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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 MARCH 31, 2003
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 May 17, 2003 the registrant had 21,095,092 shares of Common
Stock, $.01 par value, outstanding.
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HALSEY DRUG CO., INC. & SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
PAGE
----
Item 1. Financial Statements
Condensed Consolidated Balance Sheets-
March 31, 2003 (Unaudited) and December 31, 2002 ....................................... 3
Condensed Consolidated Statements of
Operations (Unaudited) - Three months ended March 31, 2003
and March 31, 2002 ..................................................................... 5
Condensed Consolidated Statements of Cash
Flows (Unaudited) - Three months ended March 31, 2003
and March 31, 2002 ..................................................................... 6
Consolidated Statement of Stockholders'
Equity (Deficit) (Unaudited) - Three months ended March 31, 2003 ....................... 8
Notes to Condensed Consolidated Financial Statements ................................... 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations .................................................... 16
Item 4. Controls and Procedures................................................................. 23
PART II. OTHER INFORMATION
Item 2. Changes in Securities................................................................... 24
Item 6. Exhibits and Reports on Form 8-K........................................................ 24
SIGNATURES ........................................................................................ 25
CERTIFICATIONS ......................................................................................... 27
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED
MARCH 31, DECEMBER 31,
2003 2002
------- -------
(IN THOUSANDS)
CURRENT ASSETS
Cash ................................................... $ 3,478 $ 9,211
Accounts Receivable - trade, net of
allowances for doubtful accounts of $16 and $14
at March 31, 2003 and December 31, 2002, respectively 769 610
Inventories ......................................... 2,020 2,285
Prepaid expenses and other current assets ........... 684 394
------- -------
Total current assets .............................. 6,951 12,500
PROPERTY, PLANT & EQUIPMENT, NET .......................... 5,614 5,367
DEFERRED PRIVATE OFFERING COSTS,
net of accumulated amortization of $88 and $9
at March 31, 2003 and December 31, 2002, respectively .... 953 1,032
OTHER ASSETS AND DEPOSITS ................................. 433 465
------- -------
$13,951 $19,364
======= =======
The accompanying notes are an integral part of these statements
3
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED
MARCH 31, DECEMBER 31,
2003 2002
--------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Current maturities of notes payable and capital lease
obligations .............................................. $ 30 $ 33
Accounts payable ........................................... 2,042 3,119
Accrued expenses ........................................... 3,156 3,115
Department of Justice Settlement ........................... 300 300
--------- ---------
Total current liabilities ............................... 5,528 6,567
TERM NOTE PAYABLE ............................................. 21,401 21,401
CONVERTIBLE SUBORDINATED DEBENTURES ........................... 77,718 77,118
Less: debt discount ......................................... (68,267) (73,955)
--------- ---------
9,451 3,163
CAPITAL LEASE OBLIGATIONS ..................................... 33 40
DEPARTMENT OF JUSTICE SETTLEMENT .............................. 381 461
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock - $.01 par value; authorized
80,000,000 shares; issued and outstanding,
21,035,323 shares at March 31, 2003 and December 31, 2002 211 211
Additional paid-in capital ................................. 148,611 148,611
Accumulated deficit ........................................ (171,665) (161,090)
--------- ---------
(22,843) (12,268)
--------- ---------
$ 13,951 $ 19,364
========= =========
The accompanying notes are an integral part of these statements
4
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
------------------------------------
2003 2002
------------ ------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Net product revenues ........................ $ 1,526 $ 1,881
Cost of manufacturing ....................... 2,873 2,901
Research and development .................... 329 372
Selling, general and administrative expenses 1,711 1,616
Plant shutdown costs ........................ -- (120)
------------ ------------
Loss from operations .................. (3,387) (2,888)
Other income (expense)
Interest expense ............................ (1,433) (1,038)
Interest income ............................. 17 4
Amortization of deferred debt discount and
private offering costs ................... (5,767) (1,535)
Other ....................................... (5) (22)
------------ ------------
NET LOSS .................................... $ (10,575) $ (5,479)
============ ============
Basic and diluted loss per share ............ $ (0.50) $ (0.36)
============ ============
Weighted average number of outstanding shares 21,035,323 15,065,240
============ ============
The accompanying notes are an integral part of these statements
5
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
----------------------------
2003 2002
-------- --------
(IN THOUSANDS)
Cash flows from operating activities
Net loss ................................................. $(10,575) $ (5,479)
-------- --------
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization ......................... 199 256
Amortization of deferred debt discount and private
offering costs ........................................ 5,767 1,535
Amortization of deferred product acquisition costs .... 14 9
Debentures and stock issued for interest ........... 600 538
Loss on disposal of assets ............................ 5 22
Changes in assets and liabilities
Accounts receivable ................................ (634) (477)
Inventories ........................................ 265 (155)
Prepaid expenses and other current assets .......... (290) (160)
Other assets and deposits .......................... 18 94
Accounts payable ................................... (912) 645
Accrued expenses ................................... 351 216
-------- --------
Total adjustments .................................. 5,383 2,523
-------- --------
Net cash used in operating activities ................. (5,192) (2,956)
-------- --------
Cash flows from investing activities
Capital expenditures .................................. (451) (188)
-------- --------
Net cash used in investing activities .............. (451) (188)
-------- --------
Cash flows from financing activities
Proceeds from issuance of term notes payable .......... -- 3,000
Payments to Department of Justice ..................... (80) (77)
Payments on notes payable and capital lease obligations (10) --
-------- --------
Net cash provided by (used in) financing activities ... (90) 2,923
-------- --------
NET DECREASE IN CASH .................................. (5,733) (221)
Cash at beginning of period .............................. 9,211 442
-------- --------
Cash at end of period .................................... $ 3,478 $ 221
======== ========
The accompanying notes are an integral part of these statements
6
Cash paid for interest was $390.
