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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended June 30, 2002
OR
[ ] TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
COMMISSION FILE NUMBER 1-10113
HALSEY DRUG CO., INC.
---------------------
(Exact name of registrant as specified in its charter)
New York 11-0853640
- -------------------------------------------------------------------------------
(State or other Jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
695 N. Perryville Road, Crimson Building No. 2, Unit 4
Rockford, Illinois 61107
- -------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(815) 399-2060
- -------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- -------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report.)
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 [ ]
As of August 12, 2002 the registrant had 15,065,240 shares of Common Stock, $.01
par value, outstanding.
HALSEY DRUG CO., INC. & SUBSIDIARIES
INDEX
Page #
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - 3
June 30, 2002 and December 31, 2001
Condensed Consolidated Statements of Operations - 5
Three and six months ended June 30, 2002 and June 30, 2001
Condensed Consolidated Statements of Cash 6
Flows - Six months ended June 30, 2002
and June 30, 2001
Consolidated Statement of Stockholders' 8
Equity (Deficit) - Six months ended June 30, 2002
Notes to Condensed Consolidated Financial 9
Statements
Item 2. Management's Discussion and Analysis of Financial 16
Condition and Results of Operations
PART II. OTHER INFORMATION
Item 2. Changes in Securities 24
Item 6. Exhibits and Reports on Form 8-K 24
SIGNATURES 25
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands) JUNE 30, DECEMBER 31,
2002 2001
------- -------
CURRENT ASSETS
Cash $ 245 $ 442
Accounts Receivable - trade, net of
allowances for doubtful accounts of
$19 at June 30, 2002 and $347 at
December 31, 2001, respectively 641 367
Inventories 2,488 2,729
Prepaid expenses and other current assets 317 238
------- -------
Total current assets 3,691 3,776
PROPERTY, PLANT & EQUIPMENT, NET 5,675 5,998
DEFERRED PRIVATE OFFERING COSTS 367 672
OTHER ASSETS AND DEPOSITS 516 623
------- -------
$10,249 $11,069
======= =======
The accompanying notes are an integral part of these statements
3
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands) JUNE 30, DECEMBER 31,
2002 2001
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Notes payable, net $ 22,688 $ 2,568
Convertible subordinated debentures, net 48,217 --
Accounts payable 3,008 2,979
Accrued expenses 6,381 6,205
Department of Justice Settlement 300 300
--------- ---------
Total current liabilities 80,594 12,052
CONVERTIBLE SUBORDINATED DEBENTURES, NET -- 46,179
TERM NOTE PAYABLE -- 17,500
DEPARTMENT OF JUSTICE SETTLEMENT 619 774
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock - $.01 par value; authorized
80,000,000 shares; 15,065,240 shares
issued and outstanding at June 30, 2002
and December 31, 2001 151 151
Additional paid-in capital 43,205 35,914
Accumulated deficit (114,320) (101,501)
--------- ---------
(70,964) (65,436)
--------- ---------
$ 10,249 $ 11,069
========= =========
The accompanying notes are an integral part of these statements
4
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(In thousands except share data)
JUNE 30
-------
FOR THE SIX MONTHS ENDED FOR THE THREE MONTHS ENDED
------------------------ --------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Product sales $ 4,139 $ 4,928 $ 2,258 $ 1,962
Product development revenues -- 5,000 -- --
------------ ------------ ------------ ------------
Net product revenues 4,139 9,928 2,258 1,962
Cost of manufacturing 6,254 7,847 3,353 3,278
Research & development 757 620 385 314
Selling, general and administrative expenses 3,515 3,016 1,899 1,355
Plant shutdown costs (120) -- -- --
------------ ------------ ------------ ------------
Loss from operations (6,267) (1,555) (3,379) (2,985)
Other income (expense)
Interest expense, net (2,166) (1,965) (1,132) (1,019)
Amortization of deferred debt discount and
private offering costs (4,375) (1,161) (2,840) (580)
Investment in joint venture -- (31) -- (17)
Other (11) 9 11 5
------------ ------------ ------------ ------------
NET LOSS $ (12,819) $ (4,703) $ (7,340) $ (4,596)
============ ============ ============ ============
Basic and diluted loss per share $ (0.85) $ (0.31) $ (0.49) $ (0.30)
============ ============ ============ ============
Weighted average number of outstanding shares 15,065,240 14,987,326 15,065,240 14,995,742
============ ============ ============ ============
The accompanying notes are an integral part of these statements
5
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(In thousands) SIX MONTHS ENDED
JUNE 30
--------
2002 2001
-------- --------
Cash flows from operating activities
Net loss $(12,819) $ (4,703)
-------- --------
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities
Depreciation and amortization 433 509
Amortization of deferred debt discount and private
offering costs 4,375 1,161
Amortization of deferred product acquisition costs 18 9
Provision for losses on accounts receivable -- (117)
Loss on disposal of assets 19 --
Debentures and stock issued for interest 1,081 1,061
Changes in assets and liabilities
Accounts receivable (1,103) 3,190
Other receivable -- 637
Inventories 241 360
Prepaid expenses and other current assets (79) 328
Other assets and deposits 119 (250)
Accounts payable 338 (807)
Accrued expenses 1,048 (586)
-------- --------
Total adjustments 6,490 5,495
-------- --------
Net cash (used in) provided by operating activities (6,329) 792
-------- --------
Cash flows from investing activities
Capital expenditures (203) (586)
Investment in joint venture -- (26)
-------- --------
Net cash used in investing activities (203) (612)
-------- --------
Cash flows from financing activities
Proceeds from issuance of term notes payable 6,500 2,000
Payments to Department of Justice (155) (150)
Payments on notes payable (10) (1,752)
-------- --------
Net cash provided by financing activities 6,335 98
-------- --------
NET (DECREASE) INCREASE IN CASH (197) 278
Cash at beginning of period 442 697
-------- --------
Cash at end of period $ 245 $ 975
======== ========
6
Supplemental disclosures of noncash investing and financing activities:
Six Months ended June 30, 2002
- ------------------------------
The Company issued approximately $1,081,000 of debentures as payment for like
amount of accrued debenture interest.
The Company issued approximately 2,120,000 warrants with an estimated relative
fair value of $2,412,000 in connection with the refinancing of existing bridge
loans in January and May 2002.
The Company issued 600,000 warrants with an estimated relative fair value of
$948,000 for the lending commitment of a bridge loan.
The Company issued approximately 775,000 warrants with an estimated relative
fair value of $961,000 in connection with the issuance of bridge loans.
The Company issued 25,000 warrants with an estimated fair value of $30,000 for
the acquisition of product ANDA's.
