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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 2004
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
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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)
616 N. NORTH COURT, SUITE 120
PALATINE, ILLINOIS 60067
(Address of Principal Executive Offices) (Zip Code)
(847) 705-7709
(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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
As of May 14, 2004 the registrant had 21,601,704 shares of Common Stock,
$.01 par value, outstanding.
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HALSEY DRUG CO., INC. & SUBSIDIARIES
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets-
March 31, 2004 (Unaudited) and December 31, 2003........................................ 3
Condensed Consolidated Statements of Operations (Unaudited) - Three months ended March
31, 2004 and March 31, 2003............................................................. 5
Condensed Consolidated Statements of Cash Flows (Unaudited) - Three months ended March
31, 2004 and March 31, 2003............................................................. 6
Consolidated Statement of Stockholders' Equity (Deficit) (Unaudited) - Three months
ended March 31, 2004.................................................................... 8
Notes to Condensed Consolidated Financial Statements.................................... 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................................................... 13
Item 4. Controls and Procedures................................................................. 21
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds............................................... 21
Item 6. Exhibits and Reports on Form 8-K........................................................ 22
SIGNATURES.......................................................................................... 23
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED
MARCH 31, DECEMBER 31,
2004 2003
---------- ------------
(IN THOUSANDS)
ASSETS
CURRENT ASSETS
Cash....................................................... $ 7,282 $ 942
Accounts Receivable - trade, net of
allowances for doubtful accounts of $414 and $428
at March 31, 2004 and December 31, 2003, respectively.... 66 467
Inventories................................................ - 312
Prepaid expenses and other current assets.................. 132 401
--------- ---------
Total current assets..................................... 7,480 2,122
PROPERTY, PLANT & EQUIPMENT, NET................................. 3,152 3,394
DEFERRED PRIVATE OFFERING COSTS,
net of accumulated amortization of $424 and $318
at March 31, 2004 and December 31, 2003, respectively.... 882 714
OTHER ASSETS AND DEPOSITS........................................ 64 392
--------- ---------
TOTAL ASSETS $ 11,578 $ 6,622
========= =========
The accompanying notes are an integral part of these statements
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
UNAUDITED
MARCH 31, DECEMBER 31,
2004 2003
---------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
CONVERTIBLE SUBORDINATED DEBENTURES.......................... $ 12,313 $ -
Less: debt discount......................................... (8,464) -
------------ ------------
3,849 -
Current maturities of notes payable and capital lease
obligations................................................ 27 45
Accounts payable............................................. 272 1,895
Accrued interest............................................. 1,993 1,544
Accrued expenses............................................. 1,352 2,108
Deferred asset proceeds...................................... 2,000 -
Department of Justice Settlement............................. - 300
------------ ------------
Total current liabilities................................. 9,493 5,892
TERM NOTE PAYABLE............................................... 5,000 21,401
BRIDGE LOANS.................................................... - 2,000
Less: debt discount.......................................... - (568)
------------ ------------
- 1,432
CONVERTIBLE SUBORDINATED DEBENTURES............................. 86,632 86,632
Less: debt discount........................................... (50,565) (56,893)
------------ ------------
36,067 29,739
CAPITAL LEASE OBLIGATIONS....................................... 92 92
DEPARTMENT OF JUSTICE SETTLEMENT................................ - 133
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock - $.01 par value; authorized
80,000,000 shares; issued and outstanding,
21,601,704 shares at March 31, 2004 and December 31, 2003.. 216 216
Additional paid-in capital.................................... 169,575 157,262
Accumulated deficit........................................... (208,865) (209,545)
------------ ------------
STOCKHOLDERS' DEFICIT........................................... (39,074) (52,067)
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY...................... $ 11,578 $ 6,622
============ ============
The accompanying notes are an integral part of these statements
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
--------------------------------------
2004 2003
------------- --------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Net product revenues.......................................... $ 628 $ 1,526
Cost of manufacturing......................................... 1,253 2,873
Research and development...................................... 238 329
Selling, general and administrative expenses.................. 1,221 1,711
------------- --------------
Loss from operations.................................... (2,084) (3,387)
Other income (expense)
Interest expense.............................................. (958) (1,433)
Interest income............................................... 7 17
Amortization of deferred debt discount and
private offering costs..................................... (10,843) (5,767)
Gain on sale of assets........................................ 1,754 -
Gain on debt restructuring.................................... 12,401 -
Other......................................................... 403 (5)
------------- --------------
NET INCOME (LOSS)............................................. $ 680 $ (10,575)
============= ==============
Earnings (loss) per share
Basic......................................................... $ .03 $ (0.50)
Diluted....................................................... $ .00 $ (0.50)
Weighted average shares outstanding
Basic......................................................... 21,601,704 21,035,323
============= ==============
Diluted....................................................... 278,020,203 21,035,323
============= ==============
The accompanying notes are an integral part of these statements
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31
---------------------------
2004 2003
-------- --------
(IN THOUSANDS)
Cash flows from operating activities
Net income (loss)............................................. $ 680 $(10,575)
-------- --------
Adjustments to reconcile net loss to net cash
used in operating activities
Depreciation and amortization.............................. 192 199
Amortization of deferred debt discount and private
offering costs............................................. 10,843 5,767
Amortization of deferred product acquisition costs......... 205 14
Debentures and stock issued for interest................... - 600
Loss on disposal of assets................................. 47 5
Gain on restructure of debt................................ (12,401) -
Changes in assets and liabilities
Accounts receivable..................................... 252 (634)
Inventories............................................. 312 265
Prepaid expenses and other current assets............... 251 (290)
Other assets and deposits............................... 124 18
Accounts payable........................................ (1,610) (912)
Accrued expenses........................................ 1,642 351
-------- --------
Total adjustments.................................... (143) 5,383
-------- --------
Net cash provide by (used in) operating activities......... 537 (5,192)
-------- --------
Cash flows from investing activities
Capital expenditures....................................... (9) (451)
-------- --------
Net cash used in investing activities................... (9) (451)
-------- --------
Cash flows from financing activities
Payments on notes payable and capital lease obligations.... (4,019) (10)
Issuance of debentures..................................... 10,264 -
Payments to Department of Justice.......................... (433) (80)
-------- --------
Net cash provided by (used in) financing activities........ 5,812 (90)
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS.......... 6,340 (5,733)
Cash and cash equivalents at beginning of period.............. 942 9,211
-------- --------
Cash and cash equivalents at end of period.................... $ 7,282 $ 3,478
======== ========
Cash paid for interest was $47 during the quarter ended March 31, 2004.
The accompanying notes are an integral part of these statements
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES FOR THE
QUARTER ENDED MARCH 31, 2004:
1. The Company's Convertible Subordinated Debentures contained
beneficial conversation features, which were valued at $12,313,000.
2. The Company has repaid $166,000 of indebtedness in the form of
product deliveries.
3. Bridge Loans of $2,000,000 and accrued interest of $49,000 were
converted into like amounts of Convertible Subordinated Debentures.
The accompanying notes are an integral part of these statements
HALSEY DRUG CO., INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
THREE MONTHS ENDED MARCH 31, 2004
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
COMMON STOCK
$.01 PAR VALUE ADDITIONAL
------------------------ PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------------ -------- ---------- ----------- ----------
Balance January 1, 2004............... 21,601,704 $ 216 $ 157,262 $ (209,545) $ (52,067)
Net income for the three
months ended March 31, 2004........ 680 680
Beneficial conversion features in
connection with issuance of
debentures......................... 12,313 12,313
------------ -------- --------- ---------- ----------
Balance at March 31, 2004............. 21,601,704 $ 216 $ 169,575 $ (208,865) $ (39,074)
============ ======== ========= ========== ==========
The accompanying notes are an integral part of these statements
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
changes in cash flows for the three months ended March 31, 2004, assuming that
the Company will continue as a going concern, have been made. The results of
operations for the three month period ended March 31, 2004 are not necessarily
indicative of the results that may be expected for the full year ended December
31, 2004. 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, 2003 included in the Company's Annual
Report on Form 10-K filed with the Securities and Exchange Commission.
At March 31, 2004 the Company had cash and cash equivalents of $7,282,000
as compared to $942,000 at December 31, 2003. The Company had working capital
deficit at March 31, 2004 of $2,013,000 and an accumulated deficit of
$208,865,000. The Company had an operating loss of $2,084,000 during the three
months ended March 31, 2004.
In the fourth quarter of 2003 and first quarter of 2004, the Company
restructured it operations, as more fully describe in Note 2, and substantially
ceased the manufacturing of the Company's generic finished dosage pharmaceutical
products and distribution of those products by the Company's subsidiary, Axiom
Pharmaceutical Corporation ("Axiom"). All manufacturing operations of Axiom
ceased on January 30, 2004.