Supplemental disclosures of noncash investing and financing activities for the
quarter ended March 31, 2003:
The Company issued $600 of debentures as payment of like amounts of debenture
accrued interest.
The Company has repaid $476 of indebtedness in the form of product deliveries.
The accompanying notes are an integral part of these statements
7
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
THREE MONTHS ENDED MARCH 31, 2003
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
COMMON STOCK
$.01 PAR VALUE ADDITIONAL
---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------- -------- --------- ---------- ----------
Balance January 1, 2003............... 21,035,323 $ 211 $ 148,611 $ (161,090) $ (12,268)
Net loss for the three
months ended March 31, 2003........ (10,575) (10,575)
------------ -------- --------- ---------- ----------
Balance at March 31, 2003............. 21,035,323 $ 211 $ 148,611 $ (171,665) $ (22,843)
============ ======== ========= ========== ==========
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 AND LIQUIDITY MATTERS
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 changes in cash
flows for the three months ended March 31, 2003, assuming that the Company will
continue as a going concern, have been made. The results of operations for the
three months period ended March 31, 2003 are not necessarily indicative of the
results that may be expected for the full year ended December 31, 2003. 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, 2002 included in the Company's Annual Report on Form
10-K filed with the Securities and Exchange Commission.
At March 31, 2003 the Company had cash and cash equivalents of
$3,478,000 as compared to $9,211,000 at December 31, 2002. The Company had
working capital at March 31, 2003 of $1,423,000 and an accumulated deficit of
$(171,665,000). The Company incurred a net loss of $10,575,000 during the three
months ended March 31, 2003.
On December 20, 2002, the Company consummated a private offering of
securities for an approximate aggregate purchase price of $26,394,000 (the "2002
Debenture Offering"). The securities issued in the Offering consisted of 5%
convertible senior secured debentures (the "2002 Debentures"). Of the
$26,394,000 in 2002 Debentures issued in the 2002 Debenture Offering,
approximately $15,894,000 of the 2002 Debentures were issued in exchange for the
surrender of a like amount of principal and accrued interest outstanding under
Company's 10% convertible promissory notes issued pursuant to various working
capital bridge loan transactions with Galen Partners III, L.P., Galen
International III, L.P., Galen Employee Fund III, L.P. (collectively, "Galen")
and certain other lenders, during the period from August 15, 2001 through and
including December 20, 2002. The 2002 Debentures, issued at par, will become due
and payable as to principal on March 31, 2006. Interest on the principal amount
of the 2002 Debentures, at the rate of 5% per annum, is payable on a quarterly
basis. Interest on the 2002 Debentures will be substantially paid by the
Company's issuance of a debenture instrument substantial identical to the 2002
Debentures issued in the 2002 Debenture Offering, in the principal amount equal
to the accrued interest for each quarterly period.
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 from operations. The Company believes that the proceeds
received in the 2002 Debenture Offering will be sufficient to satisfy the
Company's working capital requirements only through June 2003. At the Company's
request, on May 5, 2003, the Company received a letter executed by each of Care
Capital Investments II, L.P., Galen Partners III, L.P. and Essex Woodlands
Health Ventures V, L.P. (the "Majority 2002 Debentureholders") advising that the
Majority 2002 Debentureholders would provide funding to meet the Company's 2003
capital requirements, up to an aggregate amount not to exceed $8.6 million (the
"Letter of Support"). The Letter of Support provides that the amount of any
funding provided by the Majority 2002 Debentureholders would be reduced to the
extent of any funding obtained by the Company from third-party sources during
2003. The Letter of Support further provides that the terms of any funding
provided by the Majority 2002 Debentureholders will be subject to negotiation
between the Company and the Majority 2002 Debentureholders at the time of any
funding. The terms of any such funding will be subject to approval by those
directors of the Company
9
that are unaffiliated with the Majority 2002 Debentureholders. While the terms
of any funding to meet the Company's 2003 capital requirements are currently
unknown, it is likely that such terms will result in significant additional
dilution to holders of the Company's Common Stock. In consideration for the
issuance of the Letter of Support, the Company authorized the issuance of
warrants to the Majority 2002 Debentureholders exercisable for an aggregate of
645,000 shares of the Company's Common Stock at an exercise price of $.34 per
share (which is equivalent to the conversion price of the 2002 Debentures),
subject to downward adjustment to equal the consideration per share received by
the Company for its Common Stock, or the conversion/exercise price per share of
the Company's Common Stock issuable under convertible securities, in a third
part investment if lower than the exercise price of the warrants.
The Company believes that the remaining net proceeds received from the
2002 Debenture Offering, along with the funding to be provided under the Letter
of Support combined with cash flow from operations, will be sufficient to
satisfy the Company's working capital requirements through January 1, 2004.