The accompanying notes are an integral part of these statements
7
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
SIX MONTHS ENDED JUNE 30, 2002
(UNAUDITED)
(In thousands except share data)
Common Stock
$.01 par value Additional
-------------- Paid-in Accumulated
Shares Amount Capital Deficit Total
---------- ------ --------- ---------- ----------
Balance January 1, 2002 15,065,240 $ 151 $ 35,914 $ (101,501) $ (65,436)
Net loss for the six
months ended June 30, 2002 (12,819) (12,819)
Issuance of warrants and
beneficial conversion
features in connection
with convertible debt 7,261 7,261
Issuance of warrant for
the acquisition
of product ANDA's 30 30
---------- ------ -------- ---------- ---------
Balance at June 30, 2002 15,065,240 $ 151 $ 43,205 $(114,320) $ (70,964)
========== ====== ======== ========= =========
The accompanying notes are an integral part of this statement
8
HALSEY DRUG CO., INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Halsey Drug Co., Inc. and subsidiaries (the "Company") have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles in the United States for
complete financial statements. In the opinion of management, all adjustments,
consisting of normal recurring accrual adjustments, considered necessary to
present fairly the financial position, results of operations and cash flows for
the six months ended June 30, 2002, assuming that the Company will continue as a
going concern, have been made. The results of operations for the six month
period ended June 30, 2002 are not necessarily indicative of the results that
may be expected for the full year ended December 31, 2002. The unaudited
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and footnotes thereto for the year ended
December 31, 2001 included in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission.
At June 30, 2002 the Company had cash and cash equivalents of $245,000
as compared to $442,000 at December 31, 2001. The Company had a working capital
deficiency at June 30, 2002 of $(76,903,000) and an accumulated deficit of
approximately $(114,320,000). The Company incurred a loss of approximately
$(12,819,000) during the six months ended June 30, 2002. The working capital
deficiency of $(76,903,000) includes the reclassification of $65,717,000 to
current liabilities comprising the $17,500,000 term loan with Watson
Pharmaceuticals, Inc. (the "Watson Term Loan") and the Company's net outstanding
5% convertible debentures (the "Debentures) each of which are due in March 2003.
Until such time as the Company successfully develops and commercializes
new finished dosage products and active pharmaceutical ingredients, of which
there can be no assurance, the Company will continue to incur operating losses
and negative cash flow. The Company is in need of additional financing in order
to fund its working capital requirements and to develop its opiate synthesis
technologies. Although the Company is in active discussions with certain third
parties to obtain such financing, no assurance can be given that necessary
financing will be available to the Company on acceptable terms, if at all, or
that the amount of such financing, if any, will be sufficient to meet the
Company's working capital requirements and provide adequate funding for the
development of the Company's opiate synthesis technologies.
The Company has funded operations by securing bridge financing from
Galen Partners III, L.P. ("Galen"), certain of Galen's affiliates and certain
investors in the Company's Debentures (collectively, "Galen Group") in the
aggregate amount of approximately $7,000,000 advanced in five (5) separate
bridge loan transactions during the period from August 15, 2001 through April
9
5, 2002 (collectively, the "2001/2002 Galen Bridge Loans"). On May 8, 2002, the
Company and the Galen Group completed an amendment to the 2001/2002 Galen Bridge
Loan Agreement to (i) extend the maturity date of the $7,000,000 principal
amount of the 2001/2002 Galen Bridge Loans, plus accrued and unpaid interest, to
January 1, 2003, (ii) provide for the commitment of Galen to advance up to
$8,000,000 to the Company in the form of additional bridge loans to fund the
Company's working capital requirements through December 31, 2002, (the "2002
Galen Bridge Loan Commitment"), and (iii) provide for the advance by Galen to
the Company of a bridge loan of $1,000,000 under the 2002 Galen Bridge Loan
Commitment. As of August 12, 2002, $4.5 million had been advanced by Galen to
the Company in the form of bridge loans under the 2002 Galen Bridge Loan
Commitment. All advances made by Galen to the Company under the 2002 Galen
Bridge Loan Commitment have a maturity date of January 1, 2003.
The Company's efforts to obtain the approval of the U.S. Drug
Enforcement Administration ("DEA") for a registration to import raw materials
for use in production, including contesting pending third-party opposition
proceedings, and the continuing development of the Company's opiate synthesis
technologies will continue through 2004. In order to fund continued operations,
and to fund the continued development of the Company's opiate synthesis
technologies during the period from fiscal 2002 through and including 2004,
which includes the completion of planned capital improvements to the Company's
Indiana and New York facilities and the processing of the registrations and
approvals required from the DEA (including funding the legal fees and related
expenses in connection with the pending opposition proceedings relating to the
Company's request for a raw material import registration), the Company estimates
that it will be required to obtain additional sources of financing or a third
party equity investment of approximately $15.0 million (the "Working Capital
Financing"). The Company is currently seeking the Working Capital Financing
through transactions related to its business lines as well as private
financings. There can be no assurance, however, that the Working Capital
Financing will be available to the Company on acceptable terms, if at all. In
addition, the Company expects to negotiate with each of Watson, the Galen Group
and the holders of the Company's Debentures to extend the maturity date of each
of the Watson Term Loan, the 2001/2002 Galen Bridge Loans and the Debentures.
The 2001/2002 Galen Bridge Loans have a maturity date of January 1, 2003. The
Watson Term Loan and the Debentures each have a maturity date of March 31,
2003. No assurance can be given, however, that the Company will be successful in
extending the maturity dates for all or any of the Watson Term Loan, the
2001/2002 Galen Bridge Loans or the Debentures.
The failure of the Company to obtain the Working Capital Financing and
to extend the maturity dates of each of the Watson Term Loan, the 2001/2002
Galen Bridge Loans and the Debentures will require the Company to (i)
significantly curtail product development activities, (ii) if available, obtain
funding through arrangements with collaborative partners or others on terms that
may require the Company to relinquish certain rights to its products and
technologies, which the Company could otherwise pursue on its own, or that would
significantly dilute the Company's stockholders, (iii) significantly scale back
or terminate operations, and/or (iv) seek relief under applicable bankruptcy
laws. Any extended delay in obtaining the Working Capital Financing or in
obtaining the extension of the maturity dates of the Company's indebtedness will
result in the cessation of the Company's continuing development efforts relating
to its products and technologies and will have a material adverse effect on the
Company's financial condition and results of operations.
10
NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued Statement of Financial Accounting
Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets. SFAS
No. 142 requires that goodwill and intangible assets with indefinite useful
lives no longer be amortized, but instead be tested for impairment at least
annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also
requires that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of," as amended.
The Company adopted the provisions of SFAS No. 142 effective January 1,
2002. The adoption of SFAS No. 142 had no effect on the financial position or
results of operations of the Company.
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal
of Long-Lived Assets." SFAS No. 144 modifies the rules for accounting for the
impairment or disposal of long-lived assets.
The Company adopted the provisions of SFAS No. 144 effective January 1,
2002. The adoption of SFAS No. 144 had no effect on the financial position or
results of operations of the Company.
