AKORN INC - 10-Q Quarterly Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002

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

FOR THE TRANSITION PERIOD FROM TO

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COMMISSION FILE NUMBER: 0-13976

AKORN, INC.
(Exact Name of Registrant as Specified in its Charter)

LOUISIANA 72-0717400
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

2500 MILLBROOK DRIVE
BUFFALO GROVE, ILLINOIS 60089
(Address of Principal Executive Offices) (Zip Code)

(847) 279-6100
(Registrant's telephone number)

Indicate by check mark whether the issuer (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 [ ] No [X]

Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act)

Yes [ ] No [X]

At May 12, 2003 there were 19,729,759 shares of common stock, no par
value, outstanding.

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PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements (Unaudited)
Page
-----
Condensed Consolidated Balance Sheets-September 30, 2002
and December 31, 2001................................. 2

Condensed Consolidated Statements of Operations-Three and nine
months ended September 30, 2002 and 2001 (Restated)... 3

Condensed Consolidated Statements of Cash Flows-
Nine months ended September 30, 2002 and 2001
(Restated)........................................... 4

Notes to Condensed Consolidated Financial Statements........ 5

ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................... 17

ITEM 3. Quantitative and Qualitative Disclosures about Market
Risk.................................................. 25

ITEM 4. Controls and Procedures............................... 25

PART II. OTHER INFORMATION

ITEM 1. Legal Proceedings..................................... 26

ITEM 2. Changes in Securities and Use of Proceeds............. 28

ITEM 3. Default Upon Senior Securities........................ 28

ITEM 4. Submission of Matters to a Vote of Security Holders... 28

ITEM 5. Other Information..................................... 28

ITEM 6. Exhibits and Reports on Form 8-K...................... 28

AKORN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
IN THOUSANDS
(UNAUDITED)

See notes to condensed consolidated financial statements.

2

AKORN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
IN THOUSANDS, EXCEPT PER SHARE DATA
(UNAUDITED)

See notes to condensed consolidated financial statements.

3

AKORN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
IN THOUSANDS
(UNAUDITED)

See notes to condensed consolidated financial statements.

4

AKORN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE A - BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements
include the accounts of Akorn, Inc. and its wholly owned subsidiary Akorn (New
Jersey), Inc.(collectively, the "Company"). Intercompany transactions and
balances have been eliminated in consolidation. These financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and accordingly do
not include all the information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial
statements.

The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. Accordingly, the financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern. The Company has experienced losses from operations for the nine
months ended September 30, 2002 of $1.4 million and for the years ended December
31, 2001 and 2000 of $21.1 million and $3.6 million, respectively, and has a
working capital deficiency of $28.2 million as of September 30, 2002.

As described more fully herein, the Company has had three consecutive
years of operating losses (including the projected losses in 2002), is in
default under its existing credit agreement and is a party to governmental
proceedings and potential claims by the Food and Drug Administration ("FDA")
that could have a material adverse effect on the Company. Although the Company
has entered into a Forbearance Agreement (as defined below) with its senior
lenders, is working with the FDA to favorably resolve such proceeding, has
appointed a new interim chief executive officer and implemented other management
changes and has taken steps to return to profitability, there is substantial
doubt about the Company's ability to continue as a going concern. The Company's
ability to continue as a going concern is dependent upon its ability to (i)
continue to finance its current cash needs, (ii) continue to obtain extensions
of the Forbearance Agreement, (iii) successfully resolve the ongoing
governmental proceeding with the FDA and (iv) ultimately refinance its senior
bank debt and obtain new financing for future operations and capital
expenditures. If it is unable to do so, it may be required to seek protection
from its creditors under the federal bankruptcy code.

While there can be no guarantee that the Company will be able to
continue to finance its current cash needs, the Company generated positive cash
flow from operations in 2002. In addition, as of April 30, 2003, the Company had
approximately $400,000 in cash and equivalents and approximately $1.4 million of
undrawn availability under its second line of credit described below.

There can also be no guarantee that the Company will successfully
resolve the ongoing governmental proceedings with the FDA. However, the Company
has submitted to the FDA and begun to implement a plan for comprehensive
corrective actions at its Decatur, Illinois facility.

Moreover, there can be no guarantee that the Company will be successful
in obtaining further extensions of the Forbearance Agreement or in refinancing
the senior debt and obtaining new financing for future operations. However, the
Company is current on its interest payment obligations to its senior lenders,
management believes that the Company has a good relationship with its senior
lenders and, as required, the Company has retained a consulting firm, submitted
a restructuring plan and engaged an investment banker to assist in raising
additional financing and explore other strategic alternatives for repaying the
senior bank debt. The Company has also added key management personnel, including
the appointment of a new interim chief executive officer, and additional
personnel in critical areas, such as quality assurance. Management has reduced
the Company's cost structure, improved the Company's processes and systems and
implemented strict controls over capital spending. Management believes these
activities have improved the Company's profitability and cash flow from
operations and improve its prospects for refinancing its senior debt and
obtaining additional financing for future operations.

As a result of all of the factors cited in the preceding paragraphs,
management of the Company believes that the Company should be able to sustain
its operations and continue as a going concern. However, the ultimate outcome of
this uncertainty cannot be presently determined and, accordingly, there remains
substantial doubt as to whether the Company will be able to continue as a going
concern. Further, even if the Company's efforts to raise additional financing
and explore other strategic alternatives result in a transaction that repays the
senior bank debt, there can be no assurance that the current common stock will
have any value following such a transaction. In particular, if any new financing
is obtained, it likely will require the granting of rights, preferences or
privileges senior to those of the common stock and result in substantial
dilution of the existing ownership interests of the common stockholders.

As discussed in Note G -- "Financing Arrangements", the Company has
significant borrowings which require, among other things, compliance with
various covenants. The borrowings are incurred primarily under an amended and
restated revolving credit agreement (the "Credit Agreement").

On September 16, 2002, the Company was notified by its senior lenders that
it was in default due to failure to pay the principal and interest owed as of
August 31, 2002 under the then most recent extension of the Credit Agreement.
The senior lenders also notified the Company that they would forbear from
exercising their remedies under the Credit Agreement until January 3, 2003 (as
indicated below, subsequently extended to June 30, 2003) if a forbearance
agreement could be reached. On September 20, 2002, the Company and its senior
lenders entered into an agreement under which the senior lenders would agree to
forbear from exercising their remedies (the "Forbearance Agreement") and the
Company acknowledged its current default. The Forbearance Agreement provides a
second line of credit allowing the Company to borrow the lesser of (i) the
difference between the Company's outstanding indebtedness to the senior lenders
and $39,200,000, (ii) the Company's borrowing base and (iii) $1,750,000, to fund
the Company's day-to-day operations. The Forbearance Agreement provides for
certain additional restrictions on operations and additional reporting
requirements. The Forbearance Agreement also requires automatic application of
cash from the Company's operations to repay borrowings under the new revolving
loan, and to reduce the Company's other obligations to the senior lenders.

The Company, as required in the Forbearance Agreement, agreed to provide
the senior lenders with a plan for restructuring its financial obligations on or
before December 1, 2002, and agreed to retain a consulting firm by September 27,
2002 to assist in the development and execution of this restructuring plan and,
in furtherance of that commitment, on September 26, 2002, the Company entered
into an agreement (the "Consulting Agreement") with a consulting firm (AEG
Partners, LLC (the "Consultant")) whereby the Consultant would assist in the
development and execution of this restructuring plan and provide oversight and
direction to the Company's day-to-day operations. On November 18, 2002, the
Consultant notified the Company of its intent to resign from the engagement
effective December 2, 2002, based upon the Company's alleged failure to
cooperate with the Consultant, in breach of the Consulting Agreement. The
Company's senior lenders, upon learning of the Consultant's action, notified the
Company by letter dated November 18, 2002, that, as a result of the Consultant's
resignation, the Company was in default under terms of the Forbearance Agreement
and the Credit Agreement and demanded payment of all outstanding principal and
interest on the loan. This notice was followed by a second letter dated November
19, 2002, in which the senior lenders gave notice of their exercise of certain
remedies available under the Credit Agreement including, but not limited to,
their setting off the Company's deposits with the senior lender against the
Company's obligations to the senior lenders. The Company immediately entered
into discussions with the Consultant which led, on November 21, 2002, to the
Consultant rescinding its notification of resignation and to the senior lenders
withdrawing their demand for payment and restoring the Company's accounts.

During the Company's discussions with the Consultant, the Company agreed to
establish a special committee of the Board (the "Corporate Governance
Committee") consisting of Directors Ellis and Bruhl,
with Mr. Ellis serving as Chairman. The Consultant will interface with the
Corporate Governance Committee regarding the Company's restructuring actions.
The Company also agreed that the Consultant will oversee the Company's
interaction with all regulatory agencies including, but not limited to, the FDA.
In addition, the Company has agreed to a "success fee" arrangement with the
Consultant. Under terms of the arrangement, if the Consultant is successful in
obtaining an extension to January 1, 2004 or later on the Company's senior debt,
the Consultant will be paid a cash fee equal to 1 1/2% of the amount of the
senior debt which is refinanced or restructured. Additionally, the success fee
arrangement provides that the Company will issue 1,250,000 warrants to purchase
common stock at an exercise price of $1.00 per warrant share to the Consultant
upon the date on which each of the following conditions have been met or waived
by the Company: (i) the Forbearance Agreement shall have been terminated, (ii)
the Consultant's engagement pursuant to the Consulting Agreement shall have been
terminated and (iii) the Company shall have executed a new or restated
multi-year credit facility. All unexercised warrants shall expire on the fourth
anniversary of the date of issuance.