Failure to obtain a third party investment or to reach agreement with
the Majority 2002 Debentureholders on mutually acceptable terms to fund the
Company's working capital requirements for 2003 will require the Company (i) to
delay or cease the continued development of its licensed technologies and the
completion of planned capital expenditures, (ii) to obtain funds through
arrangements with third parties on terms that may require the Company to
relinquish rights to its licensed technologies, which the Company would
otherwise pursue on its own or that would dilute the Company's stockholders,
(iii) significantly scale back or terminate operations and/or (iv) seek
protection under applicable bankruptcy laws. An extended delay or a cessation of
the Company's continuing development efforts related to its opiate synthesis
technologies or delays in obtaining required DEA approvals, will have a material
adverse effect on the Company's financial condition and results of operations.
NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the requirement to report gains and
losses from extinguishment of debt as extraordinary unless they meet the
criteria of APB Opinion 30. SFAS No. 145 also requires sale-leaseback accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. The changes related to lease accounting are
effective for transactions occurring after May 15, 2002 and the changes related
to debt extinguishment are effective for fiscal years beginning after May 15,
2002. The impact of adopting the provisions related to lease accounting did not
have a material impact on the Company's financial position or results of
operations. The Company early adopted the provisions related to debt
extinguishments during the year ended December 31, 2002. The adoption did not
have a material impact on the Company's financial position or results of
operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 nullifies Emerging
Issues Task Force Issue No. 94-3 and requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. This statement also establishes that fair value is the objective for
initial measurement of the liability. SFAS No. 146 is effective for exit or
disposal activities that are initiated after December 31, 2002. The impact of
the adoption of SFAS No. 146 did not have a material impact on the Company's
financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure, an amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for an
entity that voluntarily changes to the fair value-based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions of
that Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. The Company has chosen to continue to account for
stock-based compensation using the intrinsic value method prescribed in APB
10
Opinion No. 25 and related interpretations as provided for under SFAS No. 148.
Accordingly, compensation expense is only recognized when the market value of
the Company's stock at the date of the grant exceeds the amount an employee must
pay to acquire the stock. The adoption of SFAS No. 148 did not have a material
impact on the Company's financial position or results of operations.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN No. 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN No. 45 are effective for any guarantees issued or
modified after December 31, 2002. The disclosure requirements are effective for
financial statements of interim or annual periods ending after December 15,
2002. The adoption of FIN No. 45 did not have a material impact on the Company's
financial position or results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46
"Consolidation of Variable Interest Entities." In general, a variable interest
entity is a corporation, partnership, trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. A variable interest entity
often holds financial assets, including loans or receivables, real estate or
other property. A variable interest entity may be essentially passive or it may
engage in activities on behalf of another company. Until now, a company
generally has included another entity in its consolidated financial statements
only if it controlled the entity through voting interests. FIN No. 46 changes
that by requiring a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both. FIN No. 46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first fiscal
year or interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company has
adopted FIN No. 46 effective January 31, 2003. The adoption of FIN No. 46 did
not had a material impact on the Company's financial position or results of
operations.
NOTE 3 - STRATEGIC ALLIANCE WITH WATSON PHARMACEUTICALS
On March 29, 2000, the Company completed various strategic alliance
transactions with Watson Pharmaceuticals, Inc. ("Watson"). The transactions
provided for Watson's purchase of a certain pending abbreviated new drug
application ("ANDA") from the Company for $13,500,000, for Watson's rights to
negotiate for Halsey to manufacture and supply certain identified future
products to be developed by Halsey, for Watson's marketing and sale of the
Company's core products and for Watson's extension of a $17,500,000 term loan to
the Company. (See Note 7)
As part of the strategic alliance transactions, the Company and Watson
completed a manufacturing and supply agreement providing for Watson's marketing
and sale of the Company's existing core products portfolio (the "Core Products
Supply Agreement"). The Core Products Supply Agreement obligated Watson to
purchase a minimum amount of approximately $3,060,000 per quarter (the "Minimum
Purchase Amount") in core products from the Company, through September 30, 2001
(the "Minimum Purchase Period"). At the expiration of the initial Minimum
Purchase Period, if Watson did not continue to satisfy the Minimum Purchase
Amount, the Company would then be able to market and sell the core products on
its own or through a third party. On August 8, 2001, the Company and Watson
executed an amendment to the Core Products Supply Agreement providing (i) for a
reduction of the Minimum Purchase Amount from $3,060,000 to $1,500,000 per
quarter, (ii) for an extension of the Minimum Purchase Period from the quarter
ended September 30, 2001 to the quarter ended 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
11
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 part of the
completion of the 2002 Debenture Offering (See Note 1), on December 20, 2002,
the Company and Watson further amended the Core Products Supply Agreement to
provide for the Company's satisfaction of its outstanding payment obligations to
Watson of $3,901,331 under such Agreement by the capitalization of such payment
obligation as part of the principal under the term loan with Watson (the "Watson
Term Loan"). (See Note 7) As a consequence, the Watson Term Loan was amended to
increase the principal amount of the Watson Term Loan from $17,500,000 to
$21,401,331. In addition, the maturity date of Watson Term Loan was extended
from March 31, 2003 to March 31, 2006.