As restructured, the Company is engaged in the development of proprietary
opioid abuse deterrent formulation technology (the "ADF Technology") the
manufacture, packaging and stability testing of clinical trial supplies of
finished products utilizing the ADF Technology, the evaluation of such products
in appropriate clinical trials, the development and scale up of novel active
pharmaceutical ingredient ("API") opioid synthesis technologies (the "Opioid
Synthesis Technology") , and the prosecution of the Company's application to the
Drug Enforcement Administration ("DEA") for a registration to import narcotic
raw materials ("NRMs"). The Company proposes to enter into license agreements
with strategic partners providing that such licensees will further develop abuse
deterrent formulation finished dosage products, file for regulatory approval
with the U.S. Food and Drug Administration ("FDA") and other regulatory
authorities and commercialize such products. The Company intends to manufacture
commercial quantities of such products for sale by the Company's licensees.
NOTE 2 - LIQUIDITY MATTERS
The accompanying financial statements have been prepared assuming the
Company will continue as a going concern. At December 31, 2003, the Company had
cash and cash equivalents of $942,000, working capital deficit of approximately
$3,770,000 and a stockholders' deficit of approximately $52,067,000. The Company
incurred a loss from operations of approximately $17,244,000 and a net loss of
approximately $48,455,000 during the year ended December 31, 2003. At March 31,
2004, the Company had cash and cash equivalents of $7,282,000, a working capital
deficit of $2,014,000 and an accumulated deficit of $208,865,000. The Company
incurred operating losses of $2,084,000 during the three months ended March 31,
2004. Historically, the Company has incurred significant losses
from operations and until such time as the research and development efforts are
commercialized, for which no assurance can be given, the Company will continue
to incur operating losses. These factors, among others, raise substantial doubt
about the Company's ability to continue as a going concern. Management's plans
with respect to these matters follow:
On November 6, 2003, the Company publicly announced its restructuring plan
to focus its efforts on research and development related to certain proprietary
finished dosage products and APIs. In making its determination the Board of
Directors considered, among other factors, the Company's ability and time
required to generate positive cash flow and income from the operation of the
Company's finished dosage manufacturing, packaging, labeling and distribution
facilities located in Congers, New York (collectively, the "Congers Facilities")
in the manufacture and distribution of finished dosage generic products pursuant
to abbreviated new drug applications ("ANDAs").
The Company incurred losses of $48.5 million in 2003, $59.6 million in
2002 and $12.6 million in 2001. The Board determined that near term sales of the
Company's finished dosage generic products would likely result in continued
financial losses in view of the highly competitive market environment, low
market pricing, declining market size for its existing generic products and the
lack of timely new generic product launches. Based on this analysis and other
factors, the Board concluded that the Company restructure its operations by
closing or divesting the Congers Facilities and reducing certain activities at
its Culver Facility. The plan targeted a reduction in workforce of approximately
70 employees at the Congers Facilities, 25 employees at the Culver, Indiana
facility (the "Culver Facility") and 5 employees in Rockford, Illinois.
In implementing the restructuring plan at the Culver Facility, the
reduction in work force involved approximately 25 employees engaged in or
supporting the manufacture of doxycycline hyclate and doxycycline monohydrate
APIs which were converted to finished dosage products at the Congers Facilities.
With the closure of the Congers Facilities the APIs manufactured at the Culver
Facility were not required. The Culver Facility work force reduction was
substantially completed by December 31, 2003.
In implementing the restructuring plan at the Rockford, Illinois
administrative office facility, the Company terminated its Rockford office lease
agreement and relocated the administrative functions to Palatine, Illinois. This
process was completed on February 29, 2004 resulting in a reduction in work
force of 5 employees.
In implementing the restructuring of operations at the Congers Facilities,
the reduction in work force involved essentially all of the employees at the
site. Finished generic product manufacturing operations substantially ceased on
January 30, 2004. Packaging and labeling operations ceased approximately
February 12, 2004 and quality assurance and related support activities ceased on
approximately February 27, 2004. Such dates also mark the substantial completion
of the reduction in work force of approximately 70 employees engaged in these
activities at the Congers Facilities. From approximately March 1, 2004 to March
19, 2004 a small logistics, maintenance and warehouse staff prepared the Congers
Facilities for sale to IVAX Pharmaceuticals as discussed below.
In implementing the restructuring adopted by the Board, the Company has
transitioned to a single vertically integrated operations site located in
Culver, Indiana. The Company's strategy and key activities to be conducted at
the Culver Facility are as follows:
- Development of the Company's ADF Technology for use in orally
administered opioid finished dosage products.
- Manufacture and quality assurance release of clinical trial
supplies of certain finished dosage form products utilizing the ADF
Technology.
- Evaluation of certain finished dosage products utilizing the ADF
Technology in clinical trials.
- Scale-up and manufacture of commercial quantities of certain
products utilizing the ADF Technology for sale by the Company's licensees.
- Research, development and scale up of the Company's novel Opioid
Synthesis Technologies.
- Prosecution of the Company's application to the DEA to for
registration to import NRMs for use in the production of opioid API's
utilizing the Company's Opioid Synthesis Technologies.
- Negotiating and executing license and development agreements with
strategic pharmaceutical company partners providing that such licensees
will further develop certain finished dosage products utilizing the ADF
Technology, file for regulatory approval with the FDA and other regulatory
authorities and commercialize such products.
As of December 31, 2003, the Company has recorded aggregate restructuring
expenses of approximately $3,280,000 consisting of an impairment charge of
$1,673,000 against property, plant and equipment, an impairment charge of
$1,354,000 against inventory (charged against cost of sales), and $253,000 of
other costs. All restructuring costs have been reserved for at December 31,
2003.
On February 6, 2004, the Company consummated a private offering of
convertible senior secured debentures (the "2004 Debentures") in the aggregate
principal amount of approximately $12.3 million (the "2004 Debenture Offering").
The 2004 Debentures were issued by the Company pursuant to a certain Debenture
and Share Purchase Agreement dated as of February 6, 2004 (the "2004 Purchase
Agreement") by and among the Company, Care Capital, Essex, Galen and each of the
purchasers listed on the signature page thereto. Of the approximate $12.3
million in debentures issued on February 6, 2004 under the 2004 Debenture
Offering, approximately $2.0 million of 2004 Debentures were issued in exchange
for the surrender of a like amount of principal plus accrued and unpaid interest
under the Company's 2002 Debentures issued to Care Capital, Essex and Galen
during November and December, 2003 pursuant to the Letter of Support. As the
conversion price of such debentures was less than the fair market value of the
Company's common stock on the date of issue, beneficial conversion features were
determined to exist. The Company recorded approximately $12.3 million of debt
discount limited to the face amount of the new debt, which is being amortized
over the life of the debt, which matures July 31, 2004, subject to extension to
October 31, 2004. During the three months ended March 31, 2004, the Company
recognized approximately $3.8 million of amortization expense from this
transaction.
On April 14, 2004, the Company completed an additional closing under the
2004 Purchase Agreement pursuant to which the Company issued additional 2004
Debentures in the aggregate principal amount of $579,000, bringing the aggregate
principal amount of 2004 Debentures issued by the Company under the 2004
Purchase Agreement to $12.879 million. As the conversion price of such
debentures was less than the fair market value of the Company's common stock on
the date of issue, beneficial conversion features were determined to exist. The
Company recorded approximately $0.6 million of debt discount limited to the face
amount of the new debt, which will be amortized over the life of the debt, which
matures July 31, 2004, subject to extension to October 31, 2004.
The 2004 Purchase Agreement further provides that the Company may issue
additional 2004 Debentures in the principal amount of up to approximately $1.1
million on or prior to June 5, 2004, provided that the aggregate principal
amount of 2004 Debentures issued pursuant to the 2004 Purchase Agreement shall
not exceed $14.0 million without the consent of the holders of 60% of the
principal amount of the 2004 Debentures then held by Care Capital, Essex and
Galen.
The 2004 Debentures, issued at par, bear interest at the rate of 1.62% per
annum, the short-term Applicable Federal Rate on the date of issuance. The 2004
Debentures are secured by a lien on all assets of the Company. In addition, each
of Houba, Inc. and Axiom Pharmaceutical Corporation, each a wholly-owned
subsidiary of the Company, has executed in favor of the 2004 Debenture holders,
an unconditional agreement of guaranty of the Company's obligations under the
2004 Purchase Agreement. Each guaranty is secured by all assets of such
subsidiary. In addition, the Company has pledged the stock of each such
subsidiary to the holders of the 2004 Debentures to further secure its
obligations under the 2004 Purchase Agreement.
In accordance with the terms of an Amended and Restated Subordination
Agreement dated as of February 6, 2004 between the Company, the holders of the
2004 Debentures and the holders of the Company's other outstanding debentures,
the liens on the Company's and its subsidiary's assets as well as the payment
priority of the 2004 Debentures are (i) subordinate to the Company's lien and
payment obligations in favor of Watson Pharmaceuticals under the Watson Term
Loan Agreement, and (ii) senior to the Company's lien and payment obligations in
favor of the holders of the Company's other outstanding debentures in the
aggregate principal amount of approximately $87.7 million.