As required by the Forbearance Agreement, a restructuring plan was
developed by the Company and the Consultant and presented to the Company's
senior lenders in December 2002. The restructuring plan requested that the
senior lenders convert the Company's senior debt to a term note that would
mature no earlier than February 2004 and increase the current line of credit
from $1.75 million to $3 million to fund operations and capital expenditures. In
light of the FDA's re-inspection of the Decatur facility in early December 2002,
the Company and the senior lenders agreed to defer further discussions of that
request until completion of the re-inspection and the Company's response
thereto. As a result, the senior lenders have agreed to successive short-term
extensions of the Forbearance Agreement, the latest of which is an eleventh
amendment to the Forbearance Agreement expiring on June 30, 2003. Following
completion of the FDA inspection of the Decatur facility on February 6, 2003 and
issuance of the FDA findings, the senior lenders have indicated that they are
not willing to convert the senior debt to a term loan but discussions continue
regarding a possible increase in the revolving line of credit. As required by
the Company's senior lenders, on May 9, 2003, the Company engaged Leerink Swann,
an investment banking firm, to assist in raising additional financing and
explore other strategic alternatives for repaying the senior bank debt. Subject
to the absence of any additional defaults and subject to the senior lenders'
satisfaction with the Company's progress in resolving the matters raised by the
FDA and in obtaining additional financing and exploring other strategic
alternatives, the Company expects to continue obtaining short-term extensions of
the Forbearance Agreement. However, there can be no assurance that the Company
will be successful in obtaining further extensions of the Forbearance Agreement
beyond June 30, 2003.

The Company is also a party to a governmental proceeding by the FDA (See
Note N -- "Legal Proceedings"). While the Company is cooperating
with the FDA and seeking to resolve the pending matter, an unfavorable outcome
in such proceeding may have a material impact on the Company's operations and
its financial condition, results of operations and/or cash flows and,
accordingly, may constitute a material adverse action that would result in a
covenant violation under the Credit Agreement.

In the event that the Company is not in compliance with the Credit
Agreement covenants and does not negotiate amended covenants or obtain a waiver
thereof, then the senior lenders, at their option, may demand immediate payment
of all outstanding amounts due and exercise any and all available remedies,
including, but not limited to, foreclosure on the Company's assets.

5

The Company adopted Emerging Issues Task Force Abstract ("EITF") No.
01-9 "Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor's Products)" as of January 1, 2002 and now presents the
cost related to group purchasing organization administration fees as a reduction
of revenue as opposed to selling, general and administrative expenses. 2001
amounts have been reclassified to conform with that of the 2002 presentation.
For the three and nine months ended September 30, 2002, these costs amounted to
$235,000 and $625,000, respectively. For the three and nine months ended
September 30, 2001, these costs amounted to $150,000 and $619,000, respectively

In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three and nine month periods ended September
30,2002, are not necessarily indicative of the results that may be expected for
a full year. For further information, refer to the consolidated financial
statements and footnotes for the year ended December 31, 2001, included in the
Company's Annual Report on Form 10 K/A, Amendment No. 2.

NOTE B - USE OF ESTIMATES

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ materially
from those estimates. Significant estimates and assumptions relate to the
allowance for doubtful accounts, the allowance for chargebacks, the allowance
for rebates, the reserve for slow-moving and obsolete inventory, the allowance
for product returns, the allowance for discounts, the carrying value of
intangible assets and the carrying value of deferred tax assets.

NOTE C - ACCOUNTS RECEIVABLE ALLOWANCES

In May 2001, the Company completed an analysis of its March 31, 2001
allowance for chargebacks and rebates. In performing such analysis, the Company
utilized recently obtained reports of wholesaler's inventory information, which
had not been previously obtained or utilized. Based on the wholesaler's March
31, 2001 inventories and historical chargeback and rebate activity, the Company
recorded an allowance of $6,961,000, which resulted in an expense of $12,000,000
for the three months ended March 31, 2001, as compared to an allowance of
$3,296,000 at December 31, 2000. The expense for the three months ended March
31, 2002 was $4,076,000.

During the quarter ended June 30, 2001, the Company further refined its
estimates of the chargeback and rebate liability. The expense for chargebacks
during the three month period ended June 30, 2002 and 2001 was $3,478,000 and
$7,320,000, respectively. The increase to the allowance reflected the continuing
shift of sales to customers who purchase their products through group purchasing
organizations and buying groups.

For the three and nine month periods ended September 2001, the Company
recorded a reduction of gross sales of $4,755,000 and $24,075,000, respectively,
related to chargebacks and rebates. This compares to a reduction of gross sales
for the three and nine months ended September 30, 2002 of $4,693,000 and
$12,247,000, respectively.

Based on the wholesalers' inventory information, the Company also
increased its allowance for potential product returns to $446,000 at September
30, 2001 from $232,000 at December 31, 2000. The reduction of gross sales
related to returns for the three and nine months ended September 30, 2001 was
$339,000 and $3,184,000, respectively. This compares to a reduction of gross
sales related to returns for the three and nine months ended September 30, 2002
of $790,000 and $1,822,000, respectively.

6

Based upon its unsuccessful efforts to collect past due balances, the
Company increased the allowance for doubtful accounts to $10,365,000 at
September 30, 2001 from $8,321,000 at December 31, 2000. The provision for bad
debts recorded in the three and nine month period ended September 30, 2001 was
$60,000 and $4,670,000, respectively. The Company recorded provision
(recovery) for bad debts of $370,000 and ($30,000) for the three and nine months
ended September 30, 2002, respectively. The allowance for doubtful accounts is
$1,318,000 as of September 30, 2002.

NOTE D - INVENTORY

The components of inventory are as follows (in thousands):

SEPTEMBER 30, DECEMBER 31,
2002 2001
---- ----

Finished goods ............... $ 3,589 $ 2,906
Work in process .............. 1,761 1,082
Raw materials and supplies.... 5,252 4,147
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$10,602 $ 8,135
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Inventory at September 30, 2002 and December 31, 2001 is reported net
of reserves for slow-moving, unsalable and obsolete items of $1,647,000 and
$1,845,000, respectively. For the nine months ended September 30, 2002 and 2001,
the Company recorded expenses of $493,000 and $1,830,000 respectively, related
to slow moving, unsalable and obsolete inventory. There was no expenses recorded
in the third quarter of 2002 or 2001.

NOTE E - INTANGIBLE ASSETS

Intangible assets consist primarily of product licensing and other
such costs that are capitalized and amortized on the straight-line method over
the lives of the related license periods or the estimated life of the acquired
product, which range from 17 months to 18 years. Accumulated amortization at
September 30, 2002 and December 31, 2001 was $8,062,000 and $7,132,000,
respectively. The Company annually assesses the impairment of intangibles based
on several factors, including estimated fair market value and anticipated cash
flows. On July 3, 2002, the Company settled a License Agreement dispute with
The Johns Hopkins University, Applied Physics Laboratory ("JHU/APL") (See Note
N--"Legal Proceedings") on two licensed patents. As a result of the resolved
dispute, the Company recorded an asset impairment charge of $1,559,500 in the
second quarter of 2002, representing the net value of the asset recorded on the
balance sheet of the Company less the $300,000 payment abated by JHU/APL and
the $125,000 payment received from JHU/APL. During the third quarter of 2002,
the Company recorded an impairment charge related to four intangible assets
with a gross carrying value of $383,000 (See Note H). The Company recorded an
impairment charge during the second quarter of 2002 related to an intangible
asset with gross carrying amount of $1,985,000 (See Note H, Note N and Note Q).
The Company has no goodwill or other similar asset with indefinite lives
currently recorded on its balance sheet. A summary of the Company's acquired
amortizable intangible assets as of September 30, 2002 is as follows (in
thousands):

AS OF SEPTEMBER 30, 2002
------------------------
GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION AMOUNT
------ ------------ ------

Product Licenses................................................... $ 22,685 $ 8,188 $ 14,497

The amortization expense of the above-listed acquired intangible assets
for each of the five years ending December 31, 2006 will be as follows (in
thousands):

For the year ended 12/31/02 (a)................ $ 1,411
For the year ended 12/31/03.................... 1,397
For the year ended 12/31/04.................... 1,382
For the year ended 12/31/05.................... 1,335
For the year ended 12/31/06.................... 1,282

(a) Amortization expense for the nine months ended September 30, 2002
amounted to $1,057,000.

7

NOTE F - PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment consists of the following (in thousands):

SEPTEMBER 30, DECEMBER 31,
2002 2001
---- ----

Land ........................................................................... $ 396 $ 396
Buildings and leasehold improvements ........................................... 8,256 8,208
Furniture and equipment ........................................................ 26,694 25,724
Automobiles .................................................................... 55 55
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35,401 34,383
Accumulated depreciation........................................................ (18,780) (16,440)
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16,621 17,943
Construction in progress........................................................ 18,657 15,575
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$ 35,278 $ 33,518
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Construction in progress represents capital expenditures principally
related to the Company's lyophilization project that will enable the Company to
perform processes in-house, which are currently being performed by a
sub-contractor. Subject to the Company's ability to refinance its senior debt
and obtain new financing for future operations and capital expenditures, the
Company anticipates completion of the lyophilization project in the second half
of 2004. The Company capitalized interest expense related to the lyophilization
project of $303,000 and $847,000 during the three and nine month periods ended
September 30, 2002, respectively and $313,000 and $834,000 during the three and
nine month periods ended September 30, 2001. In the third quarter of 2002, the
Company recorded a charge of $545,000 to write off abandoned construction
projects and dispose of certain other fixed assets. The charge is included in
selling, general and administrative expenses on the consolidated statement of
operations.

NOTE G - FINANCING ARRANGEMENTS

In December 1997, the Company entered into a $15,000,000 revolving Credit
Agreement with The Northern Trust Company, which was increased to $25,000,000 on
June 30, 1998 and to $45,000,000 on December 28, 1999. This Credit Agreement is
secured by substantially all of the assets of the Company and its subsidiaries
and contains a number of restrictive covenants. There were outstanding
borrowings of $39,200,000 and $44,800,000 at September 30, 2002 and December 31,
2002, respectively. The interest rate as of September 30, 2002 was 7.25%.

On April 16, 2001, the Credit Agreement was amended (the "2001 Amendment")
and included, among other things, extension of the term of the agreement,
establishment of a payment schedule, revision of the method by which the
interest rate was to be determined, and the amendment and addition of certain
covenants. The 2001 Amendment also required the Company to obtain subordinated
debt of $3 million by May 15, 2001 and waived certain covenant violations
through March 31, 2001. The 2001 Amendment required payments throughout 2001
totaling $7.5 million, with the balance of $37.5 million due January 1, 2002.
The method used to calculate interest was changed to the prime rate plus 300
basis points. Previously, the interest rate was computed at the federal funds
rate or LIBOR plus an applicable percentage, depending on certain financial
ratios.