In March 2003, the Company notified Watson that the Company intended to
commence selling the core products independent of, and in addition to, Watson's
efforts as provided for under the Core Products Agreement.
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 2003
and 2002 quarterly computation are approximately 199,850,000 and 54,585,000,
respectively, of outstanding warrants and options and the effect of convertible
debentures and convertible bridge loans outstanding which would be antidilutive.
NOTE 5 - INVENTORIES
Inventories consist of the following:
MARCH 31, 2003 DECEMBER 31, 2002
-------------- -----------------
(IN THOUSANDS)
Finished Goods........................... $ 30 $ --
Work in Process.......................... 400 831
Raw Materials............................ 1,590 1,454
------------ ------------
$ 2,020 $ 2,285
============ ============
NOTE 6 - CONVERTIBLE SUBORDINATED DEBENTURES
Convertible Subordinated Debentures consist of the following:
MARCH 31, 2003 DECEMBER 31, 2002
-------------- -----------------
(IN THOUSANDS)
1998 Debentures.......................... $ 30,541 $ 30,215
1999 Debentures.......................... 20,748 20,509
2002 Debentures.......................... 26,429 26,394
------------ ------------
77,718 77,118
Less: Debt discount...................... (68,267) (73,955)
------------ ------------
$ 9,451 $ 3,163
=========== ============
12
During the three months ended March 31, 2003, the Company issued $600,000 in new
debentures as payment of accrued interest in the same amount of these
debentures. Such debentures are convertible into 645,161 shares of the Company's
common stock at a conversion price of $.93. During the three months ended March
31, 2002, the Company issued $538,000 in new debentures as payment of accrued
interest in the same amount of these debentures. Such debentures are convertible
into 289,247 shares of the Company's common stock at a conversion price of
$1.86.
Related-Party Transactions
Certain of the 1998 Debentures and 1999 Debentures are held by members
of the Company's management and Board of Directors. The aggregate principal
amount of such debentures was approximately $368,000 and $364,000 at March 31,
2003 and December 31, 2002, respectively. Interest expense on these debentures
was approximately $4,600 and $4,300, for the quarters ended March 31, 2003 and
2002, respectively, of which approximately $4,000 for each quarter was paid
through the issuance of like debentures.
NOTE 7 - TERM NOTE PAYABLE
In connection with various strategic alliance transactions (See Note
3), Watson advanced $17,500,000 to the Company under the Watson 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 indebtedness, and carries a floating rate of
interest equal to prime plus two percent and had an original maturity date of
March 31, 2003. As part of the Company's 2002 Debenture Offering, the Watson
Term Loan was amended to (1) extend the maturity date to March 31, 2006, (2)
increase the interest rate to prime plus four and one half percent and (3)
increase the principal amount to $21,401,331 to reflect the inclusion of the
Company's payment obligations under the Core Products Supply Agreement between
Watson and the Company. The interest rate at March 31, 2003 and December 31,
2002 was 8.75%. In consideration of the amendment to the Watson Term Loan, the
Company issued to Watson a common stock purchase warrant ("Watson Warrant")
exercisable for 10,700,665 shares of the Company's common stock at an exercise
price of $.34 per share. The warrant has a term expiring December 31, 2009. The
fair value of the Watson Warrant on the date of grant, as calculated using the
Black-Scholes option-pricing model, of $11,985,745 was charged to earnings on
the date of grant as a loss on the extinguishment of debt. As of March 31, 2003,
Watson has advanced $21,401,331 to the Company under the Watson Term Loan.
NOTE 8 - STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation using the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations ("APB
No. 25") and has adopted the disclosure provisions of Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation --
Transition and Disclosure, an amendment of FASB Statement No. 123." Under APB
No. 25, when the exercise price of the Company's employee stock options equals
the market price of the underlying stock on the date of grant, no compensation
expense is recognized. Accordingly, no compensation expense has been recognized
in the consolidated financial statements in connection with employee stock
option grants.
The following table illustrates the effect on net income and earnings per share
had the Company applied the fair value recognition provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," to stock-based employee compensation.
13
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2002
-------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net loss, as reported .......................... $(10,575) $ (5,479)
Deduct: Total stock-based employee compensation
expense determined under fair value-based method
for all awards ................................. (194) (256)
-------- --------
Pro forma net loss ............................ $(10,769) $ (5,735)
======== ========
Loss per share:
Basic and diluted -- as reported ............... $ (0.50) $ (0.36)
-------- --------
Basic and diluted -- pro forma ................. $ (0.51) $ (0.38)
======== ========
Pro forma compensation expense may not be indicative of future
disclosures because they do not take into effect pro forma compensation expense
related to grants before 1995. For purposes of estimating the fair value of each
option on the date of grant, the Company utilized the Black-Scholes
option-pricing model.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
NOTE 9 - CONTINGENCIES
Other Legal Proceedings
Beginning in 1992, actions were commenced against the Company and
numerous other pharmaceutical manufacturers, in connection with the alleged
exposure to diethylstilbestrol ("DES"). The Company's insurance carrier assumed
the defense of all such matters, and the carrier has settled a substantial
number. Currently, several actions remain pending with the Company as a
defendant in the Pennsylvania Court of Common Pleas, Philadelphia Division, and
the insurance carrier is defending each action. The Company and its legal
counsel do not believe any of such actions will have a material impact on the
Company's financial condition. The ultimate outcome of these lawsuits cannot be
determined at this time, and accordingly, no adjustment has been made to the
condensed consolidated financial statements.