The 2004 Debentures (including the principal amount plus interest accrued
at the date of conversion) will convert automatically into the Company's Series
A convertible preferred stock (the "Series A Preferred") immediately following
the Company's receipt of shareholder approval at its next shareholders' meeting
to restate the Company's Certificate of Incorporation (the "Charter Amendment")
to authorize the Series A Preferred and the Junior Preferred Shares (as
described below) and the filing of the Charter Amendment with the Office of the
New York Department of State (the date of such filing, the "Charter Amendment
Filing Date"), as provided in the 2004 Purchase Agreement. The 2004 Debentures
will convert into Series A Preferred at a price per share (the "Series A
Conversion Price") of $0.6425, representing the average of the closing bid and
asked prices of the Company's Common Stock for the twenty (20) trading days
ending February 4, 2004, as reported by the Over-the-Counter ("OTC") Bulletin
Board. The Series A 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 options for the purchase of, or stock or other
securities convertible into, Common Stock ("Convertible Securities"), if lower
than the then applicable Series A Conversion Price.
Based on the $0.6425 Series A Conversion Price of the Series A Shares and
estimating the interest accrual under the 2004 Debentures prior to the Charter
Amendment Filing Date, the 2004 Debentures with an aggregate principal amount of
$14.0 million would be convertible into an aggregate of approximately 22 million
Series A Preferred shares.
In general, the Series A Preferred shares have a liquidation preference
equal to five (5) times the initial $0.6425 Series A Conversion Price (the
"Series A Liquidation Preference"). In addition, the Series A Preferred shares
are convertible into the Company's Common Stock, with each Series A Preferred
share convertible into the number of shares of Common Stock obtained by dividing
(i) the Series A Liquidation Preference, by (ii) the $0.6425 Series A Conversion
Price, as such conversion price may be adjusted, from time to time, pursuant to
the dilution protections of such shares. Without limiting the Series A
Liquidation Preference, the holders of Series A Preferred shares also have the
right to participate with the holders of the Company's Common Stock upon the
occurrence of a liquidation event, including the Company's merger, sale of all
or substantially all of its assets or a change of control transaction, on an
as-converted basis (but for these purposes only, assuming the Series A Preferred
shares to be convertible into only thirty percent (30%) of the shares of Common
Stock into which they are otherwise then convertible). The holders of Series A
Preferred shares also have the right to vote as part of a single class with all
holders of the Company's voting securities on all matters to be voted on by such
security holders. Each holder of Series A Preferred shares will have such number
of votes as shall equal the number of votes he would have had if such holder
converted all Series A Preferred shares held by such holder into shares of
Common Stock immediately prior to the record date relating to such vote.
The 2004 Purchase Agreement provides that each of Care Capital, Essex and
Galen (collectively, the "Lead 2004 Investors") has the right to designate for
nomination one member of the Company's Board of Directors, and that the Lead
Investors collectively may designate one additional member of the Board
(collectively, the Designees"). The Purchase Agreement further provides that the
Designees, if so requested by such Designee in his sole discretion, shall be
appointed to the any Committee of the Board of Directors. The Designees of Care
Capital, Essex and Galen are Messrs. Karabelas, Thangjaraj and Wesson,
respectively, each of whom are current Board members. Effective as of the
closing of the 2004 Purchase Agreement, the Lead 2004 Investors may collectively
nominate one additional Designee to the Board. The Company has agreed to
nominate and appoint to the Board of Directors, subject to shareholder approval,
one designee of each of Care Capital, Essex and Galen, and one collective
designee of the Lead 2004 Investors, for so long as each holds a minimum of 50%
of the Series A Preferred shares initially issued to such party (or at least 50%
of
the shares of Common Stock issuable upon conversion of the Series A Preferred
shares).
As of February 6, 2004, the date of the initial closing of the 2004
Purchase Agreement, the Company had issued and outstanding an aggregate of
approximately $87.7 million in principal amount of 5% convertible senior secured
debentures maturing March 31, 2006 issued pursuant to three separate Debenture
Purchase Agreements dated March 10, 1998, as amended (the "1998 Debentures"),
May 26, 1999, as amended (the "1999 Debentures") and December 20, 2002 (the
"2002 Debentures"), respectively. The 1998 Debentures, 1999 Debentures and 2002
Debentures are referred to collectively as the "1998-2002 Debentures". After
giving effect to the Company's issuance of additional 5% convertible senior
secured debentures in satisfaction of interest payments on the 1998-2002
Debentures, as of February 6, 2004, the 1998-2002 Debentures were convertible
into an aggregate of approximately 190.4 million shares of the Company's Common
Stock.
Simultaneous with the execution of the 2004 Purchase Agreement, and as a
condition to the initial closing of the 2004 Purchase Agreement, the Company,
the 2004 Debenture Investor Group and each of the holders of the 1998-2002
Debentures executed a certain Debenture Conversion Agreement, dated as of
February 6, 2004 (the "Conversion Agreement"). In accordance with the terms of
the Conversion Agreement, each holder of the 2004 Debentures agreed to convert
the 2004 Debentures held by such holder into the Company's Series A Preferred
shares and each holder of 1998-2002 Debentures agreed to convert the 1998-2002
Debentures held by such holder into the Company's Series B convertible preferred
stock (the "Series B Preferred") and/or Series C-1, C-2 and/or C-3 convertible
preferred stock (collectively, the "Series C Preferred"). The Series C Preferred
Shares together with the Series B Preferred Shares are herein referred to as,
the "Junior Preferred Shares", and the Junior Preferred Shares together with the
Series A Preferred, are collectively referred to as the "Preferred Stock". The
Conversion Agreement provides, among other things, for the automatic conversion
of the 2004 Debentures and the 1998-2002 Debentures (collectively, the
"Outstanding Debentures") into the appropriate class of Preferred Stock
immediately following the Company's receipt of shareholder approval to the
Charter Amendment authorizing the creation of the Preferred Stock and the filing
of the Charter Amendment with the Office of the New York Department of State.
Under the Conversion Agreement, the holders of approximately $6.7 million
in principal amount of 2002 Debentures issued during 2003 will convert such 2002
Debentures (plus accrued and unpaid interest) into Series B Preferred Shares. Of
the remaining approximate $81.0 million in principal amount of the 1998-2002
Debentures, approximately $31.6 million is comprised of 1998 Debentures,
approximately $21.8 million is comprised of 1999 Debentures and approximately
$27.6 million is comprised of 2002 Debentures. The 1998 Debentures will be
converted into Series C-1 Preferred shares. The 1999 Debentures will be
converted into Series C-2 Preferred shares. The remaining balance of the 2002
Debentures shall be converted into Series C-3 Preferred shares.
The number of Junior Preferred Shares to be received by each holder of
1998-2002 Debentures is based on the respective prices at which the 1998-2002
Debentures were convertible into Common Stock. The 2002 Debentures issued in
2003 have a conversion price of $0.3420 per share. The 1998 Debentures, 1999
Debentures and the remaining balance of the 2002 Debentures have conversion
prices of $0.5776, $0.5993 and $0.3481 per share, respectively. Based on the
respective conversion prices of the 1998-2002 Debentures, and estimating the
interest accrual on the 1998-2002 Debentures prior to the Charter Amendment
Filing Date, the 1998-2002 Debentures are convertible into an aggregate of
approximately 20.0 million Series B Preferred shares, 56.5 million Series C-1
Preferred shares, 37.5 million Series C-2 Preferred shares and 80.9 million
Series C-3 Preferred shares.
In general, the Junior Preferred Shares have a liquidation preference
equal to one (1) time the principal amount plus accrued and unpaid interest of
the 1998-2002 Debentures converted into Junior Preferred Shares The liquidation
preference of the Series B Preferred has priority over, and will be satisfied
prior to, the liquidation preference of the Series C Preferred. The liquidation
preference for each class of the Junior Preferred Shares is equal to the
conversion prices of such shares. The Junior Preferred Shares are convertible
into the Company's Common Stock, with each Junior Preferred Share convertible
into one share of Common Stock. The holders of the Junior Preferred Shares have
the right to vote as part of the single class with all holders of the Company's
Common Stock and the holders of the Series A Preferred on all matters to be
voted on by such stockholders, with each holder of Junior Preferred Shares
having such
number of votes as shall equal the number of votes he would have had if such
holder had converted all Junior Preferred Shares held by such holder into Common
Stock immediately prior to the record date relating to such vote.
The Company was a party to a certain loan agreement with Watson
Pharmaceuticals ("Watson") pursuant to which Watson made term loans to the
Company (the "Watson Term Loan Agreement") in the aggregate principal amount of
$21.4 million as evidenced by two promissory notes (the "Watson Notes"). It was
a condition to the completion of the 2004 Debenture Offering that simultaneous
with the closing of the 2004 Purchase Agreement, the Company shall have paid
Watson the sum of approximately $4.3 million (which amount was funded from the
proceeds of the 2004 Debenture Offering) and conveyed to Watson certain Company
assets in consideration for Watson's forgiveness of approximately $16.4 million
of indebtedness under the Watson Notes. As part of such transaction, the Watson
Notes were amended to extend the maturity date of such notes from March 31, 2006
to June 30, 2007, to provide for satisfaction of future interest payments under
the Watson Notes in the form of the Company's Common Stock, to reduce the
principal amount of the Watson Notes from $21.4 million to $5.0 million, and to
provide for the forbearance from the exercise of rights and remedies upon the
occurrence of certain events of default under the Watson Notes (the Watson Notes
as so amended, the "Amended and Restated Watson Note"). Simultaneous with the
issuance of the Amended and Restated Watson Note, each of the Lead 2004
Investors and the other investors in the 2004 Debentures as of February 6, 2004
(collectively, the "Watson Note Purchasers") purchased the Amended and Restated
Note from Watson in consideration for a payment to Watson of $1.0 million.