On July 12, 2001, the Company entered into a forbearance agreement (the
"Prior Agreement") with its senior lenders under which the lenders agreed to
forbear from taking action against the Company to enforce their rights under the
then existing Credit Agreement until January 2, 2002. As part of the Prior
Agreement, the Company acknowledged the existence of certain events of default.
These events included a default on a $1.3 million principal payment, failure to
timely make monthly interest payments due on May 31, 2001 and June 30, 2001
(these interest payments were subsequently made on July 27, 2001) and failure to
receive $3.0 million of cash proceeds of subordinated debt by May 15, 2001
(these proceeds were subsequently received on July 13, 2001).

8

The Company received two extensions, which extended the Prior Agreement to
February 1, 2002 and March 15, 2002, respectively. Both of these extensions
carried the same reporting requirements and covenants while establishing new
cash receipts covenants for the months of January and February in 2002.

On April 12, 2002, in lieu of further extending the Prior Agreement, the
Company entered into an amendment to the Credit Agreement (the "2002
Amendment"), effective January 1, 2002. The 2002 Amendment included, among other
things, extension of the term of the agreement, establishment of a payment
schedule and the amendment and addition of certain covenants. The new covenants
include minimum levels of cash receipts, limitations on capital expenditures, a
$750,000 per quarter limitation on product returns and required amortization of
the loan principal. The agreement also prohibits the Company from declaring any
cash dividends on its common stock and identifies certain conditions in which
the principal and interest on the Credit Agreement would become immediately due
and payable. These conditions include: (a) an action by the FDA which results in
a partial or total suspension of production or shipment of products, (b) failure
to invite the FDA in for re-inspection of the Decatur manufacturing facilities
by June 1, 2002, (c) failure to make a written response, within 10 days, to the
FDA, with a copy to the lender, to any written communication received from the
FDA after January 1, 2002 that raises any deficiencies, (d) imposition of fines
against the Company in an aggregate amount greater than $250,000, (e) a
cessation in public trading of the Company's stock other than a cessation of
trading generally in the United States securities market, (f) restatement of or
adjustment to the operating results of the Company in an amount greater than
$27,000,000, (g) failure to enter into an engagement letter with an investment
banker for the underwriting of an offering of equity securities by June 15,
2002, (h) failure to not be party to an engagement letter at any time after June
15, 2002 or (i) experience any material adverse action taken by the FDA, the
SEC, the DEA or any other governmental authority based on an alleged failure to
comply with laws or regulations. The Credit Agreement required a minimum payment
of $5.6 million, which relates to an estimated federal tax refund, with the
balance of $39.2 million due June 30, 2002. The Company remitted the $5.6
million payment on May 8, 2002. The Company is also obligated to remit any
additional federal tax refunds received above the estimated $5.6 million.

The Company's senior lenders agreed to extend the Credit Agreement, as
amended, to July 31, 2002 and then again to August 31, 2002. These two
extensions contain the same covenants and reporting requirements except that the
Company is not required to comply with conditions (g) and (h) which relate to
the offering of equity securities. In both instances, the balance of $39.2
million was due at the end of the extension term.

On September 16, 2002, the Company was notified by its senior lenders that
it was in default due to failure to pay the principal and interest owed as of
August 31, 2002 under the then most recent extension of the Credit Agreement.
The senior lenders also notified the Company that they would forbear from
exercising their remedies under the Credit Agreement until January 3, 2003 if a
forbearance agreement could be reached.

On September 20, 2002, the Company and its senior lenders entered into a
Forbearance Agreement under which the senior lenders would agree to forbear from
exercising their remedies and the Company acknowledged its current default. The
Forbearance Agreement provides a second line of credit allowing the Company to
borrow the lesser of (i) the difference between the Company's outstanding
indebtedness to the senior lenders and $39,200,000, (ii) the Company's borrowing
base and (iii) $1,750,000, to fund the Company's day-to-day operations. The
Forbearance Agreement requires that, except for then existing defaults, the
Company continue to comply with all of the covenants in the Credit Agreement and
provides for certain additional restrictions on operations and additional
reporting requirements. The Forbearance Agreement also requires automatic
application of cash from the Company's operations to repay borrowings under the
new revolving loan, and to reduce the Company's other obligations to the senior
lenders.

The Company, as required in the Forbearance Agreement, agreed to provide
the senior lenders with a plan for restructuring its financial obligations on or
before December 1, 2002, and agreed to retain a consulting firm by September 27,
2002 to assist in the development and execution of this restructuring plan and,
in furtherance of that commitment, on September 26, 2002, the Company entered
into the Consulting Agreement

9

with the Consultant whereby the Consultant would assist in the development and
execution of this restructuring plan and provide oversight and direction to the
Company's day-to-day operations. On November 18, 2002, the Consultant notified
the Company of its intent to resign from the engagement effective December 2,
2002, based upon the Company's alleged failure to cooperate with the Consultant,
in breach of the Consulting Agreement. The Company's senior lenders, upon
learning of the Consultant's action, notified the Company by letter dated
November 18, 2002, that, as a result of the Consultant's resignation, the
Company was in default under terms of the Forbearance Agreement and the Credit
Agreement and demanded payment of all outstanding principal and interest on the
loan. This notice was followed by a second letter dated November 19, 2002, in
which the senior lenders gave notice of their exercise of certain remedies
available under the Credit Agreement including, but not limited to, their
setting off the Company's deposits with the senior lenders against the Company's
obligations to the senior lenders. The Company immediately entered into
discussions with the Consultant which led, on November 21, 2002, to the
Consultant rescinding its notification of resignation and to the senior lenders
withdrawing their demand for payment and restoring the Company's accounts.

During the Company's discussions with the Consultant, the Company agreed to
establish the Corporate Governance Committee consisting of Directors Ellis and
Bruhl, with Mr. Ellis serving as Chairman. The Consultant will interface with
the Corporate Governance Committee regarding the Company's restructuring
actions. The Company also agreed that the Consultant will oversee the Company's
interaction with all regulatory agencies including, but not limited to, the FDA.
In addition, the Company has agreed to a "success fee" arrangement with the
Consultant. Under terms of the arrangement, if the Consultant is successful in
obtaining an extension to January 1, 2004 or later on the Company's senior debt,
the Consultant will be paid a cash fee equal to 1 1/2% of the amount of the
senior debt which is refinanced or restructured. Additionally, the success fee
arrangement provides that the Company will issue 1,250,000 warrants to purchase
common stock at an exercise price of $1.00 per warrant share to the Consultant
upon the date on which each of the following conditions have been met or waived
by the Company: (i) the Forbearance Agreement shall have been terminated, (ii)
the Consultant's engagement pursuant to the Consulting Agreement shall have been
terminated and (iii) the Company shall have executed a new or restated
multi-year credit facility. All unexercised warrants shall expire on the fourth
anniversary of the date of issuance.

As required by the Forbearance Agreement, a restructuring plan was
developed by the Company and the Consultant and presented to the Company's
senior lenders in December 2002. The restructuring plan requested that the
senior lenders convert the Company's senior debt to a term note that would
mature no earlier than February 2004 and increase the current line of credit
from $1.75 million to $3 million to fund operations and capital expenditures. In
light of the FDA's re-inspection of the Decatur facility in early December 2002,
the Company and the senior lenders agreed to defer further discussions of that
request until completion of the re-inspection and the Company's response
thereto. As a result, the senior lenders have agreed to successive short-term
extensions of the Forbearance Agreement, the latest of which is an eleventh
amendment to the Forbearance Agreement expiring on June 30, 2003. Following
completion of the FDA inspection of the Decatur facility on February 6, 2003 and
issuance of the FDA findings, the senior lenders have indicated that they are
not willing to convert the senior debt to a term loan but discussions continue
regarding a possible increase in the revolving line of credit. As required by
the Company's senior lenders, on May 9, 2003, the Company engaged Leerink Swann
as an investment banking firm, to assist in raising additional financing and
explore other strategic alternatives for repaying the senior bank debt. Subject
to the absence of any additional defaults and subject to the senior lenders'
satisfaction with the Company's progress in resolving the matters raised by the
FDA and in obtaining additional financing and exploring other strategic
alternatives, the Company expects to continue obtaining short-term extensions of
the Forbearance Agreement. However, the can be no assurances that the Company
will be successful in obtaining further extensions of the Forbearance Agreement
beyond June 30, 2003.

The Company is also a party to governmental proceedings by the FDA (See
Note N -- "Legal Proceedings"). While the Company is cooperating with the FDA
and seeking to resolve the pending matter, an unfavorable outcome in such
proceeding may have a material impact on the Company's operations

and its financial condition, results of operations and/or cash flows and,
accordingly, may constitute a material adverse action that would result in a
covenant violation under the Credit Agreement.

In the event that the Company is not in compliance with the Credit
Agreement covenants and does not negotiate amended covenants or obtain a waiver
thereof, then the senior lenders, at their option, may demand immediate payment
of all outstanding amounts due and exercise any and all available remedies,
including, but not limited to, foreclosure on the Company's assets.

On July 12, 2001 as required under the terms of the Prior Agreement, the
Company entered into a $5,000,000 subordinated debt transaction with the John N.
Kapoor Trust dtd. 9/20/89 (the "Trust"), the sole trustee and sole beneficiary
of which is Dr. John N. Kapoor, the Company's Chairman of the Board of
Directors. The transaction is evidenced by a Convertible Bridge Loan and Warrant
Agreement (the "Trust Agreement") in which the Trust agreed to provide two
separate tranches of funding in the amounts of $3,000,000 ("Tranche A" which was
received on July 13, 2001) and $2,000,000 ("Tranche B" which was received on
August 16, 2001). As part of the consideration provided to the Trust for the
subordinated debt, the Company issued the Trust two warrants which allow the
Trust to purchase 1,000,000 shares of common stock at a price of $2.85 per share
and another 667,000 shares of common stock at a price of $2.25 per share. The
exercise price for each warrant represented a 25% premium over the share price
at the time of the Trust's commitment to provide the subordinated debt. All
unexercised warrants expire on December 20, 2006.

Under the terms of the Trust Agreement, the subordinated debt bears
interest at prime plus 3%, which is the same rate the Company pays on its senior
debt. Interest cannot be paid to the Trust until the repayment of the senior
debt pursuant to the terms of a subordination agreement, which was entered into
between the Trust and the Company's senior lenders. Should the subordination
agreement be terminated, interest may be paid sooner. The convertible feature of
the Trust Agreement, as amended, allows for conversion of the subordinated debt
plus interest into common stock of the Company, at a price of $2.28 per share of
common stock for Tranche A and $1.80 per share of common stock for Tranche B.