In May 2003, the Company was notified that the Company, as well as
numerous other pharmaceutical manufacturers and distributors, was a named
defendant in a lawsuit involving a product liability claim. The claim has been
submitted to the Company's insurance carrier for defense. Because of the recent
timing of the notification, the Company's insurance carrier has not responded to
the submission. The final outcome of this lawsuit cannot be determined at this
time, and accordingly, no adjustment has been made to the condensed consolidated
financial statements.
The Company is named as a defendant in an action entitled Alfred Kohn
v. Halsey Drug Co. in the Supreme Court of New York, Bronx County. The Plaintiff
seeks damages of $1 million for breach of an alleged oral contract to pay a
finder's fee for a business transaction involving the Company. Discovery in this
action has been completed. It is the Company's expectation to file for summary
judgment in this action. In the event the Company is unsuccessful
14
in its motion for summary judgment, a trial on this action will follow. The
Company does not believe this action will have a material impact on the
Company's financial condition. The ultimate outcome of this lawsuit cannot be
determined at this time, and accordingly, no adjustment has been made to the
condensed consolidated financial statements.
In addition, the Company is a party to legal matters arising in the
general conduct of business. The ultimate outcome of such matters is not
expected to have a material adverse effect on the Company's results of
operations or financial position.
Indemnifications
Each of the purchase agreements for the 1998 Debentures, 1999
Debentures and the 2002 Debentures, contain provisions by which the Company is
obligated to indemnify the purchasers of the debentures for any losses, claims,
damages, liabilities, obligations, penalties, awards, judgments, expenses,
disbursements, arising out of or resulting from the breach of any
representation, warranty, or agreement, of the Company related to purchase of
the debentures. These indemnification obligations do not include a limit, or
maximum potential future payments, nor are there any recourse provisions or
collateral that may offset the cost. As of March 31, 2003 the Company has not
recorded a liability for any obligations arising as a result of these
indemnification agreements.
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCE CONDITION AND
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2003 VS. THREE MONTHS ENDED MARCH 31, 2002
NET PRODUCT REVENUES
The Company's net product revenues for the three months ended March 31,
2003 of $1,526,000 represents a decrease of $355,000 (19%) as compared to net
revenues for the three months ended March 31, 2002 of $1,881,000. The decrease
in net product revenues was caused by reduced shipments due to less demand from
our customers.
COST OF MANUFACTURING
For the three months ended March 31, 2003, cost of manufacturing
decreased $28,000 as compared to the three months ended March 31, 2002. As a
percentage of sales, cost of manufacturing was 188% and 154% for March 31, 2003
and 2002, respectively. The decrease was a result of reduced net product
revenues as noted above, as well as efficiencies in direct labor and other
manufacturing costs, partially offset by increased raw material costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses as a percentage of sales
for the three months ended March 31, 2003 and 2002 were 112% and 86%,
respectively. Overall these expenses in the first three months of 2003 increased
$95,000 or 6% for the same period in 2002. The increase is a result of increases
in payroll and related costs as well as increases in Company insurance premiums
during the three month period ended March 31, 2003.
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
Company's 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
2003, 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 decreased $43,000
from the same period in 2002. Research and development expenses as a percentage
of sales for the three months ended March 31, 2003 and 2002 was 22% and 20%,
respectively.
The Company is proceeding with the development of products, apart from
those obtained from Barr Laboratories, for submission to the FDA. During fiscal
2003, 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 former 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 2003, although no
16
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 the 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 2002 or in the quarter ended
March 31, 2003, it is the Company's expectation that its strategic alliance with
Watson Pharmaceuticals, Inc. and the continued development of the Company's
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 2003 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 LOSS
For the three months ended March 31, 2003, the Company had net loss of
$10,575,000 as compared to a net loss of $5,479,000 for the three months ended
March 31, 2002. Included in net loss for the three months ended March 31, 2003,
was interest expense of $1,433,000 and amortization of deferred debt discount
and private offering costs of $5,767,000, as compared to $1,038,000 and
$1,535,000, respectively, over the same period in 2002.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2003 the Company had cash and cash equivalents of
$3,478,000 as compared to $9,211,000 at December 31, 2002. The Company had
working capital at March 31, 2003 of $1,423,000. The Company had working capital
at December 31, 2002 of $5,933,000.
On December 20, 2002, the Company consummated a private offering of
securities for an approximate aggregate purchase price of $26,394,000 (the "2002
Debenture Offering"). The securities issued in the Offering consisted of 5%
convertible senior secured debentures (the "2002 Debentures"). Of the
$26,394,000 in 2002 Debentures issued in the 2002 Debenture Offering,
approximately $15,894,000 of the 2002 Debentures were issued in exchange for the
surrender of a like amount of principal and accrued interest outstanding under
Company's 10% convertible promissory notes issued pursuant to various working
capital bridge loan transactions with Galen and certain other lenders, during
the period from August 15, 2001 through and including December 20, 2002. The
2002 Debentures, issued at par, will become due and payable as to principal on
March 31, 2006. The 2002 Debentures were issued pursuant to a certain Debenture
Purchase Agreement dated December 20, 2002 (the "Purchase Agreement") by and
among the Company, Care Capital Investments II, LP ("Care Capital"), Essex
Woodlands Health Ventures V, L.P. ("Essex"), Galen and each of the purchasers
listed on the signature page thereto.