On April 30, 2002 the FASB issued Statement of Financial Accounting
Standard No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections" ("SFAS No. 145"). SFAS No. 145
rescinds Statement No. 4, which required all gains and losses from
extinguishments of debt to be aggregated and, if material, classified as an
extraordinary item, net the related income tax effect. Upon adoption of SFAS No.
145, companies will be required to apply the criteria in APB Opinion No. 30,
"Reporting the Results of Operations-reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" in determining the classification of gains and losses
resulting from the extinguishment of debt. SFAS No. 145 is effective for fiscal
years beginning after May 15, 2002. The Company is currently evaluating the
requirements and impact of this statement on its consolidated results of
operations and financial position.
On July 30, 2002, the FASB issued Statement of Financial Accounting
Standard No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" ("SFAS No. 146"). The standard requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. SFAS No. 146 is to
be applied prospectively to exit or disposal activities initiated after December
31, 2002. The Company is currently evaluating the requirements and impact of
this statement on its consolidated results of operations and financial position.
NOTE 3 - STRATEGIC ALLIANCE WITH WATSON PHARMACEUTICALS
Pursuant to the terms of the Core Products Supply Agreement with
Watson, Watson was required to purchase and pay for on a quarterly basis a
minimum of $3,060,000 for products supplied by the Company under such Agreement.
For the three quarters ending December 31, 2000, Watson had made an advance
payment of approximately $4,402,000 as required under the terms of the Core
Products Supply Agreement to be applied against future product purchases under
such Agreement. The advance payments and any additional advance payments made by
Watson under the Core Products Supply Agreement will require that the Company
supply Watson with a like amount of products without additional payments from
Watson at such time. On August 8, 2001, the Company and Watson executed an
amendment to the Core Products Supply Agreement (the "Core Products Amendment")
providing (i) for a reduction of Watson's minimum purchase requirements from
$3,060,000 to $1,500,000 per quarter, (ii) for an extension of Watson's minimum
purchase requirements from the quarter ending September 30, 2001 to quarter
ending September 30, 2002, (iii) for Watson to recover previous advance payments
made under the Core Products Supply Agreement in the form of the Company's
provision of products having a purchase price of up to $750,000 per quarter
(such credit amount to be in excess of Watson's $1,500,000 minimum quarterly
purchase obligation), and (iv) for the Company's repayment to Watson of any
remaining advance payments made by Watson under the Core Products Supply
Agreement (and which amount has not been recovered by product deliveries by the
Company to Watson as provided in Subsection (iii) above) in two (2) equal
monthly installments on October 1, 2002 and November 1, 2002. Pending the
Company's development and receipt of regulatory approval for its API's and
finished dosage products currently under development, including without
limitation, the Product sold to Watson, and the marketing and sales of the same,
of which there can be no assurance, substantially all the Company's
11
revenues expect to be derived from the Core Products Supply Agreement with
Watson. As of June 30, 2002, Watson's advance payments were $4,124,000 and the
Company has provided for the costs of satisfying its obligations to Watson.
NOTE 4 - EARNINGS (LOSS) PER SHARE
The computation of basic earnings (loss) per share of common stock is
based upon the weighted average number of common shares outstanding during the
period. Diluted earnings per share is based on basic earnings per share adjusted
for the effect of other potentially dilutive securities. Excluded from the 2002
and 2001 six month ended computation are approximately 60,720,428 and 51,338,640
respectively, of outstanding warrants and options and the effect of convertible
debentures and bridge loans outstanding which would be antidilutive.
NOTE 5 - INVENTORIES
Inventories consist of the following:
(In thousands)
June 30, 2002 December 31, 2001
-------------- -----------------
Finished Goods $ 45 $ 38
Work in Process 591 1,076
Raw Materials 1,852 1,615
--------- ---------
$ 2,488 $ 2,729
========= =========
NOTE 6 - CONVERTIBLE SUBORDINATED DEBENTURES
Convertible Subordinated Debentures consist of the following:
(In thousands)
June 30, 2002 December 31, 2001
-------------- -----------------
1998 Debentures $ 29,577 $ 28,954
1999 Debentures 20,038 19,580
--------- ------------
49,615 48,534
Less: Debt discount (1,398) (2,355)
--------- ------------
48,217 46,179
Less: Current maturities (48,217) --
--------- ------------
$ -- $ 46,179
========= ============
12
NOTE 7 - NOTES PAYABLE
Notes payable consist of the following:
(In thousands)
June 30, 2002 December 31, 2001
------------- -----------------
Bridge loans $ 9,278 $ 2,500
Capital lease obligation 57 68
--------- ------------
$ 9,335 $ 2,568
Less: Debt discount (4,147) (--)
--------- ------------
$ 5,188 $ 2,568
========= ============
Term note payable $ 17,500 $ 17,500
========= ============
On August 15, 2001, the Company and Galen Partners III, L.P., certain
of its Affiliates and certain investors in the Company's 5% convertible
subordinated debentures (collectively, the "Galen Group") executed a certain
Bridge Loan Agreement pursuant to which the Galen Group made a bridge loan to
the Company in the principal amount of $2,500,000 (the "2001/2002 Galen Bridge
Loans"). The proceeds of the 2001/2002 Galen Bridge Loans were used by the
Company to satisfy in full the Company's 10% convertible subordinated debentures
in the principal amount of $2,500,000 issued in August 1996 and which matured on
August 6, 2001. The 2001/2002 Galen Bridge Loans bear interest at the rate of
10% per annum and is secured by a lien on all the Company's assets, junior to
the security interest granted to Watson under the Watson Term Loan but senior to
the security interest granted to the holders of the Company's 5% convertible
subordinated debentures issued in March, 1998 and May, 1999. The 2001/2002 Galen
Bridge Loans had an initial maturity date of December 31, 2001.
On January 9, 2002, the Company and Galen agreed to amend the 2001/2002
Galen Bridge Loans to (1) refinance existing Bridge Loans to April 30, 2002, (2)
issue warrants expiring January 9, 2009 to purchase 194,723 shares of the
Company's common stock at an exercise price of $1.837 per share in exchange for
the extension of the maturity date, and (3) provide for $3,000,000 of additional
financing. The relative estimated fair value of the warrants, $267,000 was
recorded as additional debt discount and amortized over the life of the bridge
loan.
The Company borrowed $3,000,000 of the additional financing in
$1,000,000 installments on January 9, February 1, and March 1, 2002. Common
stock purchase warrants to purchase 75,000 shares of the Company's common stock
were issued on January 9, February 1, and March 1, 2002, at exercise prices of
$1.837, $1.87 and $2.087, respectively. The relative estimated fair value of the
warrants of $103,000, $119,000, and $112,000, respectively, was recorded as
additional debt discount and amortized over the remaining life of the bridge
loans.