The Company, in accordance with Accounting Principles Board ("APB") Opinion
No. 14, recorded the subordinated debt transaction such that the convertible
debt and warrants have been assigned independent values. The fair value of the
warrants was estimated on the date of grant using the Black-Scholes option
pricing model with the following assumptions: (i) dividend yield of 0%, (ii)
expected volatility of 79%, (iii) risk free rate of 4.75%, and (iv) expected
life of 5 years. As a result, the Company assigned a value of $1,516,000 to the
warrants and recorded this amount as additional paid in capital. In accordance
with EITF Abstract No. 00-27, the Company has also computed and recorded a value
related to the "intrinsic" value of the convertible debt. This calculation
determines the value of the embedded conversion option within the debt that has
become beneficial to the owner as a result of the application of APB Opinion No.
14. This value was determined to be $1,508,000 and was recorded as additional
paid in capital. The remaining $1,976,000 was recorded as long-term debt. The
resultant debt discount of $3,024,000, equivalent to the value assigned to the
warrants and the "intrinsic" value of the convertible debt, is being amortized
and charged to interest expense over the life of the subordinated debt.

In December 2001, the Company entered into a $3,250,000 five-year loan with
NeoPharm, Inc. ("NeoPharm") to fund the Company's efforts to complete its
lyophilization facility located in Decatur, Illinois. Under the terms of the
Promissory Note, dated December 20, 2001, interest accrues at the initial rate
of 3.6% and will be reset quarterly based upon NeoPharm's average return on its
cash and readily tradable long and short-term securities during the previous
calendar quarter. The principal and accrued interest is due and payable on or
before maturity on December 20, 2006. The note provides that the Company will
use the proceeds of the loan solely to validate and complete the lyophilization
facility located in Decatur, Illinois. The Promissory Note is subordinated to
the Company's senior debt but is senior to the Company's subordinated debt owed
to the Trust. The note was executed in conjunction with a Processing Agreement
that provides NeoPharm with the option of securing at least 15% of the capacity
of the Company's lyophilization facility each year. Dr. John N. Kapoor, the
Company's chairman is also chairman of NeoPharm and holds a substantial stock
position in NeoPharm as well as in the Company.

Contemporaneous with the completion of the Promissory Note between the
Company and NeoPharm, the Company entered into an agreement with the Trust,
which amended the Trust Agreement. The amendment extended the Trust Agreement to
terminate concurrently with the Promissory Note on December 20, 2006. The
amendment also made it possible for the Trust to convert the interest accrued on
the $3,000,000 tranche into common stock of the Company. Previously, the Trust
could only convert the interest accrued on the $2,000,000 tranche. The terms of
the agreement to change the convertibility of the Tranche A interest and the
convertibility of the Tranche B interest for the extension of the term require
shareholder approval to be received by August 31, 2002, which was subsequently
extended to June 30, 2003. If the Company's shareholders do not approve these
changes, the Company would be in default under the Trust Agreement and, at the
option of the Trust; the Subordinated Debt could be accelerated and become due
and payable on June 30, 2003. Any default under the Trust Agreement would
constitute an event of default under both the Credit Agreement and the Neopharm
Promissory Note. In the event of default, amounts due under the Credit Agreement
and the Neopharm Promissory Note could be declared to be due and payable,
notwithstanding the Forbearance Agreement which is presently in place between
the Company and its senior lender. The Company expects that it will reach
agreement with the Trust to extend, if necessary, the shareholder approval date
until the next shareholders' meeting.

In June 1998, the Company entered into a $3,000,000 mortgage agreement with
Standard Mortgage Investors, LLC of which there were outstanding borrowings of
$1,917,000 and $2,189,000 at December 31, 2002 and 2001, respectively. The
principal balance is payable over 10 years, with the final payment due in June
2007. The mortgage note bears an interest rate of 7.375% and is secured by the
real property located in Decatur, Illinois.

NOTE H - INTANGIBLE ASSET IMPAIRMENT

During the third quarter of 2002, the Company recorded an impairment
charge of $257,000 related to the product license intangible assets for the
products Sublimaze, Inapsine, Paredrine and Dry Eye Test. The Company determined
that projected profitability on the products was not sufficient to support the
carrying value of the intangible asset. The recording of this charge reduced the
carrying value of the intangible assets related to these product licenses to
zero. This charge is reflected in the selling, general and administrative
expense category of the condensed, consolidated statement of operations.

On July 3, 2002, the Company and The John Hopkins University, Applied
Physics Laboratory ("JHU/APL") mutually agreed to terminate their license
agreement. As a result, the Company no longer has any rights to the JHU/APL
patent rights as defined in the License Agreement. In exchange for relinquishing
its rights to the JHU/APL patent rights, the Company received an abatement of
the $300,000 due to JHU/APL at March 31, 2002 and a payment of $125,000 to be
received by August 3, 2002. This $125,000 payment is considered an advance
towards cash payments due from JHU/APL and will be credited against any future
cash payments due the Company as a result of JHU/APL's licensing efforts. As a
result of the resolved dispute as discussed in Note N, the Company, in the
second quarter of 2002, recorded an asset impairment charge of $1,559,500,
representing the net value of the asset recorded on the balance sheet of the
Company as of the settlement date less the $300,000 payment abated by JHU/APL
and the $125,000 payment from JHU/APL (which was received on August 3, 2002).
The Company has a right to receive 15% of all cash payments and 20% of all
equity received by JHU/APL patent rights, less any cash or equity returned by
JHU/APL to such licensee. The combined total of all such cash and equity
payments are not to exceed $1,025,000. On October 8, 2002 JHU/APL notified Akorn
that the patent rights has been sold to a third party in exchange for equity and
possible future cash payments. Akorn will record its portion of these proceeds
upon realization of this gain contingency. See Note N to the condensed
consolidated financial statements for further information on the settlement with
JHU/APL.

In May 2001, the Company discontinued one of its products due to
uncertainty of product availability from a third-party manufacturer, rising
manufacturing costs and delays in obtaining FDA approval to manufacture the
product in-house. The Company recorded an asset impairment charge of $1,168,000
related to manufacturing equipment specific to the product and an asset
impairment charge of $139,000 related to the remaining balance of the product
acquisition intangible asset during the first quarter of 2001. These amounts are
included in selling, general and administrative expense in the condensed
consolidated statements of operations.

NOTE I - NONCASH TRANSACTIONS

In July 2001, the Company amended a license agreement with The Johns
Hopkins University, Applied Physics Laboratory ("JHU/APL"). As part of that
amendment, the Company delivered research and development equipment in lieu of a
$100,000 payment. The Company recorded a gain of $51,000 upon transfer of the
equipment.

In the first quarter of 2002, the Company received an equity ownership in
Novadaq Technologies, Inc., ("Novadaq"), of 4,000,000 common shares
(representing approximately 16.4% of the outstanding shares) as part of the
settlement between the Company and Novadaq (See Note N -- "Legal Proceedings").
The Company had previously advanced $690,000 to Novadaq for development costs
and recorded these advances as an intangible asset. Based on the settlement, the
Company has reclassified these advances as an Investment in Novadaq
Technologies, Inc. The Company has determined this investment should be valued
using the cost method as described in APB No. 18, "The Equity Method of
Accounting for Investments in Common Stock."

NOTE J - RESTRUCTURING CHARGES

During 2001, the Company adopted a restructuring program to properly
size its operations to then current business conditions. These actions were
designed to reduce costs and improve operating efficiencies. The program
included, among other items, severance of employees, plant-closing costs related
to the Company's San

10

Clemente, CA sales office and rent for unused facilities under lease in San
Clemente and Lincolnshire, IL. The restructuring, affecting all three business
segments, reduced the Company's workforce by 50 employees, primarily sales and
manufacturing related, representing 12.5% of the total workforce. Activities
previously executed in San Clemente have been relocated to the Company's
headquarters. The restructuring program costs are included in selling, general
and administrative expenses in the accompanying condensed consolidated statement
of operations and resulted in a charge to operations of approximately $1,117,000
consisting of severance costs of $398,000, lease costs of $625,000 and other
costs of $94,000. During the nine months ended September 30, 2002 the Company
paid $217,000 for severance costs and $139,000 for lease costs. At September 30,
2002, the amount remaining in the accruals for the restructuring program was
approximately $172,000, representing the remaining balance of lease commitments,
which expire in February 2003. At December 31, 2001, the amount remaining in the
accruals for the restructuring program was approximately $528,000.

NOTE K - NET LOSS PER COMMON SHARE

Basic net loss per common share is based upon weighted average common
shares outstanding. Diluted net income loss per common share is based upon the
weighted average number of common shares outstanding, including the dilutive
effect of stock options, warrants and convertible debt using the treasury stock
method.

The following table shows basic and diluted earnings per share
computations for the three and nine month periods ended September 30, 2002 and
September 30, 2001 (in thousands, except per share information):

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2002 2001 2002 2001
--------------------------------------------

Net loss per share - basic:
Net loss ............................................. $ (9,387) $ (536) $(10,018) $(15,187)
Weighted average number of shares outstanding ........ 19,610 19,300 19,567 19,301
-------- -------- -------- --------

Net loss per share - basic ................................ $ (0.48) $ (0.03) $ (0.51) $ (0.79)
======== ======== ======== ========

Net loss per share - diluted:
Net loss ............................................. $ (9,387) $ (536) $(10,018) $(15,187)
Net loss adjustment for interest on
convertible debt and convertible interest on debt... - - - -
-------- -------- -------- --------

Net loss, as adjusted ................................ $ (9,387) $ (536) $(10,018) $(15,187)

Weighted average number of shares outstanding ........ 19,610 19,300 19,567 19,301
Additional shares assuming conversion of
convertible debt and convertible interest on debt.. - - - -
Additional shares assuming conversion of warrants .... - - - -
Additional shares assuming conversion of options ..... - - - -
-------- -------- -------- --------
Weighted average number of shares
outstanding, as adjusted .......................... 19,610 19,300 19,567 19,301

Net loss per share - diluted .............................. $ (0.48) $ (0.03) $ (0.51) $ (0.79)
======== ======== ======== ========

Certain convertible debt, warrants and options are not included in the
earnings per share calculation when the exercise price is greater that the
average market price for the period. In addition, options outstanding during the
three and nine month periods ended September 30, 2002 and 2001 were not
considered in the computation of diluted earnings

11

per share since the Company reported a loss from operations. The number of
shares related to warrants, options and convertible debt excluded in each period
is reflected in the following table (in thousands).