The Debentures issued to each of Care Capital and Essex are convertible
at any time after issuance into shares of the Company's Common Stock. The 2002
Debentures issued to Galen and the other investors in the Offering (excluding
Care Capital and Essex) are convertible at any time after the approval of the
Company's shareholders and debentureholders of an amendment to the Company's
Certificate of Incorporation to increase its authorized shares of Common Stock
from 80,000,000 shares to such number of shares as shall provide sufficient
authorized shares to permit the conversion of the 2002 Debentures and the
Company's other outstanding convertible securities. Subject to the foregoing,
the 2002 Debentures are convertible into shares of Common Stock at a price per
share (the "Conversion Price") of $.34. Until such time as the Company completes
a Subsequent Material Offering (as defined below) the Conversion Price is
subject to adjustment, from time to time, to equal the consideration per share
received by the Company for its Common Stock, or the conversion/exercise price
per share of the Company's Common Stock issuable under rights or option for the
purchase of, or stock or other securities convertible into, Common Stock
17
("Convertible Securities"), if lower than the then applicable Conversion Price.
Following the Company's completion of a Subsequent Material Offering, the
Conversion Price is subject to adjustment from time to time on a
weighted-average dilution basis. A "Subsequent Material Offering" is the grant
or issuance of Common Stock or Convertible Securities by the Company during any
six (6) month period for an aggregate gross consideration of at least
$10,000,000. Assuming the conversion of the 2002 Debentures at the initial
Conversion Price of $.34 per share, the 2002 Debentures are convertible into an
aggregate of approximately 77,629,000 shares of Common Stock.
The Interest Debentures are convertible at anytime after issuance into
shares of Common Stock at a price per share equal to the average of the closing
bid and asked prices of the Common Stock for the twenty (20) trading days
immediately preceding the applicable interest payment date under the 2002
Debentures, as reported by the Over-the-Counter ("OTC") Bulletin Board.
The Purchase Agreement provides that the holders of the 2002 Debentures
shall have the right to vote as part of a single class with all holders of the
Company's Common Stock on all matters to be voted upon by such stockholders.
Each 2002 Debentureholder shall have such number of votes as shall equal the
number of votes he would have had if such holder converted the entire
outstanding principal amount of his 2002 Debenture into shares of Common Stock
immediately prior to the record date relating to such vote; provided, however,
that any Debentures initially held by Care Capital shall, for so long as they
are held by Care Capital, have no voting rights.
The 2002 Debentures are secured by a lien on all assets of the Company,
tangible and intangible. In addition, each of Houba, Inc. and Halsey
Pharmaceuticals, Inc., each a wholly-owned subsidiary of the Company, has
executed in favor of the holders of the 2002 Debentures an unconditional
agreement of guarantee of the Company's obligations under the Purchase
Agreement. Each guarantee is secured by all assets of such subsidiary, and, in
the case of Houba, Inc., by a mortgage lien on its Culver, Indiana real estate.
In addition, the Company has pledged the stock of each such subsidiary to the
holders of the 2002 Debentures to further secured its obligations under the
Purchase Agreement.
In accordance with the terms of a Subordination Agreement dated
December 20, 2002 between the Company, the holders of the 2002 Debentures, the
holders of the Existing Debentures and Watson, the liens on the Company's and
its subsidiaries' assets as well as the payment priority of the 2002 Debenture
are (i) subordinate to the Company's lien and payment obligations in favor of
Watson under the Watson Term Loan, and (ii) senior to the Company's lien and
payment obligations in favor of holders of the Existing Debentures in the
aggregate principal amount of approximately $50,724,000.
Of the $26,394,000 in Debentures issued in the Offering, approximately
$15,894,000 Debentures were issued in exchange for the surrender of a like
amount of principal and accrued interest on the Company's outstanding 10%
convertible promissory notes issued pursuant to various working capital bridge
loan transactions with Galen and the certain other lenders during the period
from August 15, 2001 through and including December 20, 2002.
In connection with various strategic alliance transactions with Watson
Pharmaceuticals, Inc. ("Watson"), $17,500,000 was advanced to the Company under
a term loan (the "Watson 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
indebtedness, and carried a floating rate of interest equal to prime plus two
percent and had an original maturity date of March 31, 2003. As part of the
Company's 2002 Debenture Offering, the Watson Term Loan was amended to (1)
extend the maturity date to March 31, 2006, (2) increase the interest rate to
prime plus four and one half percent and (3) increase the principal amount to
$21,401,331 to reflect the inclusion of the Core Products Supply Agreement
advance payments. The interest rate at March 31, 2003 and December 31, 2002 was
8.75%. In consideration of the amendment to the Watson Term Loan, the Company
issued to Watson a common stock purchase warrant ("Watson Warrant") exercisable
for 10,700,665 shares of the Company's common stock at an exercise price of $.34
per share. The warrant has a term expiring December 31, 2009. The fair value of
the Watson Warrant on the date of grant, as calculated using the Black-Scholes
option-pricing model, of $11,985,745 was charged to earnings on the date of
grant as a loss on the extinguishment of debt. As of March 31, 2003, Watson has
advanced $21,401,331 to the Company under the Watson Term Loan.