In addition to Watson's forgiveness of approximately $16.4 million under
the Watson Notes, as additional consideration for the Company's payment to
Watson of approximately $4.3 million and the Company's conveyance of certain
Company assets, all current supply agreements between the Company and Watson
were cancelled and Watson waived the dilution protections contained in the
Common Stock purchase warrant dated December 20, 2002 exercisable for
approximately 10.7 million shares of the Company's Common Stock previously
issued by the Company to Watson, to the extent such dilution protections were
triggered by the transactions provided in the 2004 Debenture Offering.
The Amended and Restated Watson Note in the principal amount of $5.0
million as purchased by the Watson Note Purchasers is secured by a first lien on
all of the Company's and its subsidiaries' assets, senior to the lien securing
the Outstanding Debentures and all other Company indebtedness, carries a
floating rate of interest equal to the prime rate plus 4.5% that is payable
quarterly in shares of the Company's common stock, and matures on June 30, 2007.
As part of the restructuring of the Company's operations, in February,
2004, the Company sold certain non-revenue generating abbreviated new drug
applications ("ANDAs"). Additionally, on March 19, 2004, the Company and its
wholly-owned subsidiary, Axiom Pharmaceutical Corporation, entered into an Asset
Purchase Agreement with IVAX Pharmaceuticals New York LLC ("IVAX"). Pursuant to
the Purchase Agreement, the Company and Axiom agreed to sell to IVAX
substantially all of the Company's assets used in the operation of the Company's
former manufacturing and packaging locations in Congers, New York. Shareholder
approval is necessary to complete this transaction and will be sought of the
Company's next annual meeting of shareholders. The cash proceeds received from
this Purchase Agreement have been recorded as deferred asset proceeds on the
Company's balance sheet until shareholder approval is received. After giving
effect to the payment of legal and other professional fees relating to these
assets divestment transactions, the Company estimates that it will realize
aggregate net proceeds of approximately $4.3 million from such transactions.
The development and commercialization of APIs and finished dosage products
incorporating the Company's Opioid Synthesis Technologies and ADF Technology are
subject to various factors, many of which are outside the Company's control. For
instance, only a portion of such technologies have been tested in laboratory
settings, none have been tested in clinical settings, and all of such
technologies will need to be successfully scaled up 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 and FDA's requirements for the
maintenance of its controlled substances manufacturing registrations. The
process of seeking a DEA registration to import NRMs and contesting opposition
proceedings, and the continuing development of the Company's Opioid Synthesis
Technologies and ADF Technology are intended to continue through 2004. The
Company is currently unable to provide any assurance that
such technologies will be commercially viable, that the patent application
associated with the ADF Technology will issue, or if such patent issues that the
claims granted will be sufficiently broad to provide economic value.
Additionally no assurance can be given that the Company will succeed in
obtaining the DEA registration to import NRMs. The Company is committing
substantially all of its resources, and available capital to the development of
the Opioid Synthesis Technologies and ADF Technology. The failure of the Company
to successfully develop the ADF Technology 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 Opioid Synthesis and ADF Technologies, to obtain required
DEA and FDA approvals and to fund the capital improvements necessary for the
manufacture of APIs and finished dosage products incorporating such
technologies.
In view of the matters described above, recoverability of a major portion
of the recorded asset amounts shown in the accompanying consolidated balance
sheets is dependent upon continued operations of the Company, which in turn are
dependent upon the Company's ability to meet its financing requirements on a
continuing basis, to maintain present financing, and to succeed in its future
operations. The financial statements do not include any adjustments relating to
the recoverability and classification of recorded asset amounts or amounts and
classification of liabilities that might be necessary should the Company be
unable to continue in existence.
NOTE 3 - NEW ACCOUNTING PRONOUNCEMENTS
In January 2003, the FASB issued Financial Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN No. 46"), which addresses
consolidation by business enterprises of variable interest entities (VIEs). 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. The accounting
provisions and disclosure requirements of FIN No. 46 are effective immediately
for VIEs created or acquired after January 31, 2003, and are effective for the
Company's interim period ending March 31, 2004, for VIEs created prior to
February 1, 2003. In December 2003, the FASB published a revision to FIN No.
46 ("FIN No. 46R") to clarify some of the provisions of the interpretation and
to defer the effective date of implementation for certain entities. Under the
guidance of FIN No. 46R, public companies that have interests in VIE's that are
commonly referred to as special purpose entities are required to apply the
provisions of FIN No. 46R for periods ending after December 15, 2003. A public
company that does not have any interests in special purpose entities but does
have a variable interest in a VIE created before February 1, 2003, must apply
the provisions of FIN No. 46R by the end of the first interim or annual
reporting period ending after March 14, 2004. During the quarter ended March
31, 2004 the Company adopted the provisions of FIN No. 46R. Adoption of FIN
No. 46R did not have a material effect on the Company's financial statements.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities," ("SFAS No. 149"), which
amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts and for hedging activities under SFAS No. 133. SFAS No. 149 is
effective for contracts entered into or modified after June 30, 2003 except for
the provisions that were cleared by the FASB in prior pronouncements. The
adoption of SFAS No. 149 did not have a material impact on the Company's
financial position or results of operations.
In May 2003, the FASB issued "SFAS No. 150", "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity"
("SFAS No. 150"). This statement establishes standards for how an issuer
classifies and measures in its statement of financial position certain financial
instruments with characteristics of both liabilities and equity. In accordance
with the standard, financial instruments that embody obligations for the issuer
are required to be classified as liabilities. This Statement shall be effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact
on the Company's financial position or results of operations.
NOTE 4 - RECLASSIFICATIONS
Certain reclassifications have been made to the prior years' amounts to
conform to the current year's presentation.
NOTE 5 - EARNINGS (LOSS) PER SHARE
Basic earnings per share is computed by dividing net income (loss) by the
weighted average common shares outstanding during the period. Diluted earnings
per share is based on the treasury stock method and is computed by dividing net
income by the weighted average common shares and common share equivalents
outstanding during the periods presented assuming the exercise of all
in-the-money stock options. Common share equivalents have been excluded where
their inclusion would be anti-dilutive. A reconciliation of the numerator and
denominators of basic and diluted earnings per share for the Quarters ended
March 31, 2004 and March 31, 2003 consisted of the following (in thousands
except per share amount):
QUARTER ENDED MARCH 31, 2004 2003
----------------------- --------- --------
NUMERATOR:
Net income (loss) $ 680 $(10,575)
--------- --------
DENOMINATOR:
Basic weighted average shares outstanding 21,602 21,035
Convertible debentures 249,479 -
Warrants 6,939 -
Stock options - -
--------- --------
Diluted weighted average shares outstanding 278,020 21,035
--------- --------
Basic earnings per share $ .03 $ (.50)
--------- --------
Diluted earnings per share $ .00 $ (.50)
--------- --------
For the quarter ended March 31, 2004, stock options and warrants to
purchase 3.4 million and 9.7 million common shares respectively, were
outstanding but not included in the computation of diluted earnings per share
because the exercise prices were greater than the average market price of the
common shares. For the Quarter ended March 31, 2003, approximately 199,850,000
of outstanding warrants, options, and the effect of convertible debentures and
convertible bridge loans outstanding, have been excluded from the computation of
diluted earnings per share as they would be antidilutive to the reported net
loss.
NOTE 6 - INVENTORIES
Inventories consist of the following:
MARCH 31, 2004 DECEMBER 31, 2003
-------------- -----------------
(IN THOUSANDS)
Finished Goods....................................... $ 705 $ 357
Work in Process...................................... 198 953
Raw Materials........................................ 211 356
------------ ------------
1,114 1,666
Less impairment reserve.............................. (1,114) (1,354)
------------ ------------
$ - $ 312
============ ============
NOTE 7 - ACCRUED EXPENSES
Accrued expenses are summarized as follows:
MARCH 31, 2004 DECEMBER 31, 2003
-------------- -----------------
(IN THOUSANDS)
Payroll, Payroll Taxes and Benefits.................. $ 232 $ 468
Professional and Director Fees....................... 200 536
Property and Sales Taxes............................. 147 142
Other................................................ 773 962
------------ ------------
$ 1,352 $ 2,108
============ ============
NOTE 8 - CONVERTIBLE SUBORDINATED DEBENTURES
Convertible Subordinated Debentures consist of the following:
MARCH 31, 2004 DECEMBER 31, 2003
-------------- -----------------
(IN THOUSANDS)
1998 Debentures...................................... $ 31,212 $ 31,212
1999 Debentures...................................... 21,485 21,485
2002 Debentures...................................... 27,303 27,303
2003 Debentures...................................... 6,632 6,632
2004 Debentures...................................... 12,313 --
------------ ------------
98,945 86,632
Less: Debt discount.................................. (59,029) (56,893)
------------ ------------
39,916 29,739
Less: Current maturities, net........................ (3,849) --
------------ ------------
$ 36,067 $ 29,739
============ ============
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 $0.93.