13
The Galen Bridge Loans are convertible into shares of the Company's
common stock at $1.837 to $2.087 per share. The estimated value of the
conversion feature of $754,000, was recorded as additional debt discount and
amortized over the life of the Galen Bridge Loans.
On April 5, 2002, the Company further amended the 2001/2002 Galen
Bridge Loans to provide $1,500,000 of additional financing with a maturity date
of April 30, 2002. The April 5, 2002 bridge loan is convertible into shares of
the Company's common stock at $2.01 per share. Common stock purchase warrants to
purchase 50,000 shares of the Company's common stock were issued on April 5,
2002, at an exercise price of $2.01. The relative estimated fair value of the
warrants of $98,000 and the estimated value of the conversion feature of
$464,000 was recorded as additional debt discount and amortized over the life
of the Galen Bridge Loans.
On May 8, 2002, the Company and the Galen Group completed an amendment
to the 2001/2002 Galen Bridge Loan Agreement to (i) extend the maturity date of
a $7,000,000 principal amount of the 2001/2002 Galen Bridge Loans, plus accrued
and unpaid interest, to January 1, 2003, (ii) provide for the commitment of
Galen to advance up to $8,000,000 to the Company in the form of additional
bridge loans to fund the Company's working capital requirements through December
31, 2002 (the "2002 Galen Bridge Loan Commitment") and (iii) provide for the
advance by Galen to the Company of a bridge loan of $1,000,000 under the 2002
Galen Bridge Loan Commitment.
In consideration for the 2001/2002 Bridge Loans Maturity Date
Extension, the Company issued common stock purchase warrants to the Galen Group
to purchase an aggregate of approximately 1,925,000 shares of the Company's
common stock, representing 33,000 shares of the Company's common stock for each
$1,000,000 in bridge financing provided under the 2001/2002 Galen Bridge Loans
having a term of thirty (30) days, subject to anti-dilution protection. In
consideration for Galen's agreement to provide the 2002 Galen Bridge Loan
Commitment, the Company issued to Galen a common stock purchase warrant
exercisable for 600,000 shares of the Company's common stock at an exercise
price of $2.10. In addition, the Company will issue additional common stock
purchase warrants to Galen exercisable for up to 1,200,000 shares of the
Company's common stock, issued in installments as advances are made to the
Company under the 2002 Galen Bride Loan Commitment. The number of warrants
issuable by the Company for each advance will equal 33,000 shares of the
Company's common stock for each $1,000,000 in additional bridge financing having
a term of thirty (30) days. Such additional warrants will have an exercise price
equal to the average trading price of the Company's common stock for the twenty
(20) trading days preceding the issuance of each such warrant, subject to
anti-dilution protection.
The May 8, 2002 bridge loan is convertible into shares of the Company's
common stock at $2.16 per share. Common stock purchase warrants to purchase
approximately an aggregate of 2,789,000 shares of the Company's common stock
were issued at an exercise price of $2.16. The relative estimated fair value of
the warrants of $3,387,000 and the estimated value of the conversion feature of
$1,635,000 was recorded as additional debt discount and amortized over the life
of the Galen Bridge Loans.
On June 3, 2002, $1.0 million was advanced by Galen to the Company in
the form of a bridge loan under the 2002 Galen Bridge Loan Commitment. The
bridge loan is convertible into shares of the Company's common stock at $1.90
per share. Common stock purchase warrants to purchase approximately 236,000
shares of the Company's common stock were issued at an exercise price of $1.90.
The relative estimated fair value of the warrants of $234,000 and the estimated
value of the conversion feature of $87,000 was recorded as additional debt
discount and amortized over the remaining life of the bridge loan.
During the month of July 2002, $1.5 million was advanced by Galen to
the Company in the form of bridge loans under the 2002 Galen Bridge Loan
Commitment. The bridge loans are convertible into shares of the Company's common
stock at $1.72 and $1.45 per share. Common stock purchase warrants to purchase
204,442, and 89,999 shares of the Company's common stock were issued on July 1,
and July 23, at exercise prices of $1.72, and $1.45, respectively. The relative
estimated fair value of the warrants of approximately $206,000, and $81,000,
respectively, and the estimated value of the conversion feature of $136,000 and
$46,000, respectively will be recorded as additional debt discount in the Third
Quarter and amortized over the remaining life of the bridge loans.
On August 1, 2002, $1.0 million was advanced by Galen to the Company in
the form of a bridge loan under the 2002 Galen Bridge Loan Commitment. The
bridge loan is convertible into shares of the Company's common stock at $1.42
per share. Common stock purchase warrants to purchase 165,554 shares of the
Company's common stock was issued at an exercise price of $1.42. The relative
estimated fair value of the warrants and the estimated value of the conversion
feature will be recorded as additional debt discount in the Third Quarter and
amortized over the remaining life of the bridge loan.
All advances made by Galen to the Company under the 2002 Galen Bridge
Loan Commitment have a maturity date of January 1, 2003.
As of June 30, 2002 Watson Pharmaceuticals, Inc. had advanced
$17,500,000 to the Company under a term loan. The loan is secured by a first
lien on all of the Company's assets, senior to the lien securing all other
Company
14
indebtedness, carries a floating rate of interest equal to prime plus two
percent and matures in March 2003.
NOTE 8 - CONTINGENCIES
The Company currently is a defendant in several lawsuits involving product
liability claims. The Company's insurance carriers have assumed the defense for
all product liability and other actions involving the Company. The final outcome
of these lawsuits cannot be determined at this time, and accordingly, no
adjustment has been made to the condensed consolidated financial statements.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCE CONDITION AND RESULTS OF
OPERATIONS
Six months ended June 30, 2002 vs. six months ended June 30, 2001
NET PRODUCT REVENUES
The Company's net product revenues for the six months ended June 30,
2002 of $4,139,000 represents a decrease of $5,789,000 (58.3%) as compared to
net product revenues for the six months ended June 30, 2001 of $9,928,000.
During the six month period ending June 30, 2001, the Company recognized
$5,000,000 of product development revenues associated with the sale of certain
product rights to Watson Pharmaceuticals, Inc. The decrease in product sales was
due to the inability of the Company to obtain certain raw materials during the
six months ended June 30, 2002. The Company believes that these raw materials
will become available in the third quarter of the year. On an ongoing basis, the
Company expects to generate revenues from the development and manufacture of
both finished dosage and active pharmaceutical ingredients ("API's"), and then
partner with others for the marketing and distribution of these products.
COST OF MANUFACTURING
For the six months ended June 30, 2002, cost of manufacturing decreased
$1,593,000 to $6,254,000 as compared to the six months ended June 30, 2001 of
$7,847,000. This decrease is primarily attributable to 1) reduced costs
associated with decreased sales and 2) the elimination of manufacturing overhead
expenses from the closure of the Company's Brooklyn, New York facility in March
2001
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses as a percentage of sales
for the six months ended June 30, 2002 and 2001 were 84.9% and 30.4%,
respectively. Overall these expenses in the first six months of 2002 increased
$499,000 over the same period in 2001. The increase is primarily attributable to
legal expense incurred for patent research and regulatory matters associated
with the DEA manufacturing and import license registrations, and increases in
product marketing expenses and corporate insurance premiums.