18
The development and commercialization of APIs and finished dosage
products incorporating the Opiate Synthesis Technologies are subject to various
factors, many of which are outside the Company's control. Specifically, the
Opiate Synthesis Technologies have been tested only in laboratory settings and
will need to be successfully "scaled up" in order to be commercially viable, of
which no assurance can be given. Additionally, the Company must satisfy, and
continue to maintain compliance with, the DEA's requirements for the maintenance
of its Manufacturing Registration and the issuance and maintenance of the Import
Registration. The process of seeking the Import Registration and contesting
opposition proceedings, as well as the continuing development of the Opiate
Synthesis Technologies, will likely continue through 2004. The Company is
currently unable to provide any assurance that the Opiate Synthesis Technologies
will be commercially viable or that the Company will succeed in obtaining the
Import Registration. The Company is committing the substantial majority of its
resources, available capital and cash flow from operations to the development of
the Opiate Synthesis Technologies and to the receipt of the Import Registration.
The failure of the Company to successfully develop the Opiate Synthesis
Technologies or to obtain the Import Registration will have a material adverse
effect on the Company's operations and financial condition. The Company's cash
flow and limited sources of available financing make it uncertain that the
Company will have sufficient capital to continue to fund operations or to
otherwise complete the development of the Opiate Synthesis Technologies, to
obtain required DEA approvals and to fund the capital improvements necessary for
the manufacture of APIs and finished dosage products incorporating the Opiate
Synthesis Technologies.
The Company has budgeted approximately $2,500,000 in 2003 for the
continued development and commercialization of the Opiate Synthesis
Technologies. Of such amount, approximately $2,000,000 relates to capital
expenditures for facility improvements and the purchase of equipment at the
Company's Culver, Indiana facility, approximately $300,000 relates to capital
expenditures for environmental compliance waste discharge storage tanks at the
Culver facility, and approximately $200,000 relates to the legal fees and
related expenses for the OALJ hearing and third party opposition proceedings in
connection with the Company's application for the Import Registration. Until
such time as the Company successfully develops and commercializes new finished
dosage products and APIs, of which there can be no assurance, the majority of
the Company's revenues are expected to be derived from the Core Products Supply
Agreement with Watson, with the balance of the Company's revenues derived from a
combination of the Company's own selling efforts for the Company's core
products, which sales efforts are anticipated to commence in the second quarter
of 2003, and the Company's manufacture of non-core products for third parties.
The Company estimates that during 2003 and 2004, the Company will continue to
incur operating losses and negative cash flow. The Company believes that the net
proceeds of the Debenture Offering completed on December 20, 2002 will provide
the working capital necessary to fund operating losses only through June 2003.
At the Company's request, on May 5, 2003, the Company received a letter
executed by each of Care Capital, Galen and Essex (the "Majority 2002
Debentureholders") advising that the Majority 2002 Debentureholders would
provide funding to meet the Company's 2003 capital requirements, up to an
aggregate amount not to exceed $8.6 million (the "Letter of Support"). The
Letter of Support provides that the amount of any funding provided by the
Majority 2002 Debentureholders would be reduced to the extent of any funding
obtained by the Company from third-party sources during 2003. The Letter of
Support further provides that the terms of any funding provided by the Majority
2002 Debentureholders will be subject to negotiation between the Company and the
Majority 2002 Debentureholders at the time of any funding. The terms of any such
funding will be subject to approval by those directors of the Company that are
unaffiliated with the Majority 2002 Debentureholders. While the terms of any
funding to meet the Company's 2003 capital requirements are currently unknown,
it is likely that such terms will result in significant additional dilution to
holders of the Company's Common Stock. In consideration for the issuance of the
Letter of Support, the Company authorized the issuance of warrants to the
Majority 2002 Debentureholders exercisable for an aggregate of 645,000 shares of
the Company's Common Stock at an exercise price of $.34 per share (which is
equivalent to the conversion price of the 2002 Debentures), subject to downward
adjustment to equal the consideration per share received by the Company for its
Common Stock, or the conversion/exercise price per share of the Company's Common
Stock issuable under convertible securities, in a third part investment if lower
than the exercise price of the warrants.
19
The Company believes that the remaining net proceeds received from the
2002 Debenture Offering, along with the funding to be provided under the Letter
of Support combined with cash flow from operations, will be sufficient to
satisfy the Company's working capital requirements through January 1, 2004.
Failure to obtain a third party investment or to reach agreement with
the Majority 2002 Debentureholders on mutually acceptable terms to fund the
Company's working capital requirements for 2003 will require the Company to (i)
significantly curtail product commercialization efforts, including the
development and commercialization of the Opiate 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 to its
Opiate Synthesis Technologies, which the Company would otherwise pursue on its
own or that would dilute the Company's stockholders, (iii) significantly scale
back or terminate operations and/or (iv) seek protection under applicable
bankruptcy laws. An extended delay in obtaining necessary financing will result
in the cessation of the Company's continuing development efforts related 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 statements. 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.
20
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 and
beneficial conversion features 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 April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement eliminates the requirement to report gains and
losses from extinguishment of debt as extraordinary unless they meet the
criteria of APB Opinion 30. SFAS No. 145 also requires sale-leaseback accounting
for certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. The changes related to lease accounting are
effective for transactions occurring after May 15, 2002 and the changes related
to debt extinguishment are effective for fiscal years beginning after May 15,
2002. The impact of adopting the provisions related to lease accounting did not
have a material impact on the Company's financial position or results of
operations. The Company early adopted the provisions related to debt
21
extinguishments during the year ended December 31, 2002. The adoption did not
have a material impact on the Company's financial position or results of
operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS No. 146 nullifies Emerging
Issues Task Force Issue No. 94-3 and requires that a liability for a cost
associated with an exit or disposal activity be recognized when the liability is
incurred. This statement also establishes that fair value is the objective for
initial measurement of the liability. SFAS No. 146 is effective for exit or
disposal activities that are initiated after December 31, 2002. The impact of
the adoption of SFAS No. 146 did not have a material impact on the Company's
financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure, an amendment of FASB
Statement No. 123." SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for an
entity that voluntarily changes to the fair value-based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions of
that Statement to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. The Company has chosen to continue to account for
stock-based compensation using the intrinsic value method prescribed in APB
Opinion No. 25 and related interpretations as provided for under SFAS No. 148.
Accordingly, compensation expense is only recognized when the market value of
the Company's stock at the date of the grant exceeds the amount an employee must
pay to acquire the stock. The adoption of SFAS No. 148 did not have a material
impact on the Company's financial position or results of operations.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN No. 45 requires that upon
issuance of a guarantee, a guarantor must recognize a liability for the fair
value of an obligation assumed under a guarantee. FIN No. 45 also requires
additional disclosures by a guarantor in its interim and annual financial
statements about the obligations associated with guarantees issued. The
recognition provisions of FIN No. 45 are effective for any guarantees issued or
modified after December 31, 2002. The disclosure requirements are effective for
financial statements of interim or annual periods ending after December 15,
2002. The adoption of FIN No. 45 did not have a material impact on the Company's
financial position or results of operations.
In January 2003, the FASB issued FASB Interpretation No. 46
"Consolidation of Variable Interest Entities." In general, a variable interest
entity is a corporation, partnership, trust, or any other legal structure used
for business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that do not provide sufficient financial
resources for the entity to support its activities. A variable interest entity
often holds financial assets, including loans or receivables, real estate or
other property. A variable interest entity may be essentially passive or it may
engage in activities on behalf of another company. Until now, a company
generally has included another entity in its consolidated financial statements
only if it controlled the entity through voting interests. FIN No. 46 changes
that by requiring a variable interest entity to be consolidated by a company if
that company is subject to a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the entity's
residual returns or both. FIN No. 46's consolidation requirements apply
immediately to variable interest entities created or acquired after January 31,
2003. The consolidation requirements apply to older entities in the first fiscal
year or interim period beginning after June 15, 2003. Certain of the disclosure
requirements apply to all financial statements issued after January 31, 2003,
regardless of when the variable interest entity was established. The Company has
adopted FIN No. 46 effective January 31, 2003. The adoption of FIN No. 46 did
not have a material impact on the Company's financial position or results of
operations.
22
ITEM 4. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
Chief Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures are effective in timely alerting them to material information
relating to the Company (including its consolidated subsidiaries) required to be
included in the Company's periodic Securities and Exchange Commission filings.
No significant changes were made in the Company's internal controls or in other
factors that could significantly affect these controls subsequent to the date of
their evaluation.
Disclosure controls and procedures are those controls and other
procedures that are designed to ensure that information required to be disclosed
by the Company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified
in the Securities and Exchange Commission's rules and forms. Disclosure controls
and procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by the Company in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the Company's management, including the Company's principal executive officer
and principal financial officer, as appropriate to allow timely decisions
regarding required disclosure.
23
PART II
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the quarter ended March 31, 2003, the Company issued 5%
Convertible Debentures in the principal amount of approximately $600,000 in
satisfaction of accrued interest on Company's outstanding 5% Convertible
Subordinated Debentures issued in 1998, 1999 and 2002 (the "Convertible
Debentures").
Each of the holders of the Convertible Debentures for which interest
payments were made in 5% Convertible Subordinated Debentures 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 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.
Date: May 19, 2003 HALSEY DRUG CO., INC.
By: /s/ Michael K. Reicher
-------------------------------
Michael K. Reicher
Chairman and
Chief Executive Officer
By: /s/ Peter A. Clemens
-------------------------------
Peter A. Clemens
VP & Chief Financial Officer
25
EXHIBIT INDEX
Exhibit Document
- ------- --------
99.1 Certification of Periodic Report by Chief Executive Officer
pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange
Act of 1934
99.2 Certification of Periodic Report by Chief Financial Officer
pursuant to Rule 13a-14 and 15d-14 of the Securities Exchange
Act of 1934
99.3 Certification of Periodic Report by Chief Executive Officer
99.4 Certification of Periodic Report by Chief Financial Officer
26