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----

Anti-dilutive convertible debt and convertible interest on
debt not included in loss per share calculations........ 2,568 - 2,568 -
Anti-dilutive warrants not included
in loss per share calculations.......................... 1,667 - 1,667 -
Anti-dilutive options not included
in loss per share calculations.......................... 3,870 2,815 3,870 2,815

NOTE L - INDUSTRY SEGMENT INFORMATION

The Company classifies its operations into three business segments:
Ophthalmic, Injectable and Contract Services. The Ophthalmic segment
manufactures, markets and distributes diagnostic and therapeutic pharmaceuticals
and surgical instruments and related supplies. The Injectable segment
manufactures, markets and distributes injectable pharmaceuticals, primarily in
niche markets. The Contract Services segment manufactures products for third
party pharmaceutical and biotechnology customers based on their specifications.
The Company's basis of accounting in preparing its segment information is
consistent with that used in preparing its consolidated financial statements.

Selected financial information by industry segment is presented below
(in thousands).

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2002 2001 2002 2001
---- ---- ---- ----

REVENUES
Ophthalmic......................................... $ 7,734 $ 5,867 $ 21,520 $ 11,278
Injectable......................................... 3,203 2,574 11,401 6,030
Contract Services.................................. 1,184 4,251 6,808 11,628
------------ ----------- ------------ ------------
Total revenues.................................. $ 12,121 $ 12,692 $ 39,729 $ 28,936
============ =========== ============ ============

GROSS PROFIT (LOSS)
Ophthalmic......................................... $ 3,407 $ 2,355 $ 10,801 $ (1,206)
Injectable......................................... 1,514 1,210 5,904 (145)
Contract Services.................................. (465) 1,298 466 2,471
------------ ----------- ------------ ------------
Total gross profit (loss)....................... 4,456 4,863 17,171 1,120

Operating expenses................................. 6,472 4,716 18,521 22,830
------------ ----------- ------------ ------------
Total operating income (loss)................... (2,016) 147 (1,350) (21,710)

Interest and other income (expense), net........... (762) (1,012) (2,475) (2,684)
------------- ------------ ------------- -------------
Loss before income taxes........................ $ (2,778) $ (865) $ (3,825) $ (24,394)
============= ============ ============= =============

The Company manages its business segments to the gross profit level and
manages its operating costs on a company-wide basis. The Company does not
identify assets by segment for internal purposes.

12

NOTE M -- RESTATEMENT

Subsequent to the issuance of the Company's condensed consolidated
financial statements for the quarter ended September 30, 2001, management of the
Company determined that the Company had not adequately considered all of the
information available with respect to certain disputed receivables in
establishing its allowance for uncollectible accounts as of December 31, 2000
and that the $7,520,000 increase in its allowance for doubtful accounts that was
recognized during the three months ended March 31, 2001 should have been
recognized at December 31, 2000 and that bad debt expense for the years ended
December 31, 2000 and 2001 was understated and accounts receivable overstated,
respectively, by a corresponding amount.

In addition, management determined that the Company had not recognized the
$1,508,000 beneficial conversion feature embedded in the convertible notes
issued to The John N. Kapoor Trust in July 2001.

As a result, the Company's condensed consolidated financial statements
for the three and nine month periods ended September 30, 2001 have been restated
to appropriately account for these items. The following tables summarize the
significant effects of the restatements:

THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
------------------ ------------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
-------- ----------- -------- -----------

Provision for bad debts............ N/C N/C $ 12,190 $ 4,670
Interest expense................... $ (923) $ (1,015) (2,508) (2,600)
Loss before income taxes........... (773) (865) (31,822) (24,394)
Income tax provision benefit....... (294) (329) (12,091) (9,207)
Net loss........................... (479) (536) (19,731) (15,187)
Net loss per share:................
Basic............................ $ (0.02) $ (0.03) $ (1.02) $ (0.79)
Diluted.......................... $ (0.02) $ (0.03) $ (1.02) $ (0.79)

N/C - No Change

13

NOTE N - LEGAL PROCEEDINGS

On March 27, 2002, the Company received a letter informing it that the
staff of the SEC's regional office in Denver, Colorado, would recommend to the
SEC that it bring an enforcement action against the Company and seek an order
requiring the Company to be enjoined from engaging in certain conduct. The staff
alleged that the Company misstated its income for fiscal years 2000 and 2001 by
allegedly failing to reserve for doubtful accounts receivable and overstating
its accounts receivable balance as of December 31, 2000. The Company had
originally recorded a $7.5 million increase to the allowance for doubtful
accounts in its quarter ended March 31, 2001. The staff alleged that internal
control and books and records deficiencies prevented the Company from accurately
recording, reconciling and aging its accounts receivables. The Company also
learned that certain of its former officers, as well as a current employee had
received similar notifications. Subsequent to the issuance of the Company's
consolidated financial statements for the year ended December 31, 2001,
management of the Company determined it needed to restate the Company's
financial statements for 2000 and 2001 to record a $7.5 million increase to the
allowance for doubtful accounts as of December 31, 2000, which it had originally
recorded as of March 31, 2001. See Note Q -- "Subsequent Events".

The Company was party to a License Agreement with JHU/APL effective April
26, 2000, and amended effective July 15, 2001. Pursuant to the License
Agreement, the Company licensed two patents from JHU/APL for the development and
commercialization of a diagnosis and treatment for age-related macular
degeneration ("AMD") using Indocyanine Green ("ICG"). A dispute arose between
the Company and JHU/APL concerning the License Agreement. Specifically, JHU/APL
challenged the Company's performance required by December 31, 2001 under the
License Agreement and alleged that the Company was in breach of the License
Agreement. The Company denied JHU/APL's allegations and contended that it had
performed in accordance with the terms of the License Agreement. As a result of
the dispute, on March 29, 2002, the Company commenced a lawsuit in the U.S.
District Court for the Northern District of Illinois, seeking declaratory and
other relief against JHU/APL. On July 3, 2002, the Company reached an agreement
with JHU/APL with regard to the dispute that had risen between the two parties.
The Company and JHU/APL mutually agreed to terminate their license agreement. As
a result, the Company no longer has any rights to the JHU/APL patent rights as
defined in the License Agreement. In exchange for relinquishing its rights to
the JHU/APL patent rights, the Company received an abatement of the $300,000 due
to JHU/APL at March 31, 2002 and a payment of $125,000 to be received by August
3, 2002. The Company also has the right to receive 15% of all cash payments and
20% of all equity received by JHU/APL from any license of the JHU/APL patent
rights less any cash or equity returned by JHU/APL to such licensee. The
combined total of all such cash and equity payments are not to exceed
$1,025,000. The $125,000 payment is considered an advance towards cash payments
due from JHU/APL and will be credited against any future cash payments due the
Company as a result of JHU/APL's licensing efforts. As a result of the resolved
dispute discussed above, the Company recorded an asset impairment charge of
$1,559,500 in the second quarter of 2002. The impairment amount represents the
net value of the asset recorded on the balance sheet of the Company less the
$300,000 payment abated by JHU/APL and the $125,000 payment from JHU/APL. The
$125,000 payment was received on August 3, 2002. See Note Q -- "Subsequent
Events".

In October 2000, the FDA issued a warning letter to the Company following
the FDA's routine current Good Manufacturing Practices ("cGMPs") inspection of
the Company's Decatur manufacturing facilities. An FDA warning letter is
intended to provide notice to a company of violations of the laws administered
by the FDA. Its primary purpose is to elicit voluntary corrective action. The
letter warns that if voluntary action is not forthcoming, the FDA may use other
legal means to compel compliance. These include seizure of products and/or
injunction of the Company and responsible individuals. This letter addressed
several deviations from regulatory requirements including cleaning validations
and general documentation and requested corrective actions be undertaken by the
Company. The Company initiated corrective actions and responded to the warning
letter. Subsequently, the FDA conducted another inspection in late 2001 and
identified additional deviations from regulatory requirements, including
cleaning validations and process control issues. This led to the FDA leaving the
warning letter in place and issuing a Form 483 to document its findings. While
no further correspondence was received from the FDA, the Company responded to
the inspectional findings. This response described the Company's plan for
addressing the issues raised by the FDA and included improved cleaning
validation, enhanced process controls and approximately $2.0 million of capital
improvements. In August 2002, the FDA conducted an inspection of the Decatur
facility and identified deviations from cGMPs. The Company responded to these
observations in September 2002. In response to the Company's actions, the FDA
conducted another inspection of the Decatur facility during the period from
December 10, 2002 to February 6, 2003. This inspection identified deviations
from regulatory requirements including the manner in which the Company processes
and investigates manufacturing discrepancies and failures, customer complaints
and the thoroughness of equipment cleaning validations. Deviations identified
during this inspection had been raised in previous FDA inspections. The Company
has responded to these latest findings in writing and in a meeting with the FDA
in March 2003. The Company set forth its plan for implementing comprehensive
corrective actions, has provided a progress report to the FDA on April 15 and
May 15, 2003 and has committed to providing the FDA an additional periodic
report of progress on June 15, 2003.

As a result of the latest inspection and the Company's response, the FDA
may take any of the following actions: (i) accept the Company's reports and
response and take no further action against the Company; (ii) permit the Company
to continue its corrective actions and conduct another inspection (which likely
would not occur before the fourth quarter of 2003) to assess the success of
these efforts; (iii) seek to enjoin the Company from further violations, which
may include temporary suspension of some or all operations and potential
monetary penalties; or (iv) take other enforcement action which may include
seizure of Company products. At this time, it is not possible to predict the
FDA's course of action.

The Company believes that unless and until the FDA chooses option (i) or,
in the case of option (ii), unless and until the issues identified by the FDA
have been successfully corrected and the corrections have been verified through
reinspection, it is doubtful that the FDA will approve any NDAs or ANDAs that
may be submitted by the Company. This has adversely impacted, and is likely to
continue to adversely impact the Company's ability to grow sales. However, the
Company believes that unless and until the FDA chooses option (iii) or (iv), the
Company will be able to continue manufacturing and distributing its current
product lines.

If the FDA chooses option (iii) or (iv), such action could significantly
impair the Company's ability to continue to manufacture and distribute its
current product line and generate cash from its operations, could result in a
covenant violation under the Company's senior debt or could cause the Company's
senior lenders to refuse further extensions of the Company's senior debt any or
all of which, would have a material adverse effect on the Company's liquidity.
Any monetary penalty assessed by the FDA also could have a material adverse
effect on the Company's liquidity.

On March 6, 2002, the Company received a letter from the United States
Attorney's Office, Central District of Illinois, Springfield, Illinois, advising
the Company that the DEA had referred a matter to that office for a possible
civil legal action for alleged violations of the Comprehensive Drug Abuse
Prevention Control Act of 1970, 21 U.S.C.& 801, et. seq. and regulations
promulgated under the Act. The alleged violations relate to record keeping and
controls surrounding the storage and distribution of controlled substances. On
November 6, 2002, the Company entered into a Civil Consent Decree with the DEA.
Under terms of the Consent Decree, the Company, without admitting any of the
allegations in the complaint from the DEA, has agreed to pay a fine of $100,000,
upgrade its security system and to remain in substantial compliance with the
Comprehensive Drug Abuse Prevention Control Act of 1970. If the Company does not
remain in substantial compliance during the two-year period following the entry
of the civil consent decree, the Company, in addition to other possible
sanctions, may be held in contempt of court and ordered to pay an additional
$300,000 fine.

On April 4, 2001, the International Court of Arbitration (the "ICA") of the
International Chamber of Commerce notified the Company that Novadaq
Technologies, Inc. ("Novadaq") had filed a Request for Arbitration with the ICA
on April 2, 2001. Akorn and Novadaq had previously entered into an Exclusive
Cross-Marketing Agreement dated July 12, 2000 (the "Agreement"), providing for
their joint development and marketing of certain devices and procedures for use
in fluorescein angiography (the "Products"). Akorn's drug indocyanine green
("ICG") would be used as part of the angiographic procedure. The FDA had
requested that the parties undertake clinical studies prior to obtaining FDA
approval. In its Request for Arbitration, Novadaq asserted that under the terms
of the Agreement, Akorn should be responsible for the costs of performing the
requested clinical trials, which were estimated to cost approximately
$4,400,000. Alternatively, Novadaq sought a declaration that the Agreement
should be terminated as a result of Akorn's alleged breach. Finally, in either
event, Novadaq sought unspecified damages as a result of the alleged failure or
delay on Akorn's part in performing its obligations under the Agreement. In its
response, Akorn denied Novadaq's allegations and alleged that Novadaq had
breached the agreement. On January 25, 2002, the Company and Novadaq reached a
settlement of the dispute. Under terms of a revised agreement entered into as
part of the settlement, Novadaq will assume all further costs associated with
development of the technology. The Company, in consideration of foregoing any
share of future net profits, obtained an equity ownership interest in Novadaq
and the right to be the exclusive supplier of ICG for use in Novadaq's
diagnostic procedures. In addition, Antonio R. Pera, Akorn's then President and
Chief Operating Officer, was named to Novadaq's Board of Directors. In
conjunction with the revised agreement, Novadaq and the Company each withdrew
their respective arbitration proceedings. Subsequent to the resignation of Mr.
Pera on June 7, 2002, the Company named Bernard J. Pothast, its Chief Financial
Officer, to fill the vacancy on the Novadaq Board of Directors created by his
departure.

On December 19, 2002 and January 22, 2003, the Company received demand
letters regarding claimed wrongful deaths allegedly associated with the use of
the drug Inapsine, which the Company produced. The total claims of these two
items total $3.8 million. The Company has just begun the investigation of the
facts and circumstances surrounding these claims and cannot as of yet determine
the potential liability, if any, from these claims. The Company has submitted
these claims to its product liability insurance carrier. The Company intends to
vigorously defend itself in regards to these claims.

The Company is a party in legal proceedings and potential claims arising in
the ordinary course of its business. The amount, if any, of ultimate liability
with respect to such matters cannot be determined. Despite the inherent
uncertainties of litigation, management of the Company at this time does not
believe that such proceedings will have a material adverse impact on the
financial condition, results of operations, or cash flows of the Company.

14

NOTE O - RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the FASB issued three statements, SFAS No. 141, "Business
Combinations," SFAS No. 142, "Goodwill and Other Intangible Assets," and SFAS
No. 143, "Accounting for Asset Retirement Obligations."

SFAS No. 141 supercedes APB Opinion No. 16, "Business Combinations," and
eliminates the pooling-of-interests method of accounting for business
combinations, thus requiring all business combinations be accounted for using
the purchase method. In addition, in applying the purchase method, SFAS No. 141
changes the criteria for recognizing intangible assets apart from goodwill. The
following criteria is to be considered in determining the recognition of the
intangible assets: (1) the intangible asset arises from contractual or other
legal rights, or (2) the intangible asset is separable or dividable from the
acquired entity and capable of being sold, transferred, licensed, rented, or
exchanged. The requirements of SFAS No. 141 are effective for all business
combinations completed after June 30, 2001. The adoption of this new standard
did not have an effect on the Company's financial statements.

SFAS No. 142 supercedes APB Opinion No. 17, "Intangible Assets," and
requires goodwill and other intangible assets that have an indefinite useful
life to no longer be amortized; however, these assets must be reviewed at least
annually for impairment. The Company has adopted SFAS No. 142 as of January 1,
2002 and no impairments were recognized upon adoption.

SFAS No. 143 requires entities to record the fair value of a liability for
an asset retirement obligation in the period in which it is incurred. When the
liability is initially recorded, the entity capitalizes a cost by increasing the
carrying amount of the related long-lived asset. Over time, the liability is
accreted to its present value each period, and the capitalized cost is
depreciated over the useful life of the related asset. Upon settlement of the
liability, an entity either settles the obligation for its recorded amount or
incurs a gain or loss upon settlement. The Company has adopted SFAS No. 143 as
of January 1, 2002. The adoption of this new standard did not have an effect on
the Company's financial statements.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This statement supercedes SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This statement
also supercedes the accounting and reporting provisions of APB Opinion No. 30,
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a segment of a business (as
previously defined in that Opinion). SFAS No. 144 is effective January 1, 2002.
The adoption of this new standard did not have any effect on the Company's
financial statements upon adoption.

In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement updates, clarifies and simplifies existing
accounting pronouncements. SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains
and Losses from Extinguishments of Debt", which requires all gains and losses
from extinguishments of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. As a result, the criteria
in APB Opinion No. 30 will now be used to classify those gains and losses. SFAS
No. 64, "Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements",
amended SFAS No. 4, is no longer necessary because SFAS No. 4 has been
rescinded. SFAS No. 145 amends SFAS No. 13 "Accounting for Leases", to require
that certain lease modifications that have economic effects similar to
sale-leaseback transaction be accounted for in the same manner as sale-leaseback
transactions. Certain provisions of SFAS No. 145 are effected for fiscal years
beginning after May 15, 2002, while other provisions are effected for
transactions occurring after May 15, 2002. The adoption of SFAS No. 145 did not
have a significant impact on the Company's financial statements.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 requires the Company
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
The Company will adopt SFAS No. 146 for exit or disposal activities initiated
after December 31, 2002. The adoption of this standard did not have a material
effect on its financial statements.

In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure, an amendment of FASB Statement No.
123". This Statement amends SFAS No. 123, "Accounting for Stock-Based
Compensation", to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosure in both annual and interim
financial statements. Certain of the disclosure requirements are required for
fiscal years ending after December 15, 2002.

In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirement for Guarantees, Including
Indirect Guarantees of Indebtedness to Others, an interpretation of FASB
Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34."
This Interpretation elaborates on the disclosure to be made by a guarantor in
its interim and annual financial statements about its obligations under
guarantees issued. The Interpretation also clarifies that a guarantor is
required to recognize, at inception of a guarantee, a liability for the fair
value of the obligation undertaken. The initial recognition and measurement
provisions of the Interpretation are applicable to guarantees issued or modified
after December 31, 2002 and are not expected to have a material effect on the
Company's financial statements. The disclosure requirements are effective for
financial statements of interim or annual periods ending after December 15,
2002. The Company has determined that FIN 45 will not have an effect on the
Company's financial condition, results of operations or cash flows.

In January, 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities", with the objective of improving
financial reporting by companies involved with variable interest entities. A
variable interest entity is a corporation, partnership, trust, or 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 equity to support its activities.
Historically, entities generally were not consolidated unless the entity was
controlled through voting interests. FIN 46 changes that by requiring a variable
interest entity to be consolidated by a company if that company is subject to a
majority of risk of loss from the variable interest entity's activities or
entitled to receive a majority of the entity's residual returns, or both. A
company that consolidates a variable interest entity is called the "primary
beneficiary" of that entity. FIN 46 also requires disclosures about variable
interest entities that a company is not required to consolidate but in which it
has significant variable interest. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 1, 2003.
The consolidation requirements of FIN 46 apply to existing entities in the first
fiscal year or interim period beginning after June 15, 2003. Also, certain
disclosure requirements apply to all financial statements issued after January
31, 2003, regardless of when the variable interest entity was established. The
Company has determined that FIN 46 will not have an impact on its financial
condition, results of operations or cash flows.

Note P - DEFERRED TAX ASSET VALUATION ALLOWANCE

The Company records a valuation allowance to reduce the deferred tax assets
to the amount that is more likely than not to be realized. In performing its
analysis of whether a valuation allowance to reduce the deferred tax asset was
necessary, the Company considered both negative and positive evidence. Based
upon this analysis, the negative evidence outweighed the positive evidence in
determining the amount of the deferred tax assets that is more likely than not
to be realized. Based upon its above analysis, the Company established a
valuation allowance as of September 30, 2002 to reduce the deferred tax assets
to zero. The expense of $7.7 million related to establishing the deferred tax
assets valuation allowance has been recorded in the income tax provision
(benefit). The Company's net operating loss carry forwards expire in 2021.

15

NOTE Q - SUBSEQUENT EVENTS

Due to non-compliance with the Nasdaq report filing requirements, the
Company's stock was delisted from the NASDAQ National Market on June 24, 2002.
On October 1, 2002, a Nasdaq Listing Qualification Panel notified the Company
that the appeal of its delisting had been denied.

In the fourth quarter of 2002, the Company learned that Johns Hopkins
had licensed its two patents related to AMD (see Note N - "Legal Proceedings")
to Novadaq. Pursuant to the settlement with Johns Hopkins, the Company is
entitled to 20% of all equity received by Johns Hopkins from any license of the
patent rights. Therefore, the Company received an additional 132,000 shares of
Novadaq, valued at $23,000, which will be recorded as a gain in the fourth
quarter of 2002.

On February 27, 2003, the Company reached an agreement in principle
with the staff of the SEC's regional office in Denver, Colorado, that would
resolve the issues arising from the staff's investigation and proposed
enforcement action as discussed above. The Company has offered to consent to the
entry of an administrative cease and desist order as proposed by the staff,
without admitting or denying the findings set forth therein. The proposed
consent order finds that the Company failed to promptly and completely record
and reconcile cash and credit remittances, including from its top five
customers, to invoices posted in its accounts receivable sub-ledger. According
to the findings in the proposed consent order, the Company's problems resulted
from, among other things, internal control and books and records deficiencies
that prevented the company from accurately recording, reconciling and aging its
receivables. The proposed consent order finds that the Company's 2000 Form 10-K
and first quarter 2001 Form 10-Q misstated its account receivable balance or,
alternatively, failed to disclose the impairment of its accounts receivable and
that its first quarter 2001 Form 10-Q inaccurately attributed the increased
accounts receivable reserve to a change in estimate based on recent collection
efforts, in violation of Section 13(a) of the Exchange Act and rules 12b-20,
13a-1 and 13a-13 thereunder. The proposed consent order also finds that the
Company failed to keep accurate books and records and failed to devise and
maintain a system of adequate internal accounting controls with respect to its
accounts receivable in violation of Sections 13(b)(2)(A) and 13(b)(2)(B) of the
Exchange Act. The proposed consent order does not impose a monetary penalty
against the Company or require any additional restatement of the Company's
financial statements. The Company has recently become aware of and informed the
SEC staff of certain weaknesses in its internal controls, which it is in the
process of addressing. It is uncertain at this time what effect these actions
will have on the agreement in principle currently pending with the SEC staff.
The proposed consent order does not become final until it is approved by the
SEC. Accordingly, the Company may incur additional costs and expenses in
connections with this proceeding.

On December 18, 2002, Dr. John N. Kapoor submitted his resignation as
Chief Executive Officer of the Company. Dr. Kapoor will remain Chairman of the
Board of Directors of the Company. On February 17, 2003, Arthur S. Przybyl was
named Interim Chief Executive Officer of the Company.

On February 18, 2003 the Company announced that it had received
approval from the FDA for its Abbreviated New Drug Application ("ANDA") for
Lidocaine Jelly, 2% ("Lidocaine Jelly"), a bioequivalent to Xylocaine Jelly (R),
a product of AstraZeneca PLC used primarily as a topical anesthetic by
urologists and hospitals. This product will be manufactured at the Company's
Somerset, New Jersey facility.

In February of 2003, the Company recalled two products, Fluress and
Fluoracaine, due to container/ closure integrity problems resulting in leaking
containers. The recall has been classified by the FDA as a Class II recall,
which means that the use of, or exposure to, a violative product may cause
temporary or medically reversible adverse health consequences or that the
probability of serious health consequences as the result of such use or exposure
is remote. To date, the Company has not received any notification or complaints
from end users of the recalled products. The financial impact to the Company of
this recall is not expected to be material to the financial statements.

In March of 2003, as a result of the most recent FDA inspection, the
Company recalled twenty-four lots of product produced from the period December
2001 to June 2002 in one of its production rooms at its Decatur, Illinois
facility. The majority of the lots recalled were for third party contract
customer products. Subsequent to this decision and after discussions with the
FDA, eight of the original twenty-four lots have been exempted from the recall
due to medical necessity. At this time, the FDA has not reached a conclusion on
the classification of this recall. To date, the Company has not received any
notification or complaints from end users of the recalled products. The Company
believes the financial impact of this recall will not be material to the
financial statements.

See Notes A, G and N for recent developments regarding the Company's
Financing arrangements, legal proceedings with the FDA and the Civil Consent
Decree with the DEA.

16

ITEM 2.

AKORN, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

Management's discussion and analysis of financial condition and results
of operations should be read in conjunction with the accompanying condensed
consolidated financial statements. Subsequent to the issuance of the Company's
condensed consolidated financial statements for the quarter ended September 30,
2001, management of the Company determined that the balance of the Company's
allowance for doubtful accounts as of December 31, 2000 was understated by
$7,520,000 and that bad debt expense for the years ended December 31, 2000 and
2001 was understated and overstated, respectively, by a corresponding amount. In
addition, management determined that the Company had not recognized the
$1,508,000 beneficial conversion feature embedded in the convertible notes
issued to The John N. Kapoor Trust in July 2001. The Company's condensed
consolidated financial statements for the three and nine month periods ended
September 30, 2001 have been restated to appropriately account for these items.
See Note M "Restatement" in the condensed consolidated financial statements for
a summary of the significant effects of the restatement. The following
discussion and analysis give effect to the restatement.

Akorn, Inc. manufactures and markets diagnostic and therapeutic
pharmaceuticals in specialty areas such as ophthalmology, rheumatology,
anesthesia and antidotes, among others. Customers include physicians,
optometrists, wholesalers, group purchasing organizations and other
pharmaceutical companies.

CRITICAL ACCOUNTING POLICIES

REVENUE RECOGNITION

The Company recognizes revenue upon the shipment of goods or upon the
delivery of goods, depending on the sales terms. Revenue is recognized when all
obligations of the Company have been fulfilled and collection of the related
receivable is probable. The Company records a provision at the time of sale for
estimated chargebacks, rebates and product returns. Additionally, the Company
maintains an allowance for doubtful accounts and slow moving and obsolete
inventory. These provisions and allowances are analyzed and adjusted, if
necessary, at each balance sheet date.

ALLOWANCE FOR CHARGEBACKS AND REBATES

The Company maintains an allowance for chargebacks and rebates. These
allowances are reflected as a reduction of accounts receivable.

The Company enters contractual agreements with certain third parties such
as hospitals and group-purchasing organizations to sell certain products at
predetermined prices. The parties have elected to have these contracts
administered through wholesalers. When a wholesaler sells products to one of the
third parties that is subject to a contractual price agreement, the difference
between the price to the wholesaler and the price under contract is charged back
to the Company by the wholesaler. The Company tracks sales and submitted
chargebacks by product number for each wholesaler. Utilizing this information,
the Company estimates a chargeback percentage for each product. The Company
reduces gross sales and increases the chargeback allowance by the estimated
chargeback amount for each product sold to a wholesaler. The Company reduces the
chargeback allowance when it processes a request for a chargeback from a
wholesaler. Actual chargebacks processed can vary materially from period to
period.

Prior to March 31, 2001, the Company used historical trends and actual
experience to estimate its chargeback allowance. In May 2001, management
obtained wholesaler inventory reports as of March 31, 2001 to aid in performing
a detailed business review in an effort to better understand its current cash
flow constraints. The Company assessed the reasonableness of its chargeback
allowance by applying the product chargeback percentage based on historical
activity to the quantities of inventory on hand per the wholesaler inventory
reports. The Company had not previously obtained these reports due to the cost
of obtaining such reports and also due to the fact that the Company had not seen
any indication that its historical trends analysis was not reasonable.
Previously management believed that wholesalers maintained limited inventory
levels to balance maintaining available stock for a given product with the cost
of storing such inventory. Accordingly, management previously considered recent
sales activity in estimating wholesaler on-hand inventory levels for the purpose
of assessing the reasonableness of the allowance. However, the reports of
wholesaler inventory information suggested that the wholesalers had greater
levels of on-hand inventory than had previously been estimated and the Company
used this new information to enhance its methodology of estimating the
allowance.

Similarly, the Company maintains an allowance for rebates related to
contract and other programs with the wholesalers. The rebate allowance also
reduces gross sales and accounts receivable by the amount of the estimated
rebate amount when the Company sells its products to the wholesalers. The
Company uses historical trends and actual experience to estimate its rebate
allowances. At each balance sheet date, the Company evaluates the allowance
against actual rebates processed and such amount can vary materially from period
to period.

Based upon the wholesaler's March 31, 2001 inventories and historical
chargeback and rebate activity, the Company recorded an allowance of $6,961,000,
which resulted in an expense of $12,000,000 for the three months ended March 31,
2001, as compared to an allowance of $3,296,000 recorded at December 31, 2000.

During the quarter ended June 30, 2001, the Company further refined its
estimates of the chargeback and rebate liability determining that an additional
$2,250,000 provision needed to be recorded. The additional increase to the
allowance was necessary to reflect the continuing shift of sales to customers
who purchase their products through group purchasing organizations and buying
groups. The Company had previously seen a greater level of list price business
than is occurring in the current business environment.

The recorded allowances reflect the Company's current estimate of the
future chargeback and rebate liability to be paid or credited to the wholesaler
under the various contract and programs. For the three and nine month periods
ended September 30, 2002, the Company recorded chargeback and rebate expense of
$4,693,000 and $12,247,000, respectively. For the three and nine month periods
ended September 30, 2001, the Company recorded chargeback and rebate expense of
$4,755,000 and $24,075,000, respectively. The allowance for chargebacks and
rebate was $4,598,000 and $4,190,000 as of September 30, 2002 and December 31,
2001, respectively.

17

Allowance for Product Returns

The Company also maintains an allowance for estimated product returns.
This allowance is reflected as a reduction of accounts receivable balances. The
Company evaluates the allowance balance against actual returns processed. Actual
returns processed can vary materially from period to period. For the three and
nine months ended September 30, 2002, the Company recorded a provision for
product returns of $790,000 and $1,822,000, respectively. For the three and nine
months ended September 30, 2001, the Company recorded a provision for product
returns of $339,000 and $3,184,000, respectively. The allowance for potential
product returns was $982,000 and $548,000 at September 30, 2002 and December 31,
2001, respectively.

In addition to considering in process product returns and assessing the
potential implications of historical product return activity, the Company also
considers the wholesaler's inventory information to assess the magnitude of
unconsumed product that may result in a product return to the Company in the
future. Such wholesaler inventory information had not been historically
purchased and therefore, had not been considered in assessing the reasonableness
of the allowance prior to March 31, 2001. Historical returns had not been
significant. Based on the wholesaler's inventory information, which demonstrated
higher levels of on-hand product than previously estimated by management,
combined with increased levels of return activity, the Company increased its
allowance for potential product returns.

ALLOWANCE FOR DOUBTFUL ACCOUNTS

The Company maintains an allowance for doubtful accounts, which reflects
trade receivable balances owed to the Company that are believed to be
uncollectible. This allowance is reflected as a reduction of accounts receivable
balances. In estimating the allowance for doubtful accounts, the Company has:

- Identified the relevant factors that might affect the accounting
estimate for allowance for doubtful accounts, including: (a) historical
experience with collections and write-offs; (b) credit quality of
customers; (c) the interaction of credits being taken for discounts,
rebates, allowances and other adjustments; (d) balances of outstanding
receivables, and partially paid receivables; and (e) economic and other
exogenous factors that might affect collectibility (e.g., bankruptcies
of customers, "channel" factors, etc.).

- Accumulated data on which to base the estimate for allowance for
doubtful accounts, including: (a) collections and write-offs data; (b)
information regarding current credit quality of customers; and (c)
information regarding exogenous factors, particularly in respect of
major customers.

- Developed assumptions reflecting management's judgments as to the most
likely circumstances and outcomes, regarding, among other matters: (a)
collectibility of outstanding balances relating to "partial payments;"
(b) the ability to collect items in dispute (or subject to
reconciliation) with customers; and (c) economic and other exogenous
factors that might affect collectibility of outstanding
balances -- based upon information available at the time.

The allowance for doubtful accounts was $1,318,000 and $3,706,000 as of
September 30, 2002 and December 31, 2001, respectively. The provision (recovery)
for bad debts was $370,000 and ($30,000) for the three and nine months ended
September 30, 2002 as compared to a provision of $60,000 and $4,670,000 for the
comparable periods of the prior year. As of September 30, 2002, the Company had
a total of $4,736,000 of past due gross accounts receivable of which, $881,000
was over 60 days past due. The Company performs monthly a detailed analysis of
the receivables due from its wholesaler customers and provides a specific
reserve against known uncollectible items for each of the wholesaler customers.
The Company also includes in the allowance for doubtful accounts an amount that
it estimates to be uncollectible for all other customers based on a percentage
of the past due receivables. The percentage reserved increases as the age of the
receivables increases. Of the recorded allowance for doubtful accounts of
$1,318,000, the portion related to the wholesaler customers is $825,000 with the
remaining $493,000 reserve for all other customers.

Allowance for Discounts

The Company maintains an allowance for discounts, which reflects
discounts available to certain customers based on agreed upon terms of sale.
This allowance is reflected as a reduction of accounts receivable. The Company
evaluates the allowance balance against actual discounts taken. For the three
and nine month periods ended September 30, 2002 the Company recorded a provision
for discounts of $246,000 and $759,000, respectively. For the three and nine
month periods ended September 30, 2001 the Company recorded a provision for
discounts of $179,000 and $625,000, respectively. Prior to 2001, the Company
did not grant discounts. The allowance for discounts was $222,000 and $143,000
as of September 30, 2002 and December 31, 2001, respectively.

Allowance for Slow Moving Inventory

The Company maintains an allowance for slow-moving and obsolete
inventory based upon recent sales activity by unit and wholesaler inventory
information. The Company estimates the amount of inventory that may not be sold
prior to its expiration. In 2001, upon obtaining the wholesaler's inventory
reports, the Company learned that the wholesalers had greater levels of on-hand
inventory than had been previously estimated. This provided the Company with
greater insight as to the potentially lower buying patterns of the wholesalers
than had been previously forecasted and contemplated in estimating the levels of
inventory in assessing the adequacy of the allowance. For the nine month period
ended September 30, 2002, the Company recorded a provision for inventory
obsolescence of $493,000. The Company recorded no provision in the third quarter
of 2002. For the three and nine month periods ended September 30, 2001, the
Company recorded a provision for inventory obsolescence of $330,000 and
$1,830,000, respectively. The allowance for inventory obsolescence was
$1,647,000 and $1,845,000 as of September 30, 2002 and December 31, 2001,
respectively.

18

Income Taxes

The Company files a consolidated federal income tax return with its
subsidiary. Deferred income taxes are provided in the financial statements to
account for the tax effects of temporary differences resulting from reporting
revenues and expenses for income tax purposes in periods different from those
used for financial reporting purposes. The Company records a valuation allowance
to reduce the deferred tax assets to the amount that is more likely than not to
be realized. In performing its analysis of whether a valuation allowance to
reduce the deferred tax asset was necessary, the Company considered both
negative and positive evidence. Based upon this analysis, the negative evidence
outweighed the positive evidence in determining the amount of the deferred tax
assets that is more likely than not to be realized. Based upon its above
analysis, the Company established a valuation allowance to reduce the deferred
tax assets to zero. The expense of $7.7 million related to establishing the
deferred tax assets valuation allowance has been recorded in the income tax
provision (benefit).

Intangibles

Intangibles consist primarily of product licensing and other such costs
that are capitalized and amortized on the straight-line method over the lives of
the related license periods or the estimated life of the acquired product, which
range from 17 months to 18 years. Accumulated amortization at September 30, 2002
and December 31, 2001 was $8,188,000 and $7,132,000, respectively. The Company
annually assesses the impairment of intangibles based on several factors,
including estimated fair market value and anticipated cash flows. On July 3,
2002, the Company settled a License Agreement dispute with JHU/APL (See Note
N-"Legal Proceedings") on two licensed patents. As a result of the resolved
dispute, the Company recorded an asset impairment charge of $1,559,500 in the
second quarter of 2002, representing the net value of the asset recorded on the
balance sheet of the Company less the $300,000 payment abated by JHU/APL and the
$125,000 payment received from JHU/APL.

During the third quarter of 2002, the Company recorded an impairment
charge of $257,000 related to the product license intangible assets for the
products Sublimaze, Inapsine, Paradrine and Dry Eye test. The Company determined
that projected profitability on the products was not sufficient to support the
carrying value of the intangible asset. The recording of this charge reduced the
carrying value of the intangible assets related to these product licenses to
zero. These charges are reflected in the selling, general and administrative
expense category of the consolidated statement of operations. See Note H --
"Intangible Asset Impairment" to the consolidated financial statements in Item
8.

RESULTS OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO 2001

The following table sets forth, for the periods indicated, revenues by
segment, excluding intersegment sales.

Consolidated revenues decreased 4.5% in the quarter ended September 30,
2002 compared to the same period in 2001. Results for 2002 exclude shipments
made at or near the end of the quarter for which shipping terms are FOB
destination and, accordingly, revenue is not recognized until delivery occurs.
Prior year revenues reflect virtually all shipments to customers as virtually
all sales terms were FOB shipping point.

Ophthalmic segment revenues increased 31.8%, primarily reflecting an
increase in angiography and ointment product sales. The 2002 sales mix reflects
the Company's shift in sales and marketing efforts within the Ophthalmic segment
to those key product lines that generate higher margins. Injectable revenues
increased 24.4% compared to the same period in 2001, due to the timing of
wholesaler inventory purchases made earlier in 2001 that were reduced during the
third quarter without compensating wholesaler purchases. These were offset by
Contract services revenues which decreased 72.1% compared to the same period in
2001, due mainly to customer concerns about the status of the ongoing FDA issues
at the Company's Decatur, Illinois facility. The Company anticipates that
revenues from the Contract Services segment will continue to lag historical
levels and that ophthalmic and injectable revenues are not likely to grow until
the uses surrounding the FDA review are resolved.

Consolidated gross margin decreased from 38.3% in the third quarter of
2001 to 36.8% in the third quarter of 2002. The decline in contract service
revenues was partially offset by the Company's shift in product mix to higher
gross margin products in the angiography, antidote and ointment product lines.

Selling, general and administrative ("SG&A") expenses increased 39.1%
during the quarter ended September 30, 2002 as compared to the same period in
2001. The increase is primarily driven by an intangible asset impairment charge
of $257,000 related to the product license intangible assets for the products
Sublimaze, Inapsine, Paredrine and Dry Eye Test, and $545,000 of impaired assets
on construction-in-progress assets as well as increases in sales and marketing
expenditures and legal fees versus 2001.

The provision for bad debts was $370,000 for the third quarter 2002, as
compared to $60,000 for the same period in 2001 due to an increase in past due
wholesaler receivables.

Amortization of intangibles increased to $359,000 from $356,000 or 0.8%
over the prior year quarter.

Research and development ("R&D") expense decreased 5.9% in the quarter,
to $498,000 from $529,000 for the same period in 2001. The Company has scaled
back its research activities to preserve capital and to focus on strategic
product niches such as controlled substances and ophthalmic products which it
believes will add greater value. The lower level of R&D in the quarter also
reflects the Company's refocusing of resources away from R&D to resolve issues
in the FDA's Form 483 notification.

19

Interest expense of $764,000 was 24.7%, lower than the comparable
quarter in 2001, primarily due to a lower debt balance and lower interest rates.

An income tax provision of $6.6 million was recorded for the three
months ended September 30, 2002. The income tax provision primarily relates to
the valuation allowance of $7.7 million recorded during 2002. In performing its
analysis of whether a valuation allowance to reduce the deferred tax asset was
necessary, the Company considered both negative and positive evidence. Based
upon this analysis, the negative evidence outweighed the positive evidence in
determining the amount of the deferred tax assets that is more likely than not
to be realized. Based upon its analysis, the Company established a valuation
allowance to reduce the deferred tax assets to zero. Without the violation
allowance, the Company's effective tax rate for the quarter was 39.3% compared
to 38.0% for the prior-year period.

The Company reported a net loss of $9,387,000 or $0.48 per share for
the three months ended September 30, 2002, compared to a net loss of $536,000 or
$0.03 per share for the comparable prior year quarter. The increased net loss
was due primarily to the establishment of the valuation allowance against the
Company's deferred tax asset and, to a lesser extent, the decrease in revenues
and gross margin.

NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO 2001

The following table sets forth, for the periods indicated, revenues by
segment, excluding intersegment sales.

Consolidated revenues increased 37.3% in the nine month period ended
September 30, 2002 compared to the same period in 2001. Results for the nine
months ended September 30, 2002 exclude shipments made at or near the end of the
quarter for which shipping terms are FOB destination and, accordingly, revenue
is not recognized until delivery occurs. Prior year revenues reflect virtually
all shipments to customers as virtually all sales terms were FOB shipping point.

Ophthalmic segment revenues increased 90.8%, primarily reflecting lower
charges related to chargebacks, rebates and returns in 2002, as compared to