RESEARCH AND DEVELOPMENT EXPENSES
The Company currently conducts research and development activities at
each of its Congers, New York and Culver, Indiana facilities. The Company's
research and development activities consist primarily of the development of the
Opiate Synthesis Technologies, including the development for sale of new
chemical products and the development of APIs, as well as new generic drug
product development efforts and manufacturing process improvements. New drug
product development activities are primarily directed at conducting research
studies to develop generic drug formulations, reviewing and testing such
formulations for therapeutic equivalence to brand name products and additional
testing in areas such as bio-availability, bio-equivalence and shelf-life.
During 2002, the Company's research and development efforts will cover finished
dosage products and APIs in a variety of therapeutic applications, with an
emphasis on pain management products. Research and development expenses
increased $137,000 over the same period in 2001 and as a percentage of sales for
the six months ended June 30, 2002 and 2001 was 18.3% and 6.2%, respectively.
The Company is proceeding with the development of products, apart from
those obtained from Barr Laboratories, for submission to the FDA. During fiscal
16
2002, the Company anticipates the submission of four ANDA supplements or
amendments to the FDA. The supplements and amendments relate to the transfer of
existing ANDAs from the Company's Brooklyn facility to its Congers facility as
well as the transfer of certain ANDAs obtained from Barr Laboratories. Although
the Company has been successful in receiving ANDA approvals since its release
from the FDA's Application Integrity Policy list in December 1996, there can be
no assurance that any newly submitted ANDAs, or supplements or amendments
thereto or those contemplated to be submitted, will be approved by the FDA.
The Company is performing the necessary regulatory steps to effect the
transfer of certain of the products obtained from Barr Laboratories in April
1999 to the Company. The Company initially has identified 8 of the products for
which it will devote substantial effort in seeking approval from the FDA for
manufacture and sale. The Company estimates that certain of these Barr Products
will be available for sale in the fourth quarter of 2002, although no assurance
can be given that any of the Barr Products will receive FDA approval or that if
approved, that the Company will be successful in the manufacture and sale of
such products. It is the Company's intention to continue to evaluate the
remaining Barr Products on an ongoing basis to assess their prospects for
commercialization and likelihood of obtaining regulatory approval.
The Company is continuing development efforts relating to certain
API's. In the last few years, the Company has increased its efforts to develop
and manufacture APIs, also known as bulk chemical products. The development and
sale of APIs generally is not subject to the same level of regulation as is the
development and sale of drug products. Accordingly, APIs may be brought to
market substantially sooner than drug products. Although the Company did not
generate revenues from the sale of API's in fiscal 2001 or in the six months
ended June 30, 2002, it is the Company's expectation that its strategic alliance
with Watson Pharmaceuticals, Inc. and the continued development of the Opiate
Synthesis Technologies and other API development efforts, in addition to
assisting in the expansion of the Company's line of finished dosage products,
will generate revenues from the sale of products using internally produced APIs
starting in the fourth quarter of 2002 and such revenue segment will likely
increase thereafter as a percentage of total revenue. The Company currently
manufactures two API's and has seven others under development.
NET INCOME (LOSS)
For the six months ended June 30, 2002, the Company had a net loss of
$(12,819,000) as compared to a net loss of $(4,703,000) for the six months ended
June 30, 2001. Included in the results for the six months ended June 30, 2002
was net interest expense of $2,166,000 and amortization of deferred debt
discount and private offering costs of $4,375,000 as compared to $1,965,000 and
$1,161,000, respectively, for the six months ended June 30, 2001.
17
Three months ended June 30, 2002 vs. three months ended June 30, 2001
NET PRODUCT REVENUES
The Company's net product revenues for the three months ended June 30,
2002 of $2,258,000 represents a increase of $296,000 (15.1%) as compared to net
revenues for the three months ended June 30, 2001 of $1,962,000. The increase in
product sales reflects some progress in transitioning manufacturing operations
from our Brooklyn, NY facility, which was vacated in March 2001, to the
Company's facility in Congers, NY. Raw material product shortages are expected
to diminish through the third quarter of 2002.
On an ongoing basis, the Company expects to generate revenues from the
development and manufacture of both finished dosage and active pharmaceutical
ingredients ("API's"), and then partner with others for the marketing and
distribution of these products.
COST OF MANUFACTURING
For the three months ended June 30, 2002, cost of manufacturing
decreased by $75,000 as compared to the three months ended June 30, 2001.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses as a percentage of sales
for the three months ended June 30, 2002 and 2001 were 84.1% and 69.1%,
respectively. Overall these expenses in the three months ended June 30, 2002
increased $544,000 over the same period in 2001. The increase is primarily
attributable to legal expense incurred for patent research and regulatory
matters associated with the DEA manufacturing and import license registrations,
and increases in product marketing expenses and corporate insurance premiums.
RESEARCH AND DEVELOPMENT EXPENSES
The Company currently conducts research and development activities at
each of its Congers, New York and Culver, Indiana facilities. The Company's
research and development activities consist primarily of the development of the
Opiate Synthesis Technologies, including the development for sale of new
chemical products and the development of APIs, as well as new generic drug
product development efforts and manufacturing process improvements. New drug
product development activities are primarily directed at conducting research
studies to develop generic drug formulations, reviewing and testing such
formulations for therapeutic equivalence to brand name products and additional
testing in areas such as bioavailability, bioequivalence and shelf-life. During
2002, the Company's research and development efforts will cover finished dosage
products and APIs in a variety of therapeutic applications, with an emphasis on
pain management products. Research and development expenses for the three months
ended June 30, 2002 increased $71,000 over the same period in 2001 and as a
percentage of sales for the three months ended June 30, 2002 and 2001 was 17.1%
and 16.0%, respectively.
18
NET INCOME (LOSS)
For the three months ended June 30, 2002, the Company had a net loss of
$(7,340,000) as compared to a net loss of $(4,596,000) for the three months
ended June 30, 2001. Included in the results for the three months ended June 30,
2002 was interest expense of $1,132,000 and amortization of deferred debt
discount and private offering costs of $2,840,000 as compared to $1,019,000 and
$580,000 respectively, over the same period in 2001.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 2002 the Company had cash and cash equivalents of $245,000
as compared to $442,000 at December 31, 2001. The Company had a working capital
deficiency at June 30, 2002 of $(76,903,000), of which $65,717,000 reflects the
reclassification to current liabilities comprising the Company's payment
obligations due March 2003 under each of the $17,500,000 term loan with Watson
Pharmaceuticals, Inc. and the Company's net outstanding 5% convertible
debentures (the "Debentures"). The Company had a working capital deficiency at
December 31, 2001 of $(8,276,000).