Related-Party Transactions
Certain of the 1998 Debentures and 1999 Debentures are held a member of
the Company's management and Board of Directors. The aggregate principal amount
of such debentures was approximately $173,000 at March 31, 2004 and December 31,
2003, respectively. Interest expense on these debentures was approximately
$2,200 and $4,600 for the quarters ended March 31, 2004 and 2003, respectively.
Indemnification
Each of the purchase agreements for the Company's 1998 Debentures, 1999
Debentures, 2002 Debentures, 2003 Debentures and Bridge Loans, and 2004
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 or disbursements arising
out of or resulting from the breach of any representation, warranty or
agreement of the Company related to the purchase of the debentures and bridge
loans. These indemnification obligations do not include a limit on maximum
potential future payments, nor are there any recourse provisions or collateral
that may offset the cost. As of March 31, 2004, the Company does not believe
that any liability has been incurred as a result of these indemnification
obligations.
NOTE 9 - TERM NOTE PAYABLE
In connection with various strategic alliance transactions between the
Company and Watson completed in 2001, Watson advanced $17,500,000 to the Company
under the Watson Term Loan. The loan was 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, 2004. 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. 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 $0.34 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 December 31, 2003, Watson had advanced $21,401,331
to the Company under the Watson Term Loan and the interest rate was 8.5%.
In satisfaction of a condition to the completion of the 2004 Debenture
Offering, simultaneous with the closing of the 2004 Purchase Agreement, the
Company paid Watson the sum of approximately $4.3 million (which amount was
funded from the proceeds of the 2004 Debenture Offering) and conveyed to Watson
certain Company assets in consideration for Watson's forgiveness of
approximately $16.4 million of indebtedness under the Watson Notes. As part of
such transaction, the Watson Notes were amended to extend the maturity date of
such notes from March 31, 2006 to June 30, 2007, to provide for satisfaction of
future quarterly interest payments under the Watson Notes in the form of the
Company's Common Stock, to reduce the principal amount of the Watson Notes from
$21.4 million to $5.0 million, and to provide for the forbearance from the
exercise of rights and remedies upon the occurrence of certain events of default
under the Watson Notes (the Watson Notes as so amended, the "Amended and
Restated Watson Note"). Simultaneous with the issuance of the Amended and
Restated Watson Note, each of the Lead 2004 Investors and the other investors in
the 2004 Debentures as of February 6, 2004 (collectively, the "Watson Note
Purchasers") purchased the Amended and Restated Note from Watson in
consideration for a payment to Watson of $1,000,000.
In addition to Watson's forgiveness of approximately $16.4 million under
the Watson Notes, as additional consideration for the Company's payment to
Watson of approximately $4.3 million and the Company's conveyance of certain
Company assets, all current supply agreements between the Company and Watson
were cancelled and Watson waived the dilution protections contained in the
Watson Warrant, to the extent such dilution protections were triggered by the
transactions provided in the 2004 Debenture Offering.
The Amended and Restated Watson Note in the principal amount of $5.0
million as purchased by the Watson Note Purchasers is secured by a first lien on
all of the Company's and its subsidiaries' assets, senior to the lien securing
the Outstanding Debentures and all other Company indebtedness, carries a
floating rate of interest equal to the prime rate plus 4.5% and matures on June
30, 2007. The interest rate at March 31, 2004 was 8.50%.
NOTE 10 - INCOME TAXES
The Company has not provided for any tax expense during the the three
months ended March 31, 2004, as a result of utilizing net operating loss carry
forwards not previously provided for. Historically, the Company has incurred
significant losses from operations and until such time as the research and
development efforts are commercialized, for which no assurance can be given,
the Company will continue to incur operating losses.
NOTE 11 - 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.
THREE MONTHS ENDED MARCH 31,
2004 2003
------------ ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income (loss), as reported ............................. $ 680 $ (10,575)
Deduct: Total stock-based employee compensation
expense determined under fair value-based method
for all awards ............................................. (64) (194)
------------ ------------
Pro forma net income (loss) ................................ $ 616 $ (10,769)
============ ============
Basic EPS -- as reported .................................. $ .03 $ (0.50)
------------ ------------
Basic EPS -- pro forma .................................... $ .03 $ (0.51)
============ ============
Diluted EPS -- as reported ................................. $ .00 $ (0.50)
------------ ------------
Diluted EPS -- pro forma ................................... $ .00 $ (0.51)
============ ============
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 11 - COMMITMENTS AND CONTINGENCIES
U.S. Department of Justice Settlement
On June 21, 1993, the Company entered into a Plea Agreement with the U.S.
Department of Justice (the "DOJ") to resolve the DOJ's investigation into the
manufacturing and record keeping practices of the Company's Brooklyn, New York
plant. The Plea Agreement required the Company to pay a fine of $2,500,000 over
five years in quarterly installments of $125,000, commencing on or about
September 15, 1993.
As of February 28, 1998, the Company was in default of the payment terms
of the Plea Agreement and had made payments aggregating $350,000. On May 8,
1998, the Company and the DOJ signed the Letter Agreement serving to amend the
Plea Agreement relating to the terms of the Company's satisfaction of the fine
assessed under the Plea Agreement. Specifically, the Letter Agreement provided
that the Company will satisfy the remaining $2,150,000 of the fine through the
monthly payments of $25,000 commencing June 1, 1998, plus interest on such
outstanding balance (at the rate calculated pursuant to 28 U.S.C. Section 1961
(5.319%). Such payment schedule provide for the full satisfaction of the DOJ
fine in July 2005. The Letter Agreement also provides certain restrictions on
the payment of salary or compensation to any individual in excess of certain
amounts without the written consent of the DOJ. In addition, the Letter
Agreement requires the repayment of the outstanding fine to the extent of 25% of
the Company's after-tax profit or 25% of the net proceeds received by the
Company on any sale of a capital asset for a sum in excess of $10,000, if not
invested in another capital asset. At December 31, 2003, the Company was current
in its payment obligations, with a remaining obligation of $433,000. In February
2004, the Company fully satisfied its obligation to the DOJ.
Employment Contracts
During April 2004, the Company entered into an employment agreement with a
new officer/employee of the Company. The agreement provides for, among other
things: (i) an annual base salary of $260,000, and (ii) an aggregate of
3,000,000 options to purchase the Company's stock at an exercise price of $0.13
per common share that vest 1,000,000 option shares on October 1, 2004 and the
balance thereafter at a rate of 333,333 per calendar quarter, beginning January
1, 2005 with an exercise term expiring in ten years. The stock option is subject
to the shareholders approval to modify the Company's 1998 Stock Option Plan to
(i) increase the number of shares reserved for issuance and (ii) authorize
issuance of stock options having an exercise price less than fair market value
of the common stock of the Company on the date of issuance. The employment
agreement term is for a two year period which automatically renews for
successive one-year periods unless either the Company or the employee provides
90 days' notice of non-renewal.
During August 2003, the Company entered into an employment agreement with
a new officer/employee of the Company. The agreement provides for, among other
things: (i) an annual base salary of $300,000, and (ii) an aggregate of
5,500,000 options to purchase the Company's stock at an exercise price of $0.34
per common share that vest 1,000,000 option shares on March 31, 2004 and the
balance thereafter at a rate of 500,000 per calendar quarter, beginning June 30,
2004 which an exercise term expiring in ten years. The stock option is subject
to the shareholders approval to modify the Company's 1998 Stock Option Plan to
(i) increase the number of shares reserved for issuance and (ii) authorize
issuance of stock options having an exercise price less than fair market value
of the common stock of the Company on the date of issuance. The employment
agreement term is for a two year period which automatically renews for
successive one-year periods unless either the Company or the employee provides
90 days' notice of non-renewal. The Company is in the process of finalizing an
amendment to the employment agreement, among other things, to adjust the
Company's commitment to issue stock options from 5,500,000 shares to 8,750,000
shares and to provide for an exercise price of $0.13 per share. Upon grant, the
option will have a ten-year term and will provide for vesting in the amount of
2,750,000 shares on June 30, 2004 and the balance thereafter at a rate of
250,000 shares per calendar month, beginning July 31, 2004.
During April 2004, the Company committed to issue to current employees
stock options that upon grant, will be exercisable for an aggregate of 1,425,000
shares of the Company's common stock at an exercise price of $0.13 per common
share and will vest 25% annually over four years and provide for immediate
vesting upon change of control. The grant of these stock options is subject to
the shareholders approval to modify the Company's 1998 Stock Option Plan to (i)
increase the number of shares reserved for issuance and (ii) authorize issuance
of stock options having an exercise price less than fair market value of the
common stock of the Company on the date of issuance.
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 defense of all of such matters was assumed by
the Company's insurance carrier, and a substantial number have been settled by
the carrier. 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
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. The Company's motion for summary judgment was due to
be heard by the Court on August 8, 2003. Plaintiff Kohn deceased shortly prior
to such hearing date, and the motion for summary judgment and any trial of this
matter have been stayed pending the substitution of Mr. Kohn's estate as the
plaintiff. 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 consolidated financial statements.
On June 13, 2002, the Company was named an additional defendant in an
Amended Complaint filed in the matter entitled Vintage Pharmaceuticals, Inc., v.
Watson Pharmaceuticals, Inc., and Halsey Drug Company, Inc., pending in the
United States District Court for the Northern District of Alabama, Civil Action
No. CV 01-B-1847-NE. Vintage seeks unspecified damages from the Company for
allegedly interfering with Vintage's contract to produce Monodox(R), the brand
name of doxycycline monohydrate, for Watson. During the first quarter 2004,
Watson's motion for summary judgment was approved by the Court and the case was
dismissed against Watson. In May 2004, the Company filed for and received an
order dismissing this case with prejudice.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCE CONDITION AND RESULTS OF
OPERATIONS
THREE MONTHS ENDED MARCH 31, 2004 VS. THREE MONTHS ENDED MARCH 31, 2003
NET PRODUCT REVENUES
The Company's net product revenues for the three months ended March 31,
2004 of $628,000 represents a decrease of $898,000 (59%) as compared to net
revenues for the three months ended March 31, 2003 of $1,526,000. The decrease
in net product revenues was primarily a result of the Company's decision in the
fourth quarter of 2003 to restructure operations and cease the manufacture of
finished dosage products. The net product revenues in the first quarter of 2004
reflect the sale of substantially all remaining inventories of saleable
finished dosage products by the Company.
COST OF MANUFACTURING
For the three months ended March 31, 2004, cost of manufacturing decreased
$1,620,000 as compared to the three months ended March 31, 2003. As a percentage
of sales, cost of manufacturing was 200% and 188% for March 31, 2004 and 2003,
respectively. The percentage increase reflects the remaining fixed costs of
manufacturing during the shutdown of operations at the Company's generic
finished dosage manufacturing operations in the first quarter of 2004. The
shutdown of generic finished dosage manufacturing operations was completed in
March, 2004.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses as a percentage of sales for
the three months ended March 31, 2004 and 2003 were 194% and 112%, respectively.
Overall these expenses in the first three months of 2004 decreased $490,000 or
29% for the same period in 2003. The decrease is due primarily to a reduction in
sales and marketing expenses of $84,000 reduced payroll expenses of $80,000
resulting from the Company's decision in the fourth quarter of 2003 to eliminate
the sale of generic finished dosage products and reduce administrative staff,
and a $183,000 benefit for settlement of trade payables at a discount.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses were $238,000 and $329,000 for the three
months ended March 31, 2004 and 2003, respectively. The Company has restructured
its operations and expects to devote substantially all of its resources in 2004
to research and development activities relating to its ADF Technologies and
Opioid Synthesis Technologies.
NET INCOME (LOSS)
For the three months ended March 31, 2004, the Company had net income of
$680,000 as compared to a net loss of $10,575,000 for the three months ended
March 31, 2003. Included in net income are gains on debt restructuring of
$12,401,000 and asset sales of $1,754,000 and other income of $403,000 relating
to settlement of a liability at discount. Also included was interest expense of
$958,000 and amortization of deferred debt discount and private offering costs
of $10,843,000 as compared to interest expense of $1,433,000 and amortization of
deferred debt discount and private offering costs of $5,767,000 for the same
period in 2003.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 2004 the Company had cash and cash equivalents of $7,282,000
as compared to $942,000 at December 31, 2003. The Company had working capital
deficit of $2,013,000 at March 31, 2004 and a working capital deficit of
$3,770,000 at December 31, 2003. The Company had an accumulated deficit of
$208,865,000 and
$209,545,000 as March 31, 2004 and December 31, 2003, respectively. The Company
had an operating loss of $2,084,000 during the three months ended March 31,
2004.
On February 6, 2004, the Company consummated a private offering of
securities for an aggregate purchase price of approximately $12.3 million (the
"2004 Debenture Offering"). The securities issued in the 2004 Debenture Offering
consisted of convertible senior secured debentures (the "2004 Debentures"). The
2004 Debentures were issued by the Company pursuant to a certain Debenture and
Share Purchase Agreement dated as of February 6, 2004 (the "2004 Purchase
Agreement") by and among the Company, Care Capital Investments II, LP ("Care
Capital"), Essex Woodlands Health Ventures V, L.P. ("Essex"), Galen Partners
III, L.P. and each of the Purchasers listed on the signature page thereto
(collectively, the "2004 Debenture Investor Group"). As the conversion price of
such debentures was less than the fair market value of the Company's common
stock on the date of issue, beneficial conversion features were determined to
exist. The Company recorded approximately $12.3 million of debt discount limited
to the face amount of the new debt, which is being amortized over the life of
the debt, which matures July 31, 2004, subject to extension to October 31, 2004.
During the three months ended March 31, 2004, the Company recognized
approximately $3.8 million of amortization expense from this transaction.
On April 14, 2004 the Company completed an additional closing under the
2004 Purchase Agreement and issued additional 2004 Debentures in the aggregate
principal amount of approximately $579,000, bringing the principal amount of the
2004 Debentures issued by the Company under the 2004 Purchase Agreement to an
aggregate amount of approximately $12.879 million. As the conversion price of
such debentures was less than the fair market value of the Company's common
stock on the date of issue, beneficial conversion features were determined to
exist. The Company recorded approximately $.6 million of debt discount limited
to the face amount of the new debt, which will be amortized over the life of the
debt, which matures July 31, 2004, subject to extension to October 31, 2004.
Of the approximate $12.879 million in 2004 Debentures issued in the 2004
Debenture Offering, approximately $2.0 million of 2004 Debentures were issued in
exchange for the surrender of like amount of principal plus accrued interest
outstanding under Company's 5% convertible senior secured debentures issued
pursuant to working capital bridge loan transactions with Care Capital, Essex
Woodlands and Galen Partners III, L.P., Galen International III, L.P., and Galen
Employee Fund III, L.P. (collectively, "Galen") during November and December,
2003. The 2004 Purchase Agreement further provides that the Company may issue
additional 2004 Debentures in the principal amount of up to approximately $1.121
million on or prior to June 5, 2004, provided that the aggregate principal
amount of 2004 Debentures issued pursuant to the 2004 Purchase Agreement shall
not exceed $14.0 million without the consent of the holders of 60% of the
principal amount of the 2004 Debentures then held by Care Capital, Essex and
Galen.
The 2004 Debentures, issued at par, bear interest at the rate of 1.62% per
annum, the short-term Applicable Federal Rate on the date of issuance. The 2004
Debentures are secured by a lien on all assets of the Company. In addition, each
of Houba, Inc. and Axiom Pharmaceutical Corporation, each a wholly-owned
subsidiary of the Company, has executed in favor of the 2004 Debenture holders,
an unconditional agreement of guaranty of the Company's obligations under the
2004 Purchase Agreement. Each guaranty is secured by all assets of such
subsidiary. In addition, the Company has pledged the stock of each such
subsidiary to the holders of the 2004 Debentures to further secure its
obligations under the 2004 Purchase Agreement.
In accordance with the terms of an Amended and Restated Subordination
Agreement dated as of February 6, 2004 between the Company, the holders of the
2004 Debentures and the holders of the Company's other outstanding debentures,
the liens on the Company's and its subsidiary's assets as well as the payment
priority of the 2004 Debentures are (i) subordinate to the Company's lien and
payment obligations in favor of Watson Pharmaceuticals under the Watson Term
Loan Agreement, and (ii) senior to the Company's lien and payment obligations in
favor of the holders of the Company's other outstanding debentures in the
aggregate principal amount of approximately $87.7 million.
The 2004 Debentures (including the principal amount plus interest accrued
at the date of conversion) will
convert automatically into the Company's Series A convertible preferred stock
(the "Series A Preferred") immediately following the Company's receipt of
shareholder approval at its next shareholders' meeting to restate the Company's
Certificate of Incorporation (the "Charter Amendment") to authorize the Series A
Preferred and the Junior Preferred Shares (as described below) and the filing of
the Charter Amendment with the Office of the New York Department of State (the
date of such filing, the "Charter Amendment Filing Date"), as provided in the
2004 Purchase Agreement. The 2004 Debentures will convert into Series A
Preferred at a price per share (the "Series A Conversion Price") of $0.6425,
representing the average of the closing bid and asked prices of the Company's
Common Stock for the twenty (20) trading days ending February 4, 2004, as
reported by the Over-the-Counter ("OTC") Bulletin Board. The Series A 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 options for the purchase of, or stock or other securities convertible
into, Common Stock ("Convertible Securities"), if lower than the then applicable
Series A Conversion Price.
Based on the $0.6425 Series A Conversion Price of the Series A Shares and
estimating the interest accrual under the 2004 Debentures prior to the Charter
Amendment Filing Date, the 2004 Debentures with an aggregate principal amount of
$14.0 million would be convertible into an aggregate of approximately 21.8
million Series A Preferred shares.
In general, the Series A Preferred shares have a liquidation preference
equal to five (5) times the initial $0.6425 Series A Conversion Price (the
"Series A Liquidation Preference"). In addition, the Series A Preferred shares
are convertible into the Company's Common Stock, with each Series A Preferred
share convertible into the number of shares of Common Stock obtained by dividing
(i) the Series A Liquidation Preference, by (ii) the $0.6425 Series A Conversion
Price, as such conversion price may be adjusted, from time to time, pursuant to
the dilution protections of such shares. Without limiting the Series A
Liquidation Preference, the holders of Series A Preferred shares also have the
right to participate with the holders of the Company's Common Stock upon the
occurrence of a liquidation event, including the Company's merger, sale of all
or substantially all of its assets or a change of control transaction, on an
as-converted basis (but for these purposes only, assuming the Series A Preferred
shares to be convertible into only thirty percent (30%) of the shares of Common
Stock into which they are otherwise then convertible). The holders of Series A
Preferred shares also have the right to vote as part of a single class with all
holders of the Company's voting securities on all matters to be voted on by such
security holders. Each holder of Series A Preferred shares will have such number
of votes as shall equal the number of votes he would have had if such holder
converted all Series A Preferred shares held by such holder into shares of
Common Stock immediately prior to the record date relating to such vote.
The 2004 Purchase Agreement provides that each of Care Capital, Essex and
Galen (collectively, the "Lead 2004 Investors") has the right to designate for
nomination one member of the Company's Board of Directors, and that the Lead
Investors collectively may designate one additional member of the Board
(collectively, the Designees"). The Purchase Agreement further provides that the
Designees, if so requested by such Designee in his sole discretion, shall be
appointed to the Company's Executive Committee, Compensation Committee and any
other Committee of the Board of Directors. The Designees of Care Capital, Essex
and Galen are Messrs. Karabelas, Thangaraj and Wesson, respectively, each of
whom are current Board members. Effective as of the closing of the 2004 Purchase
Agreement, the Lead 2004 Investors may collectively nominate one additional
Designee to the Board. The Company has agreed to nominate and appoint to the
Board of Directors, subject to shareholder approval, one designee of each of
Care Capital, Essex and Galen, and one collective designee of the Lead 2004
Investors, for so long as each holds a minimum of 50% of the Series A Preferred
shares initially issued to such party (or at least 50% of the shares of Common
Stock issuable upon conversion of the Series A Preferred shares).
As of February 6, 2004, the date of the initial closing of the 2004
Purchase Agreement, the Company had issued and outstanding and aggregate of
approximately $87.7 million in principal amount of 5% convertible senior
secured debentures maturing March 31, 2006 issued pursuant to three separate
Debenture Purchase Agreements dated March 10, 1998, as amended (the "1998
Debentures"), May 26, 1999, as amended (the "1999 Debentures") and December 20,
2002 (the "2002 Debentures"), respectively. The 1998 Debentures, 1999 Debentures
and 2002 Debentures are referred to collectively as the "1998-2002 Debentures".
After giving effect to the Company's issuance of additional 5% convertible
senior secured debentures in satisfaction of interest payments on the 1998-2002
Debentures, as of February 10, 2004, the 1998-2002 Debentures were convertible
into an aggregate of approximately 190.4 million shares of the Company's Common
Stock.
Simultaneous with the execution of the 2004 Purchase Agreement, and as a
condition to the initial closing of the 2004 Purchase Agreement, the Company,
the 2004 Debenture Investor Group and each of the holders of the 1998-2002
Debentures executed a certain Debenture Conversion Agreement, dated as of
February 6, 2004 (the "Conversion Agreement"). In accordance with the terms of
the Conversion Agreement, each holder of the 2004 Debentures agreed to convert
the 2004 Debentures held by such holder into the Company's Series A Preferred
shares and each holder of 1998-2002 Debentures agreed to convert the 1998-2002
Debentures held by such holder into the Company's Series B convertible preferred
stock (the "Series B Preferred") and/or Series C-1, C-2 and/or C-3 convertible
preferred stock (collectively, the "Series C Preferred"). The Series C Shares
together with the Series B Shares are herein referred to as, the "Junior
Preferred Shares", and the Junior Preferred Shares together with the Series A
Preferred, are collectively referred to as the "Preferred Stock". The Conversion
Agreement provides, among other things, for the automatic conversion of the 2004
Debentures and the 1998-2002 Debentures (collectively, the "Outstanding
Debentures") into the appropriate class of Preferred Stock immediately following
the Company's receipt of shareholder approval to the Charter Amendment
authorizing the creation of the Preferred Stock and the filing of the Charter
Amendment with the Office of the New York Department of State.
Under the Conversion Agreement, the holders of approximately $6.7 million
in principal amount of 2002 Debentures issued during 2003 will convert such 2002
Debentures (plus accrued and unpaid interest) into Series B Preferred Shares. Of
the remaining approximate $81 million in principal amount of the 1998-2002
Debentures, approximately $31.6 million is comprised of 1998 Debentures,
approximately $21.8 million is comprised of 1999 Debentures and approximately
$27.6 million is comprised of 2002 Debentures. The 1998 Debentures will be
converted into Series C-1 Preferred shares. The 1999 Debentures will be
converted into Series C-2 Preferred shares. The remaining balance of the 2002
Debentures shall be converted into Series C-3 Preferred shares.
The number of Junior Preferred Shares to be received by each holder of
1998-2002 Debentures is based on the respective prices at which the 1998-2002
Debentures were convertible into Common Stock. The 2002 Debentures issued in
2003 have a conversion price of $0.3420 per share. The 1998 Debentures, 1999
Debentures and the remaining balance of the 2002 Debentures have conversion
prices of $0.5776, $0.5993 and $0.3481 per share, respectively. Based on the
respective conversion prices of the 1998-2002 Debentures, and estimating the
interest accrual on the 1998-2002 Debentures prior to the Charter Amendment
Filing Date, the 1998-2002 Debentures are convertible into an aggregate of
approximately 20.0 million Series B Preferred shares, 56.5 million Series C-1
Preferred shares, 37.5 million Series C-2 Preferred shares and 80.9 million
Series C-3 Preferred shares.
In general, the Junior Preferred Shares have a liquidation preference
equal to one (1) time the principal amount plus accrued and unpaid interest of
the 1998-2002 Debentures converted into Junior Preferred Shares The liquidation
preference of the Series B Preferred has priority over, and will be satisfied
prior to, the liquidation preference of the Series C Preferred. The liquidation
preference for each class of the Junior Preferred Shares is equal to the
conversion prices of such shares. The Junior Preferred Shares are convertible
into the Company's Common Stock, with each Junior Preferred Share convertible
into one share of Common Stock. The holders of the Junior Preferred Shares have
the right to vote as part of the single class with all holders of the Company's
Common Stock and the holders of the Series A Preferred on all matters to be
voted on by such stockholders, with each holder of Junior Preferred Shares
having such number of votes as shall equal the number of votes he would have had
if such holder had converted all Junior Preferred Shares held by such holder
into Common Stock immediately prior to the record date relating to such vote.
The Company was a party to a certain loan agreement with Watson
Pharmaceuticals ("Watson") pursuant to which Watson made term loans to the
Company (the "Watson Term Loan Agreement") in the aggregate principal amount of
$21.4 million as evidenced by two promissory notes (the "Watson Notes"). It was
a condition to the completion of the 2004 Debenture Offering that simultaneous
with the closing of the 2004 Purchase Agreement, the Company shall have paid
Watson the sum of approximately $4.3 million (which amount was funded from the
proceeds of the 2004 Debenture Offering) and conveyed to Watson certain Company
assets in consideration for Watson's forgiveness of approximately $16.4 million
of indebtedness under the Watson Notes. As part of such transaction, the Watson
Notes were amended to extend the maturity date of such notes from March 31, 2006
to June 30, 2007, to provide for satisfaction of future interest payments under
the Watson Notes in the form of the Company's Common Stock, to reduce the
principal amount of the Watson Notes from $21.4 million to $5.0 million, and to
provide for the forbearance from the exercise of rights and remedies upon the
occurrence of certain events of default under the Watson Notes (the Watson Notes
as so amended, the "Amended and Restated Watson Note"). Simultaneous with the
issuance of the Amended and Restated Watson Note, each of the Lead 2004
Investors and the other investors in the 2004 Debentures as of February 10, 2004
(collectively, the "Watson Note Purchasers") purchased the Amended and Restated
Note from Watson in consideration for a payment to Watson of $1.0 million.
In addition to Watson's forgiveness of approximately $16.4 million under
the Watson Notes, as additional consideration for the Company's payment to
Watson of approximately $4.3 million and the Company's conveyance of certain
Company assets, all supply agreements between the Company and Watson were
terminated and Watson waived the dilution protections contained in the Common
Stock purchase warrant dated December 20, 2002 exercisable for approximately
10.7 million shares of the Company's Common Stock previously issued by the
Company to Watson, to the extent such dilution protections were triggered by the
transactions provided in the 2004 Debenture Offering.
The Amended and Restated Watson Note in the principal amount of $5.0
million as purchased by the Watson Note Purchasers is secured by a first lien on
all of the Company's and its subsidiaries' assets, senior to the lien securing
the Outstanding Debentures and all other Company indebtedness, carries a
floating rate of interest equal to the prime rate plus 4.5% and matures on June
30, 2007.
As of April 14, 2004, after giving effect to the payment to Watson of
approximately $4.3 million to restructure the Watson Term Loan and the payment
of legal and other professional fees relating to the 2004 Debenture Offering,
the Company realized net proceeds from the 2004 Debenture Offering of
approximately $ 5.8 million (the "2004 Debenture Offering Proceeds").
In February, 2004, the Company sold certain non-revenue generating ANDAs.
In addition, on March 19, 2004, the Company and its wholly-owned subsidiary,
Axiom Pharmaceutical Corporation, entered into an Asset Purchase Agreement with
IVAX Pharmaceuticals New York LLC ("IVAX"). Pursuant to the Purchase Agreement,
the Company and Axiom agreed to sell to IVAX substantially all of the Company's
assets used in the operation of the Company's former generic manufacturing and
packaging operations located in Congers, New York. Shareholder approval is
necessary to complete this transaction and will be sought of the Company's next
annual meeting of shareholders. The cash proceeds received from this Purchase
Agreement have been recorded as deferred asset proceeds on the Company's balance
sheet until shareholder approval is received. After giving effect to the payment
of legal and other professional fees relating to these assets divestment
transactions, the Company estimates that it will realize aggregate net proceeds
from such transactions of approximately $4.3 million. (the "Asset Divestment
Proceeds").
The development, scale- up and commercialization of APIs incorporating the
Company's Opioid Synthesis Technologies and ADF Technology are subject to
various factors, many of which are outside the Company's control. To date, a
portion of such technologies have been tested in laboratory settings, and none
have been tested in clinical
settings. All such technologies will need to be successfully scaled up to be
commercially viable, of which no assurance can be given. The Company is unable
to provide any assurances that the patent application associated with the ADF
Technology will issue, or if such patent issues that the claims granted will be
sufficiently broad to provide economic value. Additionally, the Company must
satisfy, and continue to maintain compliance with the DEA's and FDA's
requirements for the maintenance of its controlled substances research and
manufacturing registrations. The process of seeking a DEA registration to import
NRMs and the continuing development of the Company's Opioid Synthesis
Technologies and ADF Technology are intended to continue through 2004. The
Company is unable to provide any assurance that the ADF Technology or the Opioid
Synthesis Technologies will be commercially viable. In addition, no assurance
can be given that the Company will succeed in obtaining the DEA registration to
import NRMs. The Company is committing substantially all of its resources and
available capital to the development of the ADF Technology and the Opioid
Synthesis Technologies. The failure of the Company to successfully develop the
ADF Technology will have a material adverse effect on the Company's operations
and financial condition.
The Company estimates that to scale up its hydrocodone bitartrate process
#1, Opioid Synthesis Technology to desirable commercial scale at its Culver
Facility, additional funding of approximately $7.0 million will be required for
facility improvements, the purchase, installation and validation of new API
manufacturing equipment, environmental waste management compliance, the
preparation of the drug master files for the API to be produced at the facility,
and related direct labor expense (collectively, the "API Scale Up Expenses").
The Company is a party to a certain Hydrocodone Option Agreement dated February
6, 2004 with Watson Pharmaceuticals ("Watson") pursuant to which the Company has
granted Watson a six (6) month exclusive option to enter into a supply agreement
with the Company for supply of hydrocodone bitartrate API (the "Hydrocodone
API"). If such option is exercised by Watson, at Watson's sole discretion, of
which there can be no assurance, Watson will fund 50% of the API Scale Up
Expenses, up to a maximum of $3.5 million and the Company has agreed to use
commercially reasonable efforts to obtain financing dedicated to fund its
portion of the API Scale Up Expenses. In the event the Company is unable to
secure financing dedicated to fund its portion of the API Scale Up Expenses, the
Hydrocodone Option provides that the parties will discuss alternatives relating
to the scale up of the its Opioid Synthesis Technology for Hydrocodone API.
There can be no assurance that Watson will exercise the Hydrocodone Option
or, even if exercised, that the Company will succeed in obtaining financing
dedicated to fund its portion of the API Scale Up Expenses. As described in this
Report, no portion of the 2004 Debenture Offering Proceeds or the Asset
Divestment Proceeds is budgeted for the API Scale Up Expenses. Until such time,
if any, as the Company secures third-party financing dedicated to the API Scale
Up Expenses, the Company will be unable to complete the commercial scale up of
its Opioid Synthesis Technologies.
Except for the professional fees related to prosecution of the Import
Registration, the 2004 Debenture Offering Proceeds and the Asset Divestment
Proceeds will be dedicated to the development of the Company's ADF Technology,
the Opioid Synthesis Technologies and for administrative and related operating
expenses.
Subsequent to the completion of the restructuring of its operations, the
Company is no longer engaged in the manufacture and sale of finished dosage
generic pharmaceutical products. As a result, the Company has no ability
presently to generate revenue from generic product sales. Accordingly, the
Company must rely on its current cash reserves to fund the development of its
ADF Technology, the Opioid Synthesis Technologies and related ongoing operating
expenses. The Company's future sources of revenue, if any, will be derived from
the sale of API manufactured using its Opioid Synthesis Technologies, contract
signing fees, milestone payments and royalties and/or profit sharing payments
from licensees for the Company's ADF Technology or Opioid Synthesis
Technologies. The Company estimates that its current cash reserves will be
sufficient to fund the development of the ADF Technology, the Opioid Synthesis
Technologies and related operating expenses through January 2005. To fund
operations through December, 2005, the Company estimates that it must raise
additional financing, or enter into alliances or collaboration agreements with
third parties providing for net proceeds to the Company of at least $5 million.
No assurance can be given that the Company will be successful in obtaining any
such financing or in
securing collaborative agreements with third parties on acceptable terms, if at
all, or if secured, that such financing or collaborative agreements will provide
for payments to the Company sufficient to continue to fund operations. In the
absence of such financing or third-party collaborative agreements, the Company
will be required to scale back or terminate operations and/or seek protection
under applicable bankruptcy laws.
Even assuming the Company is successful in securing additional sources of
financing to fund the continued development of the ADF Technology or the Opioid
Synthesis Technologies, or otherwise enters into alliances or collaborative
agreements relating to such technologies, there can be no assurance that the
Company's development efforts will result in commercial scale technologies, or
that if such technologies are capable of being scaled up, that they will result
in commercially viable products. The Company is also unable to provide any
assurance that it will succeed in its application to the DEA for a registration
to import NRMs. The Company's failure to successfully develop the ADF Technology
in a timely manner will have a material adverse impact on its 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.
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 complies with the disclosure provision of SFAS
No. 148, "Accounting for Stock-based Compensation - Transition and Disclosure,
an amendment of FASB Statement No. 123" ("SFAS No. 148"). 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.
ITEM 4. CONTROLS AND PROCEDURES
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 as of the end of the period covered by this
Report. 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.
PART II
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the quarter ended March 31, 2004, the Company issued Convertible
Subordinated Debentures in the aggregate principal amount of approximately
$12,313,000 (the "Convertible Debentures"). Approximately $2,049,000 of the
Convertible Debentures were issued in exchange for principal and accrued
interest on the Company's outstanding 5% bridge loans notes issued in November
and December, 2003 and in satisfaction of accrued interest on certain of the
Company's 5.0% Convertible Subordinated Debentures issued in 1998 and 1999.
Each of the holders of the Convertible 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 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.
The Company filed a Current Report on Form 8-K dated February 10,
2004 relating to the Company's private offering of $12.3 million of
Convertible Senior Secured Debentures.
The Company filed a Current Report on Form 8-K dated March 25, 2004
relating to the sale of the Company's Congers, New York assets.
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 14, 2004 HALSEY DRUG CO., INC.
By: /s/ Andrew D. Reddick
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Andrew D. Reddick
President & Chief Executive Officer
By: /s/ Peter A. Clemens
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Peter A. Clemens
Senior Vice President & Chief Financial Officer
EXHIBIT INDEX
Exhibit Document
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31.1 Certification of Periodic Report by Chief Executive Officer pursuant
to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934
31.2 Certification of Periodic Report by Chief Financial Officer pursuant
to Rule 13a-14 and 15d-14 of the Securities Exchange Act of 1934
32.1 Certification of Periodic Report by Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Periodic Report by Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002