annual rent expense for the
Redwood City facility is approximately $641,000. The annual rent expense
for the Greenwich office is approximately $76,000.

The Company occupies a production facility and warehouse in Lafayette,
Louisiana, with a current annual capacity, depending upon the application,
to produce 1,000,000 to 3,000,000 pounds of entrapped materials. The
existing plant, with contiguous acreage, has been designed to allow
significant expansion. The construction of the facility in 1986 was
financed primarily by 15-year tax-exempt industrial development bonds. In
1990, the bonds were refinanced. In 1995, the Company extinguished the
bond liability through an "insubstance defeasance" transaction by placing
U.S. government securities in an irrevocable trust to fund all future
interest and principal payments. In 1995 the Company sold certain assets
and subsequently leased them back for a certain fixed monthly rent over a
period of forty-eight months. The Company reported this transaction as a
financing transaction.

The Company's existing research and development and administrative
facilities are not yet being used at full capacity and management believes
that such facilities are adequate and suitable for its current and
anticipated needs. Additional manufacturing capacity could be required as
APS expands commercial production. It is anticipated that any additional
production facilities would be built on land the Company presently
occupies in Lafayette, Louisiana.

Item 3. LEGAL PROCEEDINGS

In November, 1997 Biosource Technologies, Inc. ("Biosource") filed a
complaint against the Company in the San Mateo Superior Court. Biosource
claimed damages from the Company on the grounds that the Company had
failed to pay certain minimum amounts allegedly due under a contract for
the supply of melanin.

In December 1998, the Company reached a settlement agreement with
Biosource for a net amount of $1,300,000, which consists of a $1,500,000
settlement of Biosource's claims and a $200,000 settlement of the
Company's cross claims. Pursuant to the agreement, the Company paid
Biosource $300,000 in January, 1999. The remaining $1,000,000 is payable
by any combination of cash and/or the issuance of shares of the Company's
Common Stock. The settlement agreement also provides for the termination
of the license and supply agreement between the parties.

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

None.

<PAGE>
PART II

Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER
MATTERS

Shares of the Company's common stock trade on the Nasdaq National Market,
under the symbol APOS. As of February 28, 1999, there were 565 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.

1998 High Low 1997 High Low
- ----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
First Quarter 9 3/8 5 15/16 First Quarter 10 3/8 7 3/8
Second Quarter 9 5 7/8 Second Quarter 8 1/2 6 7/8
Third Quarter 7 1/4 3 7/8 Third Quarter 8 5/8 6 7/8
Fourth Quarter 7 1/8 4 Fourth Quarter 8 3/4 6

</TABLE>

Item 6. SELECTED FINANCIAL DATA
(in thousands, except per share data)
<TABLE>
<CAPTION>

For the Years Ended and as of
December 31 1998 1997 1996 1995 1994
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Statements of Operations Data
- -----------------------------
Product revenues $13,637 12,442 6,138 5,803 5,093
Royalties, license fees and
R&D fees 6,354 4,391 2,059 451 1,402
Consumer products -- -- 10,468 9,104 9,389
Milestone payments -- 1,500 -- 750 --
Cost of sales 7,127 7,164 10,772 11,047 10,149
Research and development, net 4,382 3,740 3,506 4,139 6,334
Selling, marketing and
advertising 2,999 3,806 8,455 6,560 5,669
General and administrative 3,009 3,552 2,984 3,082 2,844
Loss on purchase commitment,
including related inventory -- -- 1,400 600 685
Net income (loss) 1,896 (683) (9,378) (9,359) (9,759)

Basic earnings (loss) per
common share 0.10 (0.04) (0.52) (0.57) (0.65)
Diluted earnings (loss) per
common share 0.09 (0.04) (0.52) (0.57) (0.65)
Weighted average common
shares outstanding - basic 19,854 18,779 17,987 16,459 15,018
Weighted average common
shares outstanding - diluted 20,381 19,815 19,494 16,953 15,401

Balance Sheet Data
- ------------------

Working capital $ 5,302 6,143 4,550 5,726 5,641
Total assets 23,081 24,180 18,444 23,082 23,508
Long-term debt, excluding
current portion -- 3,055 5,579 6,355 979
Shareholders' equity 14,535 10,241 5,010 5,233 11,786

</TABLE>

Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations(Dollar amounts are rounded to
nearest thousand)

The following tables summarize highlights from the statements of
operations expressed as a percentage change from the prior year and as a
percentage of product revenues.

STATEMENTS OF OPERATIONS HIGHLIGHTS (in thousands)
- --------------------------------------------------

For the Years Ended December 31, Annual % Change
-------------------------------- ---------------
1998 1997 1996 98/97 97/96
------ ------ ------ ----- -----

Product revenues $13,637 12,442 6,138 10% 103%
Royalties, license fees and
R&D fees 6,354 4,391 2,059 45% 113%
Consumer products -- -- 10,468 --% (100%)
Milestone payment -- 1,500 -- (100%) --%
------ ------ ------ ----- -----
Total revenues 19,991 18,333 18,665 9% (2%)

Cost of sales 7,127 7,164 10,772 (1%) (33%)
Research and development, net 4,382 3,740 3,506 17% 7%
Selling and marketing 2,999 3,806 5,405 (21%) (30%)
Advertising and promotion -- -- 3,050 --% (100%)
General and administrative 3,009 3,552 2,984 (15%) 19%
Loss on purchase commitments,
Including related inventory -- -- 1,400 --% (100%)

1998 1997 1996
---- ---- ----
Expenses expressed as a percentage
of total revenues excluding
milestone payment:
Cost of sales 36% 43% 58%
Research and development, net 22% 22% 19%
Selling and marketing 15% 23% 29%
Advertising and promotion -- -- 16%
General and administrative 15% 21% 16%
Loss on purchase commitments,
including related inventory -- -- 8%
<PAGE>

Results of Operations for the years ended December 31, 1998 and 1997
- --------------------------------------------------------------------

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
approval, launch and acceptance of new products, development of new
products, establishment of new corporate alliances, progress in research
and development programs and other risks described below or identified
from time to time in the Company's Securities and Exchange Commission
filings.

The Company's revenues are derived principally from product sales, license
fees and royalties. The Company is currently manufacturing and selling
Microsponge(R) delivery systems for use by customers in approximately 100
different skin care products. Under strategic alliance arrangements
entered into with certain corporations, APS can receive an initial license
fee, future milestone payments, royalties based on third party product
sales or a share of partners' revenues, and revenues from the supply of
Microsponge and Polytrap systems.

These strategic alliances are intended to provide the Company with the
marketing expertise and/or financial strength of other companies. In this
respect, the Company's periodic financial results are dependent upon the
degree of success of current collaborations and the Company's ability to
negotiate acceptable collaborative agreements in the future.

Product revenues for 1998 totaled $13,637,000, an increase of $1,195,000
or 10% from the prior year. This increase resulted from the launches of a
variety of new cosmeceutical products incorporating the Microsponge system
technology.

Royalties, license fees and R&D fees increased by $1,963,000 or 45% from
the prior year to a total of $6,354,000. Approximately 59% of the
increase is attributable to higher R&D fees. Increased royalties
accounted for approximately 37% of the increase. The remaining 4% of the
increase is due to upfront non-refundable license fees from corporate
partners for access to new products. Upfront non-refundable license fees
totaled $1,925,000 in 1998, an increase of $75,000 or 4% from the prior
year. Upfront non-refundable license fees that allow customers to sell
the Company's proprietary products in a specific field on territory are
recognized by the Company as earned when all contractual obligations have
been satisfied and there are no contingencies or future obligations of the
Company associated with the fee.

Total revenues for 1997 included a milestone payment of $1,500,000 from
Ortho upon receipt of marketing clearance from the FDA for Retin-A Micro
in February 1997.

Gross profit on total revenues excluding milestone payments for 1998 was
$12,865,000, an increase of $3,196,000 or 33% over the prior year.
Approximately 61% of the increase is attributable to higher revenues from
royalties, license fees and R&D fees. The remainder of the gross profit
improvement was mainly due to increased sales of higher margin proprietary
cosmeceutical products.

Research and development expenses increased by $642,000 or 17% to
$4,382,000 due mainly to increased headcount, increased expenditure on new
technology and expenses resulting from the move to new facilities in the
first quarter of 1998.

Selling and marketing expense decreased by $807,000 or 21% from the prior
year to $2,999,000 primarily as a result of reduced headcount, reduced
outside services and one-time expenses related to the relocation of a
senior executive in the prior year.

General and administrative expenses decreased by $543,000 or 15% to
$3,009,000. This decrease was primarily attributable to a favorable
settlement of the lawsuit from Biosource and a reduction in a variety of
outside services.

Interest income decreased by $124,000 or 34% from the prior year due to
lower average cash balances. Interest expense decreased by $247,000 or
23% due mainly to scheduled principal repayments during the year.

Net income for 1998 was $1,896,000, an improvement of $2,579,000 over the
prior year's net loss of $683,000.

Results of Operations for the years ended December 31, 1997 and 1996
- --------------------------------------------------------------------

Product revenues excluding revenues from consumer products for 1997
totaled $12,442,000, an increase of $6,305,000 or 103% over the prior
year. This increase resulted primarily from the launches of a variety of
new products incorporating the Microsponge(R) system technology by the
Company's marketing partners. These product launches included Anew
Retinol Recovery Complex PM Treatment which is marketed by Avon, and
TxSystems(TM) AFIRM retinol formulation and Beta Lift peel kits which are
marketed by Medicis Pharmaceutical.

Royalties, license fees and R&D fees increased by $2,331,000 or 113% to
$4,391,000 due mainly to royalties received from Ortho on sales of Retin-
A(R) Micro(TM) and from Lander on sales of certain consumer products.
License fees received from new corporate partners for access to new
products also contributed to the increase.

Total revenues for 1997 of $18,333,000 also included recognition of
$1,500,000 as a portion of a milestone payment received from J&J upon
receipt of marketing clearance from the Food and Drug Administration
("FDA") for Retin-A Micro in February 1997.

Total revenues of $18,665,000 for 1996 included $10,468,000 from sales of
consumer products most of which were licensed out to Lander Company
effective January 1, 1997.

Gross profit on total revenues excluding milestone payment for 1997 was
$9,669,000, an increase of $1,776,000 over the prior year. Expressed as a
percentage of total revenues excluding milestone payment, gross profit
increased from 42% to 57%. Approximately 71% of the increase was
attributable to increased royalties, license fees and R&D fees. The
remainder was attributable to increased sales of higher margin proprietary
cosmeceutical products and increased manufacturing volume.

Operating expenses for 1997 of $11,098,000 represented a decrease of
$5,247,000 or 32% from the prior year total of $16,345,000. Operating
expenses for the prior year included a loss on purchase commitment for the
purchase of melanin for $1,400,000.

Selling and marketing expense decreased by $1,599,000 or 30% from the
year-ago period to $3,806,000 in 1997. This substantial decrease was due
primarily to the execution of the Company's strategic plan whereby it is
no longer responsible for the direct selling, advertising and distribution
of consumer products. Effective January 1, 1997, the Company out-licensed
most of its consumer products to Lander Company in return for a royalty
stream. This also resulted in the elimination of spending on advertising
and promotion of products which had been $3,050,000 in the prior year.

Research and development expenses increased by $234,000 or 7% to
$3,740,000 in 1997 as the Company continued to invest in the expansion of
its technology base.

General and administrative expense increased by $568,000 or 19% to
$3,552,000 in 1997 due mainly to increased spending on a variety of
outside services.

Interest income increased by $47,000 or 15% to $370,000 due to higher
average cash balances. Interest expense decreased by $171,000 or 14% to
$1,053,000 due mainly to scheduled principal repayments during the year.

The net loss for the year of $683,000 represented a decrease of 93% or
$8,695,000 from the year-ago loss of $9,378,000.

Capital Resources and Liquidity
- -------------------------------

Total assets as of December 31, 1998 were $23,081,000 compared with
$24,180,000 at December 31, 1997. Working capital decreased to $5,302,000
from $6,143,000 for the same period and cash and cash equivalents
decreased to $4,088,000 from $8,672,000. For the year ended December 31,
1998, the Company's operating activities used $1,548,000 of cash compared
to $30,000 in the prior year. The Company invested approximately
$4,382,000 in product research and development and $2,999,000 in selling
and marketing the Company's products and technologies.

Accounts receivable increased to $2,533,000 at December 31, 1998 from
$2,288,000 at December 31, 1997. Days sales outstanding increased to 68
days in 1998 from 67 days in 1997. Receivables from royalties, license
fees and R&D fees increased to $2,297,000 in 1998 from $1,100,000 in 1997
due mainly to an increase in related revenues in the fourth quarter of
1998. Royalty payments are not typically due from customers until 45 days
after the end of each quarter. Research and development fees are
typically billed at the end of each quarter.

Capital expenditures for the year ended December 31, 1998 totaled
$2,710,000 compared to $2,800,000 in the prior year. Capital expenditures
were incurred for plant expansion projects at the Company's manufacturing
facility in Lafayette, Louisiana which are necessary to meet anticipated
higher volume requirements. This stage of the plant expansion has been
completed. Capital expenditures were also incurred for leasehold
improvements to the newly-leased corporate offices and research and
development facility in Redwood City and for replacement of non-Year 2000
compliant systems.

The Company has financed its operations, including technology and product
research and development, from amounts raised in debt and equity
financings, the sale of Microsponge and Polytrap delivery systems and
analytical standard products; payments received under licensing
agreements; and interest earned on short-term investments.

During 1998, the company received approximately $1,651,000 from the
exercise of approximately 310,000 warrants to purchase common stock which
had been issued in conjunction with a 1994 private placement.

In March 1999, the Company received a $4,000,000 term loan with a fixed
interest rate of 13.87%. The loan is secured by the assets of the
Company's manufacturing facility in Louisiana and a portion of the
Company's accounts receivable. Principal and interest payments are due in
equal monthly installments over a period of forty-eight months commencing
March 1999.

The term loan was obtained mainly to refinance the scheduled debt
repayments made in the first quarter of 1999.

The Company's existing cash and cash equivalents, collections of trade
accounts receivable, together with interest income and other revenue
producing activities including licensing fees, royalties and research and
development fees are expected to be sufficient to meet the Company's
working capital requirements for the foreseeable future, assuming no
changes to existing business plans.

Year 2000
- ---------

The Company is conducting a comprehensive review of its internal computer
systems to ensure these systems are adequate to address the issues
expected to arise in connection with the Year 2000. These issues include
the possibility that software which uses only the last two digits to refer
to the year will no longer function properly for years that begin with 20
rather than 19. In addition, the Company is reviewing the status of its
customers and suppliers with regard to this issue and assessing the
potential impact of non-compliance by such parties on the Company's
operations.

The Company has developed a phased program to address Year 2000 issues.
The first phase consists of identifying necessary changes to application
software used by the Company. The Company utilizes an integrated ERP
system for the majority of its manufacturing and financial systems and has
received the Year 2000 compliant version of the software from the vendor.
Implementation of the upgraded software was completed on September 30,
1998.

The second phase consists of determining whether Company systems not
addressed in Phase One (including non-IT systems) are Year 2000 compliant.
Identification of systems that are not Year 2000 compliant has been
completed. The Company is now in the process of upgrading or replacing
these systems. The Company expects to upgrade or replace these non-
compliant systems by the third quarter of 1999.

The third phase consists of determining the extent to which the Company
may be impacted by third parties' systems, which may not be Year 2000-
compliant. The Year 2000 computer issue creates risk for the Company from
third parties with whom the Company deals on financial transactions
worldwide. While the Company expects to complete efforts in the second
quarter of 1999, there can be no assurance that the systems of other
companies with which the Company deals or on which the Company's systems
rely will be converted on a timely basis, or that any such failure to
convert by another company could not have an adverse effect on the
Company.

Based on current estimates, management expects the total cost to remediate
non-compliant systems will be less than $650,000 (approximately $580,000
of which was incurred in 1998). Most of the costs incurred were for
purchases of new systems and related equipment. The estimate may change
materially as the Company continues to review and audit the result of its
work. The Company expects to fund all costs to upgrade or replace systems
that are not Year 2000-compliant through operating cash flows.

The Company has not yet determined its most likely worst case Year 2000
scenario. Potential Year 2000 scenarios are going to be considered in the
Company's contingency plans.

The Company is currently in the process of developing formal contingency
plans for addressing any problems which may result if the work performed
in phase two and three do not successfully resolve all issues by the Year
2000. The Company expects to complete its contingency plans in the second
quarter of 1999.

Failure to complete any necessary remediation by the Year 2000 may have a
material adverse impact on the operations of the Company. Failure of
third parties, such as customers and suppliers, to remediate Year 2000
problems in their IT and non-IT systems would also have a material adverse
impact on the operations of the Company.

New Accounting Standards
- ------------------------

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131 "Disclosures about Segments of A
Business Enterprise" (SFAS 131) which is effective for financial
statements beginning after December 15, 1997, and establishes standards
for disclosures about segments of an enterprise. Currently the Company
operates in a single segment.
In June 1998, the FASB issued SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133) which will be effective for
all fiscal quarters of fiscal years beginning after June 15, 1999. SFAS
133 establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement
of financial position and measure those instruments at fair value. SFAS
133 generally provides for matching the timing of gain or loss recognition
on the hedging instrument with the recognition of (a) the changes in the
fair value of the hedged asset or liability that are attributed to the
hedged risk or (b) the earnings effect of hedged forecasted transactions.
Earlier application of all provisions of this statement is encouraged but
it is permitted only as of the beginning of any fiscal quarter that begins
after issuance of this statement. The Company anticipates that adoption
of this statement will not have a material effect on the consolidated
financial statements.

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The Company does not believe that there is any material market risk
exposure with respect to derivative or other financial instruments which
would require disclosure under this item.

<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Consolidated Balance Sheets
- ---------------------------
<TABLE>
<CAPTION>
December 31,
-------------------------
1998 1997
---- ----
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents $ 4,088,173 8,672,021
Accounts receivable less allowance
for doubtful accounts of $96,284 and
$57,453 at December 31, 1998 and 1997,
respectively 2,532,527 2,288,297
Receivables for royalties, license fees
and R&D fees 2,296,852 1,100,368
Accrued interest receivable 3,801 13,606
Inventory 2,959,443 2,639,129
Advances to officers and employees 338,947 96,706
Prepaid expenses and other 592,599 430,839
---------- ----------
Total current assets 12,812,342 15,240,966

Property and equipment, net 8,643,856 6,771,173
Deferred loan costs, net 90,428 353,693
Prepaid license fees, net -- 82,880
Goodwill and other intangibles, net of
accumulated amortization of $1,286,873
and $1,102,480 at December 31, 1998
and 1997, respectively 1,351,813 1,477,542
Other long-term assets 182,892 254,180
---------- ----------
Total Assets $ 23,081,331 24,180,434
========== ==========

Liabilities and Shareholders' Equity

Current Liabilities:
Accounts payable $ 1,347,737 1,636,189
Accrued expenses 1,057,287 2,832,299
Accrued settlement liability 1,300,000 1,800,000
Current portion - long-term debt 3,055,460 2,523,389
Deferred revenue 750,000 306,014
---------- ----------
Total current liabilities 7,510,484 9,097,891

Deferred revenue - long-term 1,035,855 1,785,855
Long-term debt -- 3,055,460
---------- ----------
Total Liabilities 8,546,339 13,939,206

Commitments and Contingencies

Shareholders' Equity:
Preferred stock, authorized 2,500,000
shares; none issued or outstanding at
December 31, 1998 and 1997 -- --
Common stock, $.01 par value,
authorized 50,000,000 shares; issued
and outstanding 19,993,311 and
19,464,821 at December 31, 1998 and
1997, respectively 199,933 194,648
Warrants, issued and outstanding:
196,538 at December 31, 1998 and
506,816 at December 31, 1997 497,192 983,192
Additional paid-in capital 84,206,508 81,327,554
Accumulated deficit (70,368,641) (72,264,166)
---------- ----------
Total Shareholders' Equity 14,534,992 10,241,228
---------- ----------
Total Liabilities and Shareholders'
Equity $ 23,081,331 24,180,434
========== ==========

<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>

<PAGE>
Consolidated Statements of Operations
- -------------------------------------
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Revenues
Product revenues $13,637,093 12,441,484 6,138,094
Royalties, license fees and R&D
fees 6,354,186 4,391,175 2,059,301
Consumer products -- -- 10,467,512
Milestone payments -- 1,500,000 --
---------- ---------- ----------
Total revenues 19,991,279 18,332,659 18,664,907

Expenses
Cost of sales 7,126,573 7,164,120 10,771,766
Research and development, net 4,381,913 3,740,337 3,506,161
Selling and marketing 2,999,424 3,806,030 5,404,774
Advertising and promotion -- -- 3,050,180
General and administrative 3,009,488 3,551,977 2,984,213
Loss on purchase commitment,
including related inventory -- -- 1,400,000
---------- ---------- ----------
Operating income (loss) 2,473,881 70,195 (8,452,187)
---------- ---------- ----------

Interest expense (805,364) (1,052,715) (1,223,303)
Interest income 246,260 370,478 322,986
Other expense, net (19,252) (71,119) (25,595)
---------- ---------- ----------
Net income (loss) $ 1,895,525 (683,161) (9,378,099)
========== ========== ==========

Basic earnings (loss) per common
Share $ 0.10 (0.04) (0.52)
========== ========== ==========
Diluted earnings (loss) per
common share $ 0.09 (0.04) (0.52)
========== ========== ==========
Weighted average common shares
outstanding - basic 19,854,103 18,778,921 17,987,153
========== ========== ==========
Weighted average common shares
Outstanding - diluted 20,380,832 19,814,833 19,494,412
========== ========== ==========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE

<PAGE>
Consolidated Statements of Shareholders' Equity
- -----------------------------------------------

For the Years Ended December 31, 1998, 1997 and 1996

</TABLE>
<TABLE>
<CAPTION>

Accumulated
Common Stock Additional Other
Common Stock Warrants Paid-In Comprehensive Accumulated Shareholders'
Shares Amount Shares Amount Capital Income Deficit Equity
----------- -------- --------- ---------- ----------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1995 17,026,666 $170,267 1,628,611 $2,653,076 $64,600,516 $12,348 $(62,202,906) $5,233,301
---------- ------- --------- --------- ---------- ------- ---------- ----------
Options exercised 416,219 4,162 -- -- 1,993,017 -- -- 1,997,179
Shares retired (12,836) (128) -- -- (97,747) -- -- (97,875)
Private placement,
net of $62,149 in
offering costs 201,922 2,019 86,538 295,751 1,640,081 -- -- 1,937,851
Common stock to be
issued in connection
with the agreement with
Johnson & Johnson (432,101) (4,321) -- -- 4,321 -- -- --
Common stock issued in
connection with the
agreement with Johnson
& Johnson 432,101 4,321 -- -- (4,321) -- -- --
Common stock issued in
connection with the
agreement with Lander
Company, net of $39,547
in offering costs 356,761 3,567 -- -- 2,956,976 -- -- 2,960,543
Common stock issued to
Dow Corning, net of
$4,000 in offering costs 200,000 2,000 -- -- 1,194,000 -- -- 1,196,000
Common stock issued to
Biosource 94,000 940 -- -- 599,060 -- -- 600,000
Securities issued in debt
financing arrangements 10,675 107 4,325 (50,935) 78,353 -- -- 27,525
Fair value of stock
options issued to
non-employees -- -- -- -- 161,299 -- -- 161,299
Warrants exercised 66,337 663 (87,500) (155,200) 539,537 -- -- 385,000
Warrants expired -- -- (200,000) (285,000) 285,000 -- -- --
Reclassification
adjustment for
unrealized holding
gains included
in net income -- -- -- -- -- (12,348) -- (12,348)
Net loss -- -- -- -- -- -- (9,378,099) (9,378,099)
---------- ------- --------- --------- ---------- ------- ---------- ----------
Balance December 31,
1996 18,359,744 $183,597 1,431,974 $2,457,692 $73,950,092 $ -- $(71,581,005) $ 5,010,376
---------- ------- --------- --------- ---------- ------- ---------- ----------
Options exercised 165,374 1,654 -- -- 777,452 -- -- 779,106
Fair value of stock
options issued to
non-employees -- -- -- -- 96,757 -- -- 96,757
Common stock issued to
employees under the
Employee Stock Purchase
Plan 14,545 145 -- -- 87,125 -- -- 87,270
Warrants exercised 925,158 9,252 (925,158) (1,474,500) 6,416,128 -- -- 4,950,880
Net loss -- -- -- -- -- -- (683,161) (683,161)
---------- ------- --------- --------- ---------- ------- ---------- ----------
Balance, December 31,
1997 19,464,821 $194,648 506,816 $ 983,192 $81,327,554 $ -- $(72,264,166) $10,241,228
---------- ------- --------- --------- ---------- ------- ---------- ----------
Options exercised 79,598 796 -- -- 413,072 -- -- 413,868
Fair value of stock
options issued to
non-employees -- -- -- -- 42,200 -- -- 42,200
Restricted stock
awards 100,000 1,000 -- -- 99,857 -- -- 100,857
Common stock issued to
employees under the
Employee Stock Purchase
Plan 38,614 386 -- -- 190,249 -- -- 190,635
Warrants exercised 310,278 3,103 (310,278) (486,000) 2,133,576 -- -- 1,650,679
Net income -- -- -- -- -- -- 1,895,525 1,895,525
---------- ------- --------- --------- ---------- ------- ----------- ----------
Balance, December 31,
1998 19,993,311 $199,933 196,538 $ 497,192 $84,206,508 $ -- $(70,368,641) $14,534,992
========== ======= ========= ========= ========== ======= =========== ==========
<FN>
See accompanying notes to consolidated financial statements.
</FN>
</TABLE>

<PAGE>
Consolidated Statements of Cash Flows
- --------------------------------------

<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 1,895,525 (683,161) (9,378,099)
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 1,104,337 980,933 1,393,805
Provision for loss on purchase
commitments, including inventory -- -- 1,400,000
Allowance for doubtful accounts 38,830 22,967 9,331
Stock compensation awards to non-employees 42,200 96,757 161,299
Restricted stock awards 100,857 -- --
Amortization of deferred loan costs 263,265 263,265 215,366
Changes in operating assets and liabilities:
Accounts receivable (283,060) (1,286,817) 958,682
Receivables for royalties, license fees and
R&D fees (1,196,484) (458,667) (197,346)
Accrued interest receivable 9,805 (9,643) 12,510
Inventory (320,314) (554,056) 5,573,511
Advances to officers and employees (242,241) (3,727) (23,058)
Prepaid expenses and other (161,760) (199,753) 684,192
Assets held for sale -- -- (2,181,004)
Other long-term assets 71,288 (194,577) 129,425
Accounts payable and accrued expenses (2,063,464) 654,324 (6,075,821)
Accrued settlement liability (500,000) -- 1,200,000
Deferred revenue (306,014) 1,341,869 --
--------- --------- ----------
Net cash used in operating activities (1,547,230) (30,286) (6,117,207)
--------- --------- ----------

Cash flows from investing activities:
Purchases of property and equipment (2,709,747) (2,799,683) (719,640)
Purchases of intangible assets (58,664) (400,000) --
Proceeds from sale of equipment and
assets held for sale -- 2,181,004 --
Purchases of marketable securities -- -- (512,513)
Maturities and sales of marketable
securities -- -- 500,165
--------- --------- ----------
Net cash used in investing activities (2,768,411) (1,018,679) (731,988)
--------- --------- ----------

Cash flows from financing activities:
Repayment of long-term debt (2,523,389) (1,490,779) (870,598)
Proceeds from long-term debt and warrants -- -- 758,795
Proceeds from private placements, net of
offering costs -- -- 1,937,851
Proceeds from stock issued to Lander
Company, net of offering costs -- -- 2,960,543
Proceeds from the exercise of common
stock options and warrants, net of
common stock retired 2,064,547 5,729,986 2,284,304
Proceeds from issuance of shares under
the employee Stock Purchase Plan 190,635 87,270 --
--------- --------- ----------
Net cash (used in) provided by financing
activities (268,207) 4,326,477 7,070,895
--------- --------- ----------

Net (decrease) increase in cash and cash
equivalents (4,583,848) 3,277,512 221,700
Cash and cash equivalents at the beginning
of the year 8,672,021 5,394,509 5,172,809
--------- --------- ----------
Cash and cash equivalents at the end of
the year $ 4,088,173 8,672,021 5,394,509
========= ========= =========
Cash paid in interest $ 559,664 790,379 893,239
========= ========= =========
<FN>
Supplemental disclosure of non-cash financing transactions:
During the first quarter of 1996, the Company acquired all rights to the Polytrap technology from Dow Corning
Corporation ("DCC") in exchange for 200,000 shares of common stock valued at $1,200,000.
During the first quarter of 1996, the Company paid Biosource for the 1995 purchase commitment totaling
$600,000 by issuing 94,000 shares of common stock.
In 1996, the Company offset a deposit of approximately $188,000 with a creditor against a loan from the same
creditor (Note 8).

See accompanying notes to consolidated financial statements.
</FN>
</TABLE>

<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------
DECEMBER 31, 1998, 1997 AND 1996
- --------------------------------

Note 1 Business

Advanced Polymer Systems, Inc. ("APS" or the "Company") develops,
manufactures and sells patented delivery systems that allow for the
controlled release of active ingredients which have benefits in the
ethical dermatology, cosmetic and personal care areas. Certain projects
are conducted under development and licensing arrangements with large
companies, others are part of joint ventures in which APS is a major
participant, and a number of projects are exclusive to APS. Prior to
1997, APS also marketed and distributed a range of consumer products for
personal care through its subsidiary, Premier, Inc. ("Premier").
Effective January 1, 1997, APS licensed the consumer products to a third
party.

Note 2 Summary of Significant Accounting Policies

Principles of Consolidation: The consolidated financial statements
include the financial statements of the Company and its wholly owned
subsidiaries, Premier, Advanced Consumer Products, Inc. ("ACP") and APS
Analytical Standards. All significant intercompany balances and
transactions have been eliminated in consolidation.

Cash Equivalents and Marketable Securities
- ------------------------------------------

For purposes of the Consolidated Statements of Cash Flows and
Consolidated Balance Sheets, the Company considers all short-term
investments that have original maturities of less than three months to
be cash equivalents. Short-term investments consist primarily of
commercial paper, master notes and repurchase agreements. All
investments were classified as cash equivalents in the accompanying
financial statements since there were no investments with original
maturities longer than three months. The Company has classified its
investments in certain debt and equity securities as "available-for-
sale".

Financial Instruments
- ---------------------

The Company's investments are recorded at fair value with unrealized
holding gains and losses reported as a separate component of
shareholders' equity. The carrying amounts reported in the balance
sheets for cash, receivables, accounts payable, accrued liabilites and
short-term and long-term debt approximate fair values due to the short-
term maturities.

Inventory
- ---------

Inventory is stated at the lower of cost or market value, utilizing the
average cost method (Note 6).

Property and Equipment
- ----------------------

Property and equipment are carried at cost. Depreciation is computed
using the straight-line method over the estimated useful lives of the
assets, not exceeding twenty years (Note 7).

Prepaid License Fees
- --------------------

A fee paid to Biosource in 1992 was amortized over a seven-year period
consistent with the term of the agreement (Note 3). Amortization of
prepaid license fees totalled $82,880, $82,872 and $137,880 in 1998,
1997 and 1996, respectively. As of December 31, 1998, the prepaid
license fee has been fully amortized.

Deferred Loan Costs
- -------------------

Deferred charges relate to costs incurred in obtaining certain loans.
These charges are being amortized over the life of the loans using the
effective interest method (Note 8).

Long-Lived Assets, Including Goodwill and Other Intangibles
- -----------------------------------------------------------

In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of" as
circumstances dictate, the Company evaluates whether changes have
occurred that would require revision of the remaining estimated lives
of recorded long-lived assets, including goodwill, or render those
assets not recoverable. If such circumstances arise, recoverability
is determined by comparing the undiscounted net cash flows of long-
lived assets to their respective carrying values. The amount of
impairment, if any, is measured based on the projected discounted cash
flows using an appropriate discount rate. At this time, the Company
believes that no significant impairment of long-lived assets, including
goodwill and other intangibles, has occurred and that no reduction of
the estimated useful lives of such assets is warranted.

In 1997, APS acquired all the rights to Exact(R) acne medication from
Johnson & Johnson Consumer Products, Inc. for $350,000. Effective
January 1, 1997, APS licensed Exact and other consumer products to
Lander Company. The rights are being amortized on a straight-line
basis over the length of the licensing agreement with Lander.

In the first quarter of 1996, APS acquired all patents and rights to
the Polytrap technology from Dow Corning Corporation in exchange for
200,000 shares of its common stock. APS recorded intangible assets
totalling $1,200,000 relating to this transaction. The intangible
assets are being amortized on a straight-line basis over a period of
approximately 10 years, which is the remaining life of the main patent
acquired.

In 1992, APS acquired for 157,894 shares of its common stock, the
outstanding 25% interest in ACP, APS' over-the-counter
consumer products subsidiary. The acquisition was accounted for as a
purchase. Excess of cost over net assets acquired arising from the
purchase was amortized over five years on a straight-line basis.

Amortization of intangible assets totalled $184,392, $188,259 and
$279,756, in 1998, 1997 and 1996, respectively.

Stock-Based Compensation
- ------------------------

The Company has chosen to account for stock-based compensation using
the intrinsic value method prescribed in Accounting Principles Board
Opinion No. 25, Accounting for "Stock Issued to Employees" and related
interpretations. Accordingly, except for stock options issued to non-
employees and restricted stock awards to employees, no compensation
cost has been recognized for the Company's fixed stock option plans and
stock purchase plan (Note 10).

Use of Estimates
- ----------------

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated
financial statements and related notes to financial statements.
Changes in such estimates may affect amounts in future periods.

Revenue Recognition
- -------------------

Product revenues are recorded upon shipment of products.

The Company has several licensing agreements that generally provide for
the Company to receive periodic minimum payments, royalties, and/or
non-refundable license fees. These licensing agreements typically
require a non-refundable license fee and allow customers to sell the
Company's proprietary products in a specific field or territory. The
license agreements provide for APS to earn future revenue through
product sales and/or, in some cases, royalty payments. The license
fees are non-refundable even if the agreements are terminated before
their term or APS fails to supply product to the licensee. These
amounts are classified as Royalties, License Fees and R&D Fees in the
accompanying consolidated statements of operations.

Contractually required minimum royalties are recorded ratably
throughout the contractual period. Royalties in excess of minimum
royalties are recognized as earned when the related product is shipped
to the end customer by the Company's licensees based on information
received by the Company from its licensees. Upfront non-refundable
fees, including license fees, are recognized as earned when all
contractual obligations have been satisfied and there are no
contingencies or future obligations of the Company associated with the
fee.

A milestone payment is a payment made by a third party or corporate
partner to the Company upon the achievement of a predetermined
milestone as defined in a legally binding contract. Milestone payments
are recognized as revenue when the milestone event has occurred and the
Company has completed all milestone related services such that the
milestone payment is currently due and is non-refundable. In 1997, the
Company achieved a milestone payment with the receipt of marketing
clearance from the FDA for Retin-A(R) Micro(TM) (Note 15).

Advertising and Promotion Costs
- -------------------------------

Advertising and promotion costs are expensed as incurred.

Earnings (Loss) Per Share
- -------------------------

The Company has adopted and retroactively applied the provisions of
Statement of Financial Accounting Standards No. 128 "Earnings per
Share" ("FAS 128") for all periods presented. FAS 128 requires the
Company to report both basic earnings per share, which is computed by
dividing net income by the weighted-average number of common shares
outstanding, and diluted earnings per share, which is computed by
dividing net income by the total of weighted-average number of common
shares outstanding and dilutive potential common shares outstanding
(Note 11).

Deferred Revenue
- ----------------

Prepaid royalties paid to APS by Ortho-McNeil Pharmaceutical
Corporation ("Ortho"), a subsidiary of Johnson & Johnson Inc. ("J&J"),
as part of the retinoid licensing agreement are reported as deferred
revenues (Note 15).

In accordance with the licensing agreement, 25% of the royalties earned
by APS are applied against the deferred revenues after certain annual
minimum royalty payments are met.

Concentrations of Credit Risk
- -----------------------------

Financial instruments which potentially expose the Company to
concentrations of credit risk, as defined by Statement of Financial
Accounting Standards No. 105, consist primarily of trade accounts
receivable. Approximately 65% and 51% of the recorded trade
receivables were concentrated with five and five customers in the
cosmetic and personal care industries as of December 31, 1998 and 1997,
respectively. To reduce credit risk, the Company performs ongoing
credit evaluations of its customers' financial conditions. The Company
does not generally require collateral.

Reclassifications
- -----------------

Certain reclassifications have been made to the prior year financial
statements to conform with the presentation in 1998.

Note 3 Related Party Transactions

The Company has entered into agreements with Biosource Technologies, Inc.
("Biosource") of which Toby Rosenblatt, a member of the Company's Board of
Directors, is a stockholder and a former director. All agreements between
APS and Biosource have been, and will continue to be, considered and
approved by a vote of the disinterested directors. The agreements
provided APS worldwide rights to use and sell Biosource's biologically-
synthesized melanin in Microsponge systems for all sun protection,
cosmetic, ethical dermatology and over-the-counter skin care purposes. In
return, APS was required to make annual minimum purchases of melanin, pay
royalties on sales of APS melanin-Microsponge products and was required to
prepay $500,000 of royalties. For estimated losses on purchase
commitments and related inventory, the Company accrued $0,$0 and
$1,400,000 in 1998, 1997 and 1996, respectively. All minimum financial
commitments under the current agreements have been expensed by APS.

In 1996, APS paid Biosource the 1995 minimum purchase commitment by
issuing Biosource 94,000 shares of APS common stock.

In November, 1997 Biosource filed a complaint against the Company in the
San Mateo Superior Court. In December 1998, the Company reached a
settlement agreement with Biosource for a net amount of $1,300,000, which
consists of a $1,500,000 settlement of Biosource's claims and a $200,000
settlement of the Company's cross claims (Note 4). The Company's
consolidated financial statemements for the period ended December 31, 1998
include a favorable decrease in accrued settlement liability of $500,000
resulting from the settlement agreement.

As of December 31, 1998, the Company has an outstanding secured loan
receivable of $253,000 from an officer of the Company. The loan bears an
interest rate of approximately 5% and is secured by the shares of Company
stock owned by the officer. The loan was approved by the Compensation
Committee of the Company's Board of Directors. Repayment of the loan is
due by December 31, 1999.

Note 4 Legal Proceeding

In November, 1997 Biosource filed a complaint against the Company in the
San Mateo Superior Court. Biosource claimed damages from the Company on
the grounds that the Company had failed to pay certain minimum amounts
allegedly due under a contract for the supply of melanin.

Note 5 Cash Equivalents

All investments in debt securities have been classified as cash
equivalents in the accompanying balance sheets as they had original
maturities of 90 days or less.

At December 31, 1998 and 1997, the amortized cost and estimated market
value of investments in debt securities are set forth in the tables below:

December 31, 1998
--------------------------------
Estimated
Cost Marked Value
--------------------------------
Available-for-Sale:
Corporate debt securities $1,984,204 1,984,204
Other debt securities 152,119 152,119
--------- ---------
Totals $2,136,323 2,136,323
========= =========

December 31, 1997
--------------------------------
Estimated
Cost Market Value
--------------------------------
Available-for-Sale:
Corporate debt securities $6,726,919 6,726,919
Other debt securities 869,634 869,634
--------- ---------
Totals $7,596,553 7,596,553
========= =========

Note 6 Inventory

The major components of inventory are as follows:

December 31,
---------------------------
1998 1997
---- ----
Raw materials and work-in-process $ 743,383 834,496
Finished goods 2,216,060 1,804,633
--------- ---------
Total inventory $2,959,443 2,639,129
========= =========

Note 7 Property and Equipment

Property and equipment consist of the following:

December 31,
---------------------------
1998 1997
---------- ----------
Building $ 1,831,392 1,823,625
Land and improvements 163,519 163,519
Leasehold improvements 1,423,584 1,233,074
Furniture and equipment 14,504,305 13,001,437
---------- ----------
Total property and equipment 17,922,800 16,221,655
Accumulated depreciation
and amortization (9,278,944) (9,450,482)
---------- ----------
Property and equipment, net $ 8,643,856 6,771,173
========== ==========

Depreciation expense amounted to $837,064, $709,802 and $976,163 for the
years ended December 31, 1998, 1997, and 1996, respectively.

Note 8 Long-Term Debt

Long-term debt consists of the following:
<TABLE>
<CAPTION>

December 31,
--------------------
1998 1997
---- ----
<S> <C> <C>
Bank loan, interest payable monthly, principal
due in non-equal installments commencing
December 1, 1996 through March 1, 1999,
secured by the assets and operating cash
flow of a subsidiary of the Company and
guaranteed by the Company $1,550,000 2,550,000

Term loan, subordinated to bank loan, interest
payable quarterly, principal due in non-equal
installments commencing December 1, 1996
through March 1, 1999, secured by the assets
and operating cash flows of a subsidiary of
the Company and guaranteed by the Company 852,500 1,402,500

Term loan, principal and interest due in equal
monthly installments commencing October 1996
through December 1999, secured by certain
real and personal property 652,960 1,626,349
--------- ---------
Total 3,055,460 5,578,849
Less current portion 3,055,460 2,523,389
--------- ---------
Long-term debt $ -- 3,055,460
========= =========

</TABLE>

In 1995, the Company received an aggregate amount of $8,122,334 from three
financing arrangements.

The first financing arrangement was a $3,000,000 bank loan with an
interest rate equal to two percentage points above the Prime Rate (7.75%
as of December 31, 1998). The loan is secured by the assets and operating
cash flows of a subsidiary of the Company and guaranteed by the Company.

The second financing arrangement was a $1,650,000 term loan with a
syndicate of lenders and a fixed interest rate of 14%. The loan is also
secured by the assets and operating cash flows of a subsidiary of the
Company and guaranteed by the Company. The security interest of the debt
holders is subordinated to the bank loan's security interest.

In the third quarter of 1995, the Company consummated a transaction
whereby certain assets were sold to a third party and subsequently leased
back for a fixed rental stream over a period of forty-eight months. The
Company has the option either to purchase all the properties at the
expiration of the term of the lease or extend the term of the lease. The
Company reported this transaction as a financing transaction since the
requirements for consummation of a sale were not met. A deposit of
$188,000 with the lender was offset against the loan balance as of
December 31, 1998 and 1997. This transaction has been reflected in the
table above as a term loan.

The terms of certain financing agreements contain, among other provisions,
requirements for a subsidiary of the Company to maintain defined levels of
earnings, net worth and various financial ratios, including debt to net
worth. In conjunction with the debt financing agreements, APS issued a
total of 197,500 warrants with an original exercise price of $7.00 per
share of common stock. In accordance with the original terms of the
warrant agreements, the exercise price on 110,000 of the warrants
outstanding at December 31, 1997 was reduced to $3.00 per share on
December 31, 1997 as a result of the Company reporting a net loss for the
1997 fiscal year.

All costs incurred in obtaining the financing arrangements have been
capitalized as deferred charges, and are being amortized over the life of
the loans using the effective interest method. Interest paid in 1998,
1997 and 1996 approximated interest expense reflected in the Consolidated
Statements of Operations.

Note 9 Commitments

Lease Commitments: Total rental expense for property and equipment was
$1,019,534, $770,187 and $655,283 for 1998, 1997 and 1996, respectively.

The Company's future minimum lease payments under noncancellable operating
leases for facilities as of December 31, 1998, are as follows:

Years Ending Minimum
December 31, Payments
------------ -----------
1999 $ 768,279
2000 770,849
2001 747,455
2002 737,333
2003 675,135
Thereafter 573,474
----------
$4,272,525
==========

Note 10 Shareholders' Equity

Private Placements and Common Stock Warrants: In January 1996, in
accordance with a 1994 private placement agreement, APS issued J&J 432,101
shares of common stock as a result of the APS stock price not achieving
certain predetermined levels. The 200,000 warrants issued to J&J in
conjunction with this private placement expired in 1996 (Note 15).

During 1997, 925,158 warrants issued in connection with a 1994 private
placement were exercised. In March 1998, the remaining 310,278 warrants
from the 1994 private placement were exercised.

In conjunction with certain debt financing agreements made in 1995 (Note
8), APS issued a total of 197,500 warrants with an original exercise price
of $7.00 per share of common stock. In accordance with the warrant
agreements, the exercise price was reduced to $3.00 on December 31, 1997
as a result of the Company reporting a net loss for the 1997 fiscal year.
These warrants expire on March 27, 2000.

In the first quarter of 1996, the Company formed a collaborative agreement
with Lander Company under which the Company received approximately
$2,961,000 in net proceeds from the sale of 356,761 shares of common
stock. The agreement also provided for licensing fees, research and
development funding and royalties on product sales.

In 1996, APS acquired all patents and rights to the Polytrap technology
from Dow Corning in exchange for 200,000 shares of APS common stock (Note
2).

During the second quarter of 1996, APS received $1,937,851 net of offering
costs, through a private placement and sale of 201,922 shares of common
stock and 86,538 warrants exercisable over a three-year period. The
warrants are exercisable at the following prices:

Number of Shares Exercise Price
---------------- --------------
28,846 $ 7.43
28,846 9.90
28,846 12.38

Shareholders Rights Plan: On August 19, 1996, the Board of Directors
approved a Shareholders Rights Plan under which shareholders of record on
September 3, 1996 received a dividend of one Preferred Stock purchase
right ("Rights") for each share of common stock outstanding. The Rights
were not exercisable until 10 business days after a person or group
acquired 20% or more of the outstanding shares of common stock or
announced a tender offer which could have resulted in a person or group
beneficially owning 20% or more of the outstanding shares of common stock
(an "Acquisition") of the Company. The Board of Directors approved an
increase in threshold to 30% in December 1997. Each Right, should it
become exercisable, will entitle the holder (other than acquirer) to
purchase company stock at a discount. The Board of Directors may
terminate the Rights plan or, under certain circumstances, redeem the
rights.

In the event of an Acquisition without the approval of the Board, each
Right will entitle the registered holder, other than an acquirer and
certain related parties, to buy at the Right's then current exercise price
a number of shares of common stock with a market value equal to twice the
exercise price.

In addition, if at the time when there was a 30% shareholder, the Company
were to be acquired by merger, shareholders with unexercised Rights could
purchase common stock of the acquirer with a value of twice the exercise
price of the Rights.

The Board may redeem the Rights for $0.01 per Right at any time prior to
Acquisition. Unless earlier redeemed, the Rights will expire on August
19, 2006.

Stock-Based Compensation Plans: The Company has two types of stock-based
compensation plans, a stock purchase plan and stock option plans.

In 1997, the stockholders approved the Company's 1997 Employee Stock
Purchase Plan (the "Plan"). Under the 1997 Employee Stock Purchase Plan,
the Company is authorized to issue up to 400,000 shares of common stock to
its employees, nearly all of whom are eligible to participate. Under the
terms of the Plan, employees can elect to have up to a maximum of 10
percent of their base earnings withheld to purchase the Company's common
stock. The purchase price of the stock is 85 percent of the lower of the
closing prices for the Company's common stock on: (i) the first trading
day in the enrollment period, as defined in the Plan, in which the
purchase is made, or (ii) the purchase date. The length of the enrollment
period may not exceed a maximum of 24 months. Enrollment dates are the
first business day of May and November provided that the first enrollment
date was April 30, 1997. Approximately 50 percent of eligible employees
participated in the Plan in 1998. Under the Plan, the Company issued
38,614 shares in 1998, 14,545 shares in 1997 and no shares in 1996. The
weighted average fair value of purchase rights granted during 1998 and
1997 were $1.65 and $2.77, respectively. The weighted average exercise
price of the purchase rights exercised during 1998 and 1997 were $3.83 and
$6.00, respectively. As of December 31, 1998, the Company had 346,841
shares reserved for issuance under the stock purchase plan.

The Company has various stock option plans for employees, officers,
directors and consultants. The options are granted at fair market value
and expire no later than ten years from the date of grant. The options
are exercisable in accordance with vesting schedules that generally
provide for them to be fully exercisable four years after the date of
grant.

The following table summarizes option activity for 1998, 1997 and 1996:

<TABLE>
<CAPTION>
1998 1997 1996
----------------- ------------------ --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------------- ------------------ --------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning
of year 2,947,755 $6.63 2,901,440 $6.46 2,972,324 $5.98
Granted 777,000 5.18 313,500 7.50 502,500 7.89
Exercised (79,598) 5.20 (165,374) 4.71 (416,219) 4.80
Expired or Cancelled (77,974) 7.83 (101,811) 8.36 (157,165) 6.25
--------- --------- ---------
Outstanding at end of year 3,567,183 6.32 2,947,755 6.63 2,901,440 6.46
========= ========= =========
Options exercisable at
year-end 2,698,960 2,259,683 1,945,056
Shares available for future
grant at year end 293,269 358,295 569,984
Weighted-average fair
value of options granted
during the year $2.45 $4.25 $5.12

</TABLE>

The following table summarizes information about fixed stock options
outstanding at December 31, 1998:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------- -------------------
Weighted Weighted Weighted
Average Average Average
Range of Number Remaining Remaining Number Remaining
Exercise Outstanding Contractual Exercise Exercisable Exercise
Prices 12/31/98 Life Price at 12/31/98 Price
- ----------- ----------- ----------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C>
$3.44-$5.25 1,205,490 6.8 years $ 4.55 875,285 $ 4.64
$5.38-$6.25 939,620 5.9 5.66 796,079 5.59
$6.38-$8.13 933,073 7.3 7.28 538,596 7.28
$9.25-$15.00 489,000 4.0 10.12 489,000 10.12
--------- ---------
$3.44-$15.00 3,567,183 6.3 6.32 2,698,960 6.44
========= =========

</TABLE>

The Company has adopted the disclosure only provisions of Statement of
Financial Accounting Standards No. 123, ("SFAS No. 123") "Accounting for
Stock-Based Compensation." Accordingly, except for stock options issued
to non-employees and restricted stock awards to employees, no compensation
cost has been recognized for the various fixed stock option plans and
stock purchase plan. The compensation cost that has been charged against
income for the stock options issued to non-employees and restricted stock
awards to employees was $142,057, $96,800 and $161,300 for 1998, 1997 and
1996, respectively. Had compensation cost for the Company's stock-based
compensation plans been determined consistent with the fair value method
provisions of SFAS No. 123, the Company's net loss and loss per common
share would have increased to the pro-forma amounts indicated below:

1998 1997 1996
----------- ----------- ---------
Net income (loss)
- as reported $ 1,895,525 (683,161) (9,378,099)
Net income (loss)
- pro-forma 165,570 (2,010,319) (10,462,871)
Basic earnings (loss) per
common share 0.10 (0.04) (0.52)
Diluted earnings (loss) per
common share 0.09 (0.04) (0.52)
Basic earnings (loss) per
common share - pro-forma 0.01 (0.11) (0.58)
Diluted earnings (loss) per
common share - pro-forma 0.01 (0.11) (0.58)

For stock options, the fair value of each option grant is estimated on the
date of grant using the Black-Scholes option pricing model with the
following weighted-average assumptions used for grants in 1998, 1997 and
1996, respectively: dividend yield of 0 for all years; expected
volatility of 48 percent, 60 percent and 85 percent; risk-free interest
rates of 4.7 percent, 5.7 percent and 6.1 percent; and expected life of
five years, five years and four years for all the stock option plans.

For the stock purchase plan, the fair value of each award is also
estimated using the Black-Scholes option pricing model. For purchase
rights granted in 1998, the multiple option approach with the following
assumptions were used for expected terms of six, twelve, eighteen and
twenty-four months: risk-free interest rate of 5.1%; volatility of 54%;
and dividend yield of zero. The purchase rights granted in 1997 were
valued using the following assumptions for expected terms of six, twelve,
eighteen and twenty-four months, respectively: risk-free interest rates
of 5.7 percent, 5.8 percent, 6.0 percent and 6.0 percent; volatility of 40
percent for all four terms; and dividend yield of zero for all terms.
There were no grants under the stock purchase plan in 1996.

The amounts disclosed above under the fair value method of SFAS No. 123
include compensation costs and fair values for options and purchase rights
granted since January 1, 1995 and may not be representative of the effects
in future years.

Note 11 Earnings Per Share

In the fourth quarter of 1997, the Company adopted and retroactively applied
the requirements of Statement of Financial Accounting Standards No. 128,
"Earnings Per Share", to all periods presented. The following table sets
forth the computation of the Company's basic and diluted earnings (loss) per
share:

<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Net income (loss) (numerator) $ 1,895,525 (683,161) (9,378,099)
========== ========== ==========

Shares calculation (denominator):
Weighted average shares
outstanding - basic 19,854,103 18,778,921 17,987,153
Effect of dilutive securities:
Stock options and employee
stock purchase plan 381,518 634,655 859,767
Warrants 145,211 401,257 647,492
---------- ---------- ----------
Weighted average shares
outstanding - diluted 20,380,832 19,814,833 19,494,412
========== ========== ==========
Earnings (loss) per share -
basic 0.10 (0.04) (0.52)
========== ========== ==========

Earnings (loss) per share -
diluted 0.09 (0.04) (0.52)
========== ========== ==========
</TABLE>

The following options with expiration dates ranging from December 18, 2001 to
June 10, 2008 were outstanding during the periods presented, but were not
included in the computation of diluted earnings per share since the exercise
prices of the options were greater than the average market price of the
common shares:

<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Number outstanding 1,362,432 757,417 522,000
Range of exercise prices $6.81 - $15.00 $7.88 - $15.00 $9.25 - $11.13
</TABLE>

Note 12 Comprehensive Income

During the first quarter of 1998, the Company adopted Statement of
Financial Accounting Standards No. 130 "Reporting Comprehensive Income"
which establishes standards for reporting and display of comprehensive
income and its components in a full set of general purpose financial
statements. For the years ended December 31, 1998 and 1997, comprehensive
income (loss) was the same as net income (loss). For the year ended
December 31, 1996, a reclassification adjustment for gains included in net
income is reported in the Statement of Shareholders' Equity.

Note 13 Defined Contribution Plan

The Company sponsors a defined contribution plan covering substantially
all of its employees. In the past three calendar years, the Company made
matching contributions equal to 50% of each participant's contribution
during the plan year up to a maximum amount equal to the lesser of 3% of
each participant's annual compensation or $4,800, $4,750 and $4,750 for
the 1998, 1997 and 1996 calendar years, respectively. The Company may
also contribute additional discretionary amounts as it may determine. For
the years ended December 31, 1998, 1997 and 1996, the Company contributed
to the plan approximately $124,000, $110,000 and $110,000, respectively.
No discretionary contributions have been made to the plan since its
inception.

Note 14 Income Taxes

A reconciliation of the federal statutory rate of 34% to the Company's
effective tax rate is as follows:

December 31
------------------------
1998 1997 1996
---- ---- ----
U.S. Federal statutory rate (benefit) 34.00% (34.00)% (34.00)%
State taxes, net of federal income
tax benefit -- -- --
Net losses without benefits -- 31.40 33.75
Utilization of temporary differences
for which no benefit was previously
recognized (34.76) -- --
Nondeductible expenses 0.76 2.60 0.25
----- ----- -----
Total tax expense (benefit) -- -- --
===== ===== =====

At December 31, 1998, the Company had net federal operating loss
carryforwards of approximately $73,400,000 for income tax reporting
purposes and California operating loss carryforwards of approximately
$3,460,000. The federal net operating losses expire beginning in 1999
through the year 2018. The California net operating loss carryforwards
expire beginning in 1999 through the year 2003. A federal net operating
loss carryforward from 1983 in the approximate amount of $147,000 expired
December 31, 1998. A California net operating loss carryforward from 1993
in the approximate amount of $370,000 expired on December 31, 1998.

The Company also has investment tax credits and research and experimental
tax credits aggregating approximately $1,692,000 and $909,000 for federal
and California purposes, respectively. The federal credit carryforwards
expire beginning in 1999 through the year 2018. The California credits
carry over indefinitely until utilized.

In addition, there are California credit carryforwards for qualified
manufacturing and research and development equipment of approximately
$20,000; these credits expire beginning in 2003 through the year 2006.

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of
December 31, 1998 and 1997 are presented below:

<TABLE>
<CAPTION>
1998 1997
------------ -----------
<S> <C> <C>
Deferred tax assets:
Deferred research expenditures $ 1,544,000 1,367,000
Accruals and reserves not
currently deductible for tax
purposes 977,000 1,934,000
Net operating loss carryforwards 25,260,000 25,680,000
Credit carryforwards 2,621,000 2,445,000
Other 286,000 246,000
---------- ----------
Gross deferred tax assets 30,688,000 31,672,000
Less valuation allowance (29,927,000) (31,522,000)
---------- ----------
Total deferred tax assets 761,000 150,000
---------- ----------
Deferred tax liabilities:
Property and equipment (761,000) (150,000)
---------- ----------
Total deferred tax liabilities (761,000) (150,000)
---------- ----------
Net deferred taxes $ -- --
========== ==========
</TABLE>

The net change in the valuation allowance for the year ended December 31,
1998 was a decrease of approximately $1,595,000. The net change in the
valuation allowance for the years ended December 31, 1997 and 1996 was an
increase of approximately $340,000 and $3,756,000, respectively.
Management believes that sufficient uncertainty exists regarding the
realizability of its deferred asset and, accordingly, a valuation
allowance is required.

Gross deferred tax assets as of December 31, 1998 include approximately
$2,800,000 relating to the exercise of stock options, for which any
related tax benefits will be credited to equity when realized.

Note 15 Ortho-McNeil Pharmaceutical Corporation

In May 1992, APS entered into development, and licensing and investment
agreements with Ortho-McNeil Pharmaceutical Corporation ("Ortho") for the
development of retinoid products. The first product is a Microsponge
system entrapment of tretinoin (trans-retinoic acid or "t-RA"), a
prescription acne drug 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.

The terms of the agreements included an $8,000,000 investment in APS for
723,006 newly issued shares of APS common stock and the payment to APS of
$6,000,000 in R&D fees by J&J.

J&J made a second equity investment in the Company in May 1994. Under
this agreement, J&J purchased 1,000,000 shares of newly issued common
stock in consideration for $5,000,000. In January 1996, APS issued J&J
432,101 shares of common stock as a result of the APS stock price not
achieving certain predetermined levels. The 200,000 warrants issued in
1994 to J&J in conjunction with this equity investment expired in 1996.
As of December 31, 1998, J&J owned approximately 7% of the APS common
shares outstanding.

In February 1995, APS received $750,000 in prepaid royalties and an
additional $750,000 as a milestone payment on the submission to the FDA of
its New Drug Application for the tretinoin prescription acne treatment.
The milestone payment was recognized as revenue upon receipt. The prepaid
royalties of $750,000 were recorded as deferred revenues. In February
1997, upon receipt of approval from the FDA to market Retin-A(R) Micro
(tretinoin gel) microsphere for the treatment of acne, APS received
$3,000,000 from Ortho of which one half is a milestone payment which was
recognized as revenue in 1997 and half is prepaid royalties which was
recorded as deferred revenues. APS earns a mark-up on Microsponge systems
supplied to Ortho and Ortho pays APS a royalty on product sales, subject
to certain minimums. Should these minimums not be achieved, Ortho would
lose its exclusivity and APS would regain marketing rights to the retinoid
products.

Note 16 Subsequent Event (Unaudited)

In March 1999, the Company received a $4,000,000 term loan with a fixed
interest rate of 13.87%. The loan is secured by the assets of the
Company's manufacturing facility in Louisiana. Principal and interest
payments are due in equal monthly installments over a period of forty-
eight months commencing March 1999.

The term loan was obtained mainly to refinance the scheduled debt
repayments made in the first quarter of 1999.

<PAGE>
Independent Auditors' Report

The Board of Directors and Shareholders
Advanced Polymer Systems, Inc.:

We have audited the accompanying consolidated balance sheets of Advanced
Polymer Systems, Inc. and subsidiaries as of December 31, 1998 and 1997,
and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the years in the three-year period
ended December 31, 1998. In connection with our audits of the
consolidated financial statements, we also have audited the consolidated
financial statement schedule as listed in Item 14(a)2. These consolidated
financial statements and consolidated financial statement schedule are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and the
financial statement schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Advanced Polymer Systems, Inc. and subsidiaries as of December 31, 1998
and 1997, and the results of their operations and their cash flows for
each of the years in the three-year period ended December 31, 1998, in
conformity with generally accepted accounting principles. Also in our
opinion, the related financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth
therein.

/s/KPMG LLP

San Francisco, California
March 12, 1999

Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure

Not applicable.

<PAGE>
Part III

Item 10. Directors and Executive Officers of the Registrant

APS incorporates by reference the information set forth under the captions
"Nomination and Election of Directors" and "Executive Compensation" of the
Company's Proxy Statement (the "Proxy Statement") for the annual meeting
of shareholders to be held on June 16, 1999.

Item 11. Executive Compensation

APS incorporates by reference the information set forth under the caption
"Executive Compensation" of the Proxy Statement.

Item 12. Security Ownership of Certain Beneficial Owners and
Management

The Company incorporates by reference the information set forth under the
caption "Beneficial Stock Ownership" of the Proxy Statement.

Item 13. Certain Relationships and Related Transactions

The Company incorporates by reference the information set forth under the
caption "Certain Transactions" of the Proxy Statement.

<PAGE>
Part IV

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K

(a) 1. Financial Statements
The financial statements and supplementary data set forth in Part
II of the 10-K Annual Report are incorporated herein by
reference.
2. Financial Statement Schedules
Schedule II Valuation Accounts
All other schedules have been omitted because the information is
not required or is not so material as to require submission of
the schedule, or because the information is included in the
financial statements or the notes thereto.
3. Exhibits
3-A-Copy of Registrant's Certificate of Incorporation. (1)
3-B-Copy of Registrant's Bylaws. (1)
10-C-Registrant's 1992 Stock Plan dated August 11, 1992. (2)*
10-D-Registrant's 1997 Employee Stock Purchase Plan dated March
5, 1997 (9)*
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. (11)
10-N-Agreement with Johnson & Johnson dated April 14, 1992. (3)
10-P-Warrant to Purchase Common Stock. (5)
10-S-Lease Agreement between Registrant and Financing for Science
International dated September 1, 1995 (6)
10-T-Security and Loan Agreement between Registrant and Venture
Lending dated September 27, 1995 (6)
10-U-Asset Purchase Agreement with Dow Corning Corporation dated
January 23, 1996 (7)
10-V-Investment Agreement between Registrant and Lander Company.
(8)
10-W-License, Assignment and Supply Agreement between Registrant
and Lander Company. (10)
21-Proxy Statement for the Annual Meeting of Shareholders. (4)
23-Consent of Independent Auditors.
27-Financial Data Schedules

(b) Reports on Form 8-K
None.

(d) Financial Statement Schedules
See Item 14(a)2 of this Form 10-K.
- --------------------------------------------------------------------------
(1)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Registration Statement on Form S-1 (Registration No. 33-15429) and
incorporated herein by reference.
(2)Filed as Exhibit No. 28.1 to Registrant's Registration Statement on
Form S-8 (Registration No. 33- 50640), and incorporated herein by
reference.
(3)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1992, and
incorporated herein by reference.
(4)To be filed supplementally.
(5)Filed as an Exhibit with corresponding Exhibits 4.1, 4.2, 4.3 and
4.4 to Registrant's Registration Statement on Form S-3 (Registration
No.33-82562) and incorporated herein by reference.
(6)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1995.
(7)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1995, and
incorporated herein by reference.
(8)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended March
31, 1996, and incorporated herein by referenced.
(9)Filed an Exhibit No. 99.1 to Registrant's Registration Statement on
Form S-8 (Registration No. 333-35151), and incorporated herein by
reference.
(10)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1996 and
incorporated herein by reference.
(11)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.

* Management Contract or Compensatory plans.

<PAGE>
For purposes of complying with the amendments to the rules governing
Registration Statements on Form S-8 (effective July 13, 1990) under the
Securities Act of 1933 ("the Act"), as amended, the undersigned registrant
hereby undertakes as follows, which undertaking shall be incorporated by
reference into Part II of the registrant's Registration Statements on Form
S-8 Nos. 33-18942, 33-21829, 33-29084, 33-50640, 333-06841, 333-35151 and
333-60585 filed on April 25, 1990, May 12, 1988, September 30, 1991,
August 11, 1992, June 26, 1996, September 8, 1997 and August 4, 1998,
respectively.

Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers and controlling
persons of the registrant pursuant to the foregoing provisions, or
otherwise, the registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other
than the payment by the registrant of expenses incurred or paid by a
director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities
being registered, the registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.

<PAGE>
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.

ADVANCED POLYMER SYSTEMS, INC.

By: /s/John J. Meakem, Jr.
----------------------------------------------
John J. Meakem, Jr.
Chairman, President, Chief Executive Officer
<TABLE>
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.
<CAPTION>

Signature Title Date
- --------------------------------------------------------------------------
<S> <C> <C>
/S/ John J. Meakem, Jr. Chairman, President,
- ------------------------- Chief Executive Officer March 29, 1999
John J. Meakem, Jr. --------------

/S/ Michael O'Connell Executive Vice President,
- ------------------------- Chief Administrative Officer and
Michael O'Connell Chief Financial Officer March 29, 1999
--------------

/S/ Carl Ehmann Director March 29, 1999
- ------------------------- --------------
Carl Ehmann

/S/ Jorge Heller Director March 29, 1999
- ------------------------- --------------
Jorge Heller

/S/ Peter Riepenhausen Director March 29, 1999
- ------------------------- --------------
Peter Riepenhausen

/S/ Toby Rosenblatt Director March 29, 1999
- ------------------------- --------------
Toby Rosenblatt

/S/ Gregory H. Turnbull Director March 29, 1999
- ------------------------- --------------
Gregory H. Turnbull

/S/ C. Anthony Wainwright Director March 29, 1999
- ------------------------- --------------
C. Anthony Wainwright

/S/ Dennis Winger Director March 29, 1999
- ------------------------- --------------
Dennis Winger

</TABLE>

<PAGE>
Schedule II

Valuation Accounts
<TABLE>
<CAPTION>
Additions
Beginning Charged to Ending
Balance Expense Deductions Balance
- ---------------------------------------------------------------------------
<S> <C> <C> <C> <C>
December 31, 1996
Accounts receivable, allowance
for doubtful accounts $68,650 9,331 30,454 47,527

December 31, 1997
Accounts receivable, allowance
for doubtful accounts 47,527 22,967 13,040 57,454

December 31, 1998
Accounts receivable, allowance
for doubtful accounts 57,454 38,830 -- 96,284

</TABLE>

<PAGE>
CONSENT OF INDEPENDENT AUDITORS

The Board of Directors and Shareholders
Advanced Polymer Systems, Inc.:

We consent to incorporation by reference in the Registration Statements
(Nos. 33-18942, 33-21829, 33-29084, 33-50640, 333-06841, 333-35151 and
333-60585) on Forms S-8 of Advanced Polymer Systems, Inc. and in the
Registration Statements (Nos. 33-47399, 33-51326, 33-67936, 33-82562, 33-
88972, 333-00759, 333-042527 and 333-69815) on Forms S-3 of Advanced
Polymer Systems, Inc. of our report dated March 12, 1999, relating to the
consolidated balance sheets of Advanced Polymer Systems, Inc. and
subsidiaries as of December 31, 1998 and 1997, and the related
consolidated statements of operations, shareholders' equity and cash flows
for each of the years in the three-year period ended December 31, 1998,
and the related schedule, which report appears in the December 31, 1998
annual report on Form 10-K of Advanced Polymer Systems, Inc.

/s/KPMG LLP

San Francisco, California
March 26, 1999

<PAGE>
EXHIBIT INDEX
Form 10-K Annual Report

3-A-Copy of Registrant's Certificate of Incorporation. (1)
3-B-Copy of Registrant's Bylaws. (1)
10-C-Registrant's 1992 Stock Plan dated August 11, 1992. (2)*
10-D-Registrant's 1997 Employee Stock Purchase Plan dated March 5, 1997
(9)*
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. (11)
10-N-Agreement with Johnson & Johnson dated April 14, 1992. (3)
10-P-Warrant to Purchase Common Stock. (5)
10-S-Lease Agreement between Registrant and Financing for Science
International dated September 1, 1995 (6)
10-T-Security and Loan Agreement between Registrant and Venture Lending
dated September 27, 1995 (6)
10-U-Asset Purchase Agreement with Dow Corning Corporation dated January
23, 1996 (7)
10-V-Investment Agreement between Registrant and Lander Company. (8)
10-W-License, Assignment and Supply Agreement between Registrant and
Lander Company. (10)
21-Proxy Statement for the Annual Meeting of Shareholders. (4)
23-Consent of Independent Auditors.
27-Financial Data Schedules
- --------------------------------------------------------------------------
(1)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Registration Statement on Form S-1 (Registration No. 33-15429) and
incorporated herein by reference.
(2)Filed as Exhibit No. 28.1 to Registrant's Registration Statement on
Form S-8 (Registration No. 33- 50640), and incorporated herein by
reference.
(3)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1992, and
incorporated herein by reference.
(4)To be filed supplementally.
(5)Filed as an Exhibit with corresponding Exhibits 4.1, 4.2, 4.3 and 4.4
to Registrant's Registration Statement on Form S-3 (Registration
No.33-82562) and incorporated herein by reference.
(6)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended September
30, 1995.
(7)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on Form 10-K for the year ended December 31, 1995, and
incorporated herein by reference.
(8)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended March 31,
1996, and incorporated herein by referenced.
(9)Filed an Exhibit No. 99.1 to Registrant's Registration Statement on
Form S-8 (Registration No. 333-35151), and incorporated herein by
reference.
(10)Filed as an Exhibit with corresponding Exhibit No. to Registrant's
Annual Report on form 10-K for the year ended December 31, 1996, and
incorporated herein by reference.
(11)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.

* Management Contract or Compensatory plans.

<PAGE>
<ARTICLE>5
<LEGEND>THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
THE UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31,
1998, AND CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE 12
MONTHS ENDED DECEMBER 31, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
<MULTIPLIER> 1
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,088,173
<SECURITIES> 0
<RECEIVABLES> 4,829,379
<ALLOWANCES> 96,284
<INVENTORY> 2,959,443
<CURRENT-ASSETS> 12,812,342
<PP&E> 17,922,800
<DEPRECIATION> 9,278,944
<TOTAL-ASSETS> 23,081,331
<CURRENT-LIABILITIES> 7,510,484
<BONDS> 0
0
0
<COMMON> 199,933
<OTHER-SE> 14,335,059
<TOTAL-LIABILITY-AND-EQUITY> 23,081,331
<SALES> 13,637,093
<TOTAL-REVENUES> 19,991,279
<CGS> 7,126,573
<TOTAL-COSTS> 7,126,573
<OTHER-EXPENSES> 10,390,825
<LOSS-PROVISION> 38,830
<INTEREST-EXPENSE> 805,364
<INCOME-PRETAX> 1,895,525
<INCOME-TAX> 0
<INCOME-CONTINUING> 1,895,525
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,895,525
<EPS-PRIMARY> 0.10
<EPS-DILUTED> 0.09

</TABLE>