In addition to the other strategic alliance transactions with Watson
Pharmaceuticals, Inc. ("Watson") completed on March 29, 2000, the Company and
Watson executed a Loan Agreement providing for Watson's extension of a
$17,500,000 term loan to the Company (the "Watson Term Loan"). The Watson Term
Loan provides for funding in installments upon the Company's request for
advances and the provision to Watson of a supporting use of proceeds relating to
each such advance. As of June 30, 2002, Watson had advanced the full $17.5
million available to the Company under the Watson Term Loan. The Watson Term
Loan is secured by a first lien on all of the Company's assets, senior to the
liens securing all other Company indebtedness, carries a floating rate of
interest equal to prime plus two percent and matures in March 2003. The net
proceeds of the Watson Term Loan were used in part to satisfy certain bridge
loans made by Galen Partners III, L.P. ("Galen") to the Company during 2000, to
satisfy Company's payment obligations under the Settlement Agreement with the
landlord of its Brooklyn, New York facility, to fund capital improvements and to
fund the Company's working capital requirements.
Pursuant to the terms of the Core Products Supply Agreement with
Watson, Watson was required to purchase and pay for on a quarterly basis a
minimum of $3,060,000 for products supplied by the Company under such Agreement.
For the three quarters ending December 31, 2000, Watson had made an advance
payment of approximately $4,402,000 as required under the terms of the Core
Products Supply Agreement to be applied against future product purchases under
such Agreement. The advance payments and any additional advance payments made by
Watson under the Core Products Supply Agreement will require that the Company
supply Watson with a like amount of products without additional payments from
Watson at such time. On August 8, 2001, the Company and Watson executed an
amendment to the Core Products Supply Agreement (the "Core Products Amendment")
providing (i) for a reduction of Watson's minimum purchase requirements from
$3,060,000 to $1,500,000 per quarter, (ii) for an extension of Watson's minimum
19
purchase requirements from the quarter ending September 30, 2001 to quarter
ending September 30, 2002, (iii) for Watson to recover previous advance payments
made under the Core Products Supply Agreement in the form of the Company's
provision of products having a purchase price of up to $750,000 per quarter
(such credit amount to be in excess of Watson's $1,500,000 minimum quarterly
purchase obligation), and (iv) for the Company's repayment to Watson of any
remaining advance payments made by Watson under the Core Products Supply
Agreement (and which amount has not been recovered by product deliveries by the
Company to Watson as provided in Subsection (iii) above) in two (2) equal
monthly installments on October 1, 2002 and November 1, 2002. Pending the
Company's development and receipt of regulatory approval for its API's and
finished dosage products currently under development, including without
limitation, the Product sold to Watson, and the marketing and sales of the same,
of which there can be no assurance, substantially all the Company's revenues
expect to be derived from the Core Products Supply Agreement with Watson. As of
June 30, 2002, Watson's advance payments were $4,124,000 and the Company has
provided for the costs of satisfying its obligations to Watson.
The Company secured bridge financing from Galen, certain of Galen's
affiliates and certain investors in the Company's 5% convertible subordinated
debentures (collectively, the "Galen Group") in the aggregate amount of
approximately $7,000,000 funded through five (5) separate bridge loan
transactions during the period from August 15, 2001 through April 5, 2002
(collectively, the "2001/2002 Galen Bridge Loans"). $2,500,000 of the 2001/2002
Galen Bridge Loans were used by the Company to satisfy in full the Company's 10%
convertible subordinated debentures in the principal amount of $2,500,000 issued
in August 1996 and which matured on August 6, 2001. The remaining $4,500,000
balance of the 2001/2002 Galen Bridge Loans was used for working capital to fund
continuing operations. The Galen Bridge Loans bear interest at the rate of 10%
per annum and are secured by a lien on all the Company's assets, junior to the
security interest granted to Watson under the Watson Term Loan but senior to the
security interest granted to the holders of the Company's 5% convertible
subordinated debentures issued in March, 1998 and May, 1999. The promissory
notes issued in the 2001/2002 Galen Bridge Loans are convertible into common
stock at an average initial conversion price of $2.33 per share, which
conversion price equals the average trading price of the Company's common stock
for the 20 days preceding the closing date of each bridge loan advance. The
conversion price of the promissory notes is subject to full-ratchet dilution
protection to equal the lower purchase price/conversion price of the Company's
securities issued in a subsequent offering. In consideration for the extension
of the 2001/2002 Galen Bridge Loans, the Company issued to the Galen Group
common stock purchase warrants to purchase an aggregate of 657,461 shares of the
Company's common stock at an average initial exercise price of $2.22 per share.
The exercise price of the Warrants is subject to full-ratchet dilution
protection to equal the lower purchase price/conversion price of the Company's
securities issued in a subsequent offering.
Until such time as the Company successfully develops and commercializes new
finished dosage products and active pharmaceutical ingredients, of which there
can be no assurance, the Company will continue to incur operating losses and
negative cash flow. The Company is in need of additional financing in order to
fund its working capital requirements and to develop its opiate synthesis
technologies. Although the Company is in active discussions with certain third
parties to obtain such financing, no assurance can be given that necessary
financing will be available to the Company on acceptable terms, if at all, or
that the amount of such financing, if any, will be sufficient to meet the
Company's working capital requirements and provide adequate funding to provide
for the development of the Company's opiate synthesis technologies.
20
On May 8, 2002, the Company and the Galen Group completed an amendment to
the 2001/2002 Galen Bridge Loan Agreement to (i) extend the maturity date of the
$7,000,000 principal amount of the 2001/2002 Galen Bridge Loans, plus accrued
and unpaid interest, to January 1, 2003, (ii) provide for the commitment of
Galen to advance up to $8,000,000 to the Company in the form of additional
bridge loans to fund the Company's working capital requirements through December
31, 2002 (the "2002 Galen Bridge Loan Commitment") and (iii) provide for the
advance by Galen to the Company of a bridge loan of $1,000,000 under the 2002
Galen Bridge Loan Commitment.
In consideration for the 2001/2002 Bridge Loans Maturity Date Extension, the
Company issued common stock purchase warrants to the Galen Group to purchase an
aggregate of approximately 1,925,000 shares of the Company's common stock,
representing 33,000 shares of the Company's common stock for each $1,000,000 in
bridge financing provided under the 2001/2002 Galen Bridge Loans having a term
of thirty (30) days. With respect to the 2002 Galen Bridge Loan Commitment,
advances bear interest at the rate of ten percent (10%) per annum, are secured
by a lien on all the Company's assets and have a maturity date of January 1,
2003. Promissory notes issued under the 2002 Galen Bridge Loan Commitment are
convertible into the Company's common stock at a conversion price equal to the
average of the trading price of the Company's common stock for the twenty (20)
trading days preceding the issuance of each promissory note, subject to
full-ratchet dilution protection to equal the lower purchase price/conversion
price of the Company's securities issued in a subsequent offering. In
consideration for Galen's agreement to provide the 2002 Galen Bridge Loan
Commitment, the Company issued to Galen a common stock purchase warrant
exercisable for 600,000 shares of the Company's common stock at an exercise
price equal to the average trading price for the Company's common stock for the
twenty (20) trading days preceding the issuance of such warrant, subject to the
same full-ratchet dilution protections provided in the bridge loan promissory
notes. In addition, the Company will issue additional common stock purchase
warrants to Galen exercisable for up to 1,200,000 shares of the Company's common
stock, issued in installments as advances are made to the Company under the 2002
Galen Bridge Loan Commitment. The number of warrants issuable by the Company for
each advance will equal 33,000 shares of the Company's common stock for each
$1,000,000 in additional bridge financing having a term of thirty (30) days.
Such additional warrants will have an exercise price equal to the average
trading price of the Company's common stock for the twenty (20) trading days
preceding the issuance of each such warrant, subject to the same full-ratchet
dilution protections provided in the bridge loan promissory notes.
The May 8, 2002 bridge loan is convertible into shares of the Company's
common stock at $2.16 per share. Common stock purchase warrants to purchase
approximately an aggregate of 2,789,000 shares of the Company's common stock
21
were issued at an exercise price of $2.16. The relative estimated fair value of
the warrants of $3,387,000 and the estimated value of the conversion feature of
$1,635,000 was recorded as additional debt discount and amortized over the life
of the Galen Bridge Loan.
On June 3, 2002, $1.0 million was advanced by Galen to the Company in the
form of a bridge loan under the 2002 Galen Bridge Loan Commitment. The bridge
loan is convertible into shares of the Company's common stock at $1.90 per
share. Common stock purchase warrants to purchase approximately 236,000 shares
of the Company's common stock were issued at an exercise price of $1.90. The
relative estimated fair value of the warrants of $234,000 and the estimated
value of the conversion feature of $87,000 was recorded as additional debt
discount and amortized over the remaining life of the bridge loans.
During the month of July 2002, $1.5 million was advanced by Galen to the
Company in the form of bridge loans under the 2002 Galen Bridge Loan Commitment.
The bridge loans are convertible into shares of the Company's common stock at
$1.72 and $1.45 per share. Common stock purchase warrants to purchase 204,442,
and 89,999 shares of the Company's common stock were issued on July 1, and July
23, at exercise prices of $1.72, and $1.45, respectively. The relative estimated
fair value of the warrants of approximately $206,000, and $81,000, respectively,
and the estimated value of the conversion feature of $136,000 and 46,000,
respectively will be recorded as additional debt discount in the Third Quarter
and amortized over the remaining life of the bridge loans.
On August 1, 2002, $1.0 million was advanced by Galen to the Company in the
form of a bridge loan under the 2002 Galen Bridge Loan Commitment. The bridge
loan is convertible into shares of the Company's common stock at $1.42 per
share. Common stock purchase warrants to purchase 165,554 shares of the
Company's common stock was issued at an exercise price of $1.42. The relative
estimated fair value of the warrants and the estimated value of the conversion
feature will be recorded as additional debt discount in the Third Quarter and
amortized over the remaining life of the bridge loan. All advances made by Galen
to the Company under the 2002 Galen Bridge Loan Commitment have a maturity date
of January 1, 2003.
The Company's efforts to obtain the approval of the U.S. Drug Enforcement
Administration ("DEA") for a registration to import raw materials for use in
production, including contesting pending third-party opposition proceedings, and
the continuing development of the Company's opiate synthesis technologies will
continue through 2004. In order to fund continued operations, and to fund the
continued development of the Company's opiate synthesis technologies during the
period from fiscal 2002 through and including 2004, which includes the
completion of planned capital improvements to the Company's Culver, Indiana and
Congers, NY facilities and the processing of the registrations and approvals
required from the DEA (including funding the legal fees and related expenses in
connection with pending opposition proceedings relating to the Company's request
for a raw material import registration), the Company estimates that it will be
required to obtain additional sources of financing or a third party equity
investment of approximately $15.0 million (the "Working Capital Financing"). The
Company is seeking the Working Capital Financing through transactions related to
its business lines as well as private financings and is currently in active
negotiations with certain third parties. There can be no assurance, however,
that such ongoing negotiations will be successful or that the Working Capital
Financing will be available to the Company on acceptable terms, if at all. In
addition, the Company expects to negotiate with each of Watson, the Galen Group
and the holders of the Company's Debentures to extend the maturity date of each
of the Watson Term Loan, the 2001/2002 Galen Bridge Loans and the Debentures.
The 2001/2002 Galen Bridge Loans have a maturity date of January 1, 2003. The
Watson Term Loan and the Debentures each have a maturity date of March 31, 2003.
No assurance can be given, however, that the Company will be successful in
extending the maturity dates for any or all of the Watson Term Loan, the
2001/2002 Galen Bridge Loans or the Debentures.
The failure of the Company to obtain the Working Capital Financing and the
extend the maturity dates of each of the Watson Term Loan, the 2001/2002 Galen
Bridge Loans and the Debentures will require the Company to (i) significantly
curtail product commercialization efforts, including the development and
commercialization of the opiate
22
synthesis technologies, (ii) if available, obtain funding through arrangements
with collaborative partners or others on terms that may require the Company to
relinquish certain rights in its opiate synthesis technologies, which the
Company could otherwise pursue on its own, or that would significantly dilute
the Company's stockholders, (iii) significantly scale back or terminate
operations, and/or (iv) seek relief under applicable bankruptcy laws. Any
extended delay in obtaining the working capital financing or in obtaining the
extension of the maturity dates of the Company's indebtedness will result in the
cessation of the Company's continuing development efforts relating to its opiate
synthesis technologies and will have a material adverse effect on the Company's
financial condition and results of operations.
CRITICAL ACCOUNTING POLICIES
Financial Reporting Release No. 60, which was released by the Securities
and Exchange Commission ("SEC") in December 2001, requires all companies to
include a discussion of critical accounting policies or methods used in the
preparation of financial statement. Note A of the Notes to Consolidated
Financial Statements, as contained in the Company's Annual Report on Form 10-K,
includes a summary of the Company's significant accounting policies and methods
used in the preparation of the financial statements. In preparing these
financial statements, the Company has made its best estimates and judgments of
certain amounts included in the financial statements, giving due consideration
to materiality. The application of these accounting policies involves the
exercise of judgment and use of assumptions as to future uncertainties and, as a
result, actual results could differ from these estimates. The Company does not
believe there is a great likelihood that materially different amounts would be
reported under different conditions or using different assumptions. The
Company's critical accounting policies are as follows:
REVENUE RECOGNITION
The Company recognizes revenue at the time a product is shipped to
customers. The Company established sales provisions for estimated chargebacks,
discounts, rebates, returns, pricing adjustments and other sales allowances
concurrently with the recognition of revenue. The sales provisions are
established based upon consideration of a variety of factors, including but not
limited to, actual return and historical experience by product type, the number
and timing of competitive products approved for sale, the expected market for
the product, estimated customer inventory levels by product, price declines and
current and projected economic conditions and levels of competition. Actual
product return, chargebacks and other sales allowances incurred are, however,
dependent upon future events. Management continually monitors the factors that
influence sales allowance estimates and make adjustments to these provisions
when allowances may differ from established allowances.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
Estimates are used in determining the allowance for doubtful accounts
based on the Company's historical collections experience, current trends, credit
policy and a percentage of its accounts receivable by aging category. In
determining these percentages, the Company looks at historical write-offs of its
receivables. The Company also looks at the credit quality of its customer base
as well as changes in its credit policies. The Company continuously monitors
collections and payments from its customers. While credit losses have
historically been within expectations and the provisions established, the
Company cannot guarantee that it will continue to experience the same credit
loss rates that it has in the past.
INVENTORIES
The Company's inventories are stated at the lower of cost or market, with
cost determined on the first-in, first-out basis. In evaluating whether
inventory is stated at the lower of cost or market, management considers such
factors as the amount of inventory on hand, remaining shelf life and current and
expected market conditions, including levels of competition. As appropriate, the
Company records provisions to reduce inventories to their net realizable value.
INCOME TAXES
Deferred income taxes are recognized for temporary differences between
financial statement and income tax bases of assets and liabilities and loss
carry-forwards for which income tax benefits are expected to be realized in
future years. A valuation allowance is established, when necessary, to reduce
deferred tax assets to the amount expected to be realized. In estimating future
tax consequences, the Company generally considers all expected future events
other than an enactment of changes in the tax laws or rates. The Company has
recorded a full valuation allowance to reduce its deferred tax assets to the
amount that is more likely than not to be realized. While the Company has
considered future taxable income in assessing the need for the valuation
allowance, in the event the Company were to determine that it would be able to
realize its deferred tax assets in the future in excess of its net recorded
amount, an adjustment to the deferred tax asset would increase income in the
period such determination was made.
STOCK COMPENSATION
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of APB Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB No. 25") and comply with the disclosure provision of SFAS
No. 123, "Accounting for Stock-based Compensation" ("SFAS No. 123"). If the
Company were to include the cost of stock-based employee compensation in the
financial statements, the Company's operating results would decline based on the
fair value of the stock-based employee compensation.
DEFERRED DEBT DISCOUNT
Deferred debt discount results from the issuance of stock warrants in
connection with the issuance of subordinated debt and other notes payable. The
amount of the discount is recorded as a reduction of the related obligation and
is amortized over the remaining life of the related obligations. Management
determines the amount of the discount, based, in part, by the relative fair
values ascribed to the warrants determined by an independent valuation or
through the use of the Black-Scholes valuation model. Inherent in the
Black-Scholes valuation model are assumptions made by management regarding the
estimated life of the warrant, the estimated volatility of the Company's common
stock and the expected dividend yield.
New Accounting Pronouncements
In July 2001, the FASB issued Statement of Financial Accounting
Standards No. 142 ("SFAS No. 142"), "Goodwill and Other Intangible Assets. SFAS
No. 142 requires that goodwill and intangible assets with indefinite useful
lives no longer be amortized, but instead be tested for impairment at least
annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also
requires that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed of," as amended.
The Company adopted the provisions of SFAS No. 142 effective January 1,
2002. The adoption of SFAS No. 142 had no effect on the financial position or
results of operations of the Company.
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144 ("SFAS No. 144"), "Accounting for the Impairment or Disposal
of Long-Lived Assets." SFAS No. 144 modifies the rules for accounting for the
impairment or disposal of long-lived assets.
The Company adopted the provisions of SFAS No. 144 effective January 1,
2002. The adoption of SFAS No. 144 had no effect on the financial position or
results of operations of the Company.
On April 30, 2002 the FASB issued Statement of Financial Accounting
Standard No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of
FASB Statement No. 13, and Technical Corrections" ("SFAS No. 145"). SFAS No. 145
rescinds Statement No. 4, which required all gains and losses from
extinguishments of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. Upon adoption of SFAS No.
145, companies will be required to apply the criteria in APB Opinion No. 30,
"Reporting the Results of Operations-reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" in determining the classification of gains and losses
resulting from the extinguishment of debt. SFAS No. 145 is effective for fiscal
years beginning after May 15, 2002. The Company is currently evaluating the
requirements and impact of this statement on its consolidated results of
operations and financial position.
On July 30, 2002, the FASB issued Statement of Financial Accounting
Standard No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" ("SFAS No. 146"). The standard requires companies to recognize costs
associated with exit or disposal activities when they are incurred rather than
at the date of a commitment to an exit or disposal plan. Examples of costs
covered by the standard include lease termination costs and certain employee
severance costs that are associated with a restructuring, discontinued
operation, plant closing, or other exit or disposal activity. SFAS No. 146 is to
be applied prospectively to exit or disposal activities initiated after December
31, 2002. The Company is currently evaluating the requirements and impact of
this statement on its consolidated results of operations and financial position.
23
PART II
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the quarter ended June 30, 2002, the Company issued (i) 5%
Convertible Debentures in the principal amount of approximately $544,000 in
satisfaction of accrued interest on the Company's outstanding 5% Convertible
Subordinated Debentures issued in March and June 1998, and May and July 1999
(the "Convertible Debentures"), and (ii) convertible promissory notes and
warrants pursuant to outstanding bridge loans (the "Bridge Loan Securities").
Each of the holders of the Convertible Debentures for which interest
payments were made in 5% Convertible Subordinated Debentures, and the bridge
lenders receiving the Bridge Loan Securities are accredited investors as defined
in Rule 501(a) of Regulation D promulgated under the Securities Act of 1933, as
amended (the "Act"). The 5% Convertible Subordinated Debentures issued in
satisfaction of the interest payments under the Convertible Debentures and the
Bridge Loan Securities were issued without registration under the Act in
reliance upon Section 4(2) of the Act and Regulation D promulgated thereunder.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) The exhibits required to be filed as part of this Report on
form 10-Q are listed in the attached Exhibit Index.
(b) Reports on Form 8-K. None.
24
SIGNATURES
Pursuant to the requirements 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.
HALSEY DRUG CO., INC.
Date: August 12, 2002 BY: s/s Michael K. Reicher
----------------------
Michael K. Reicher
Chairman and Chief
Executive Officer
Date: August 12, 2002 BY: s/s Peter A. Clemens
----------------------
Peter A. Clemens
VP & Chief Financial
Officer
25
EXHIBIT INDEX
99.1 Certification of Periodic Report Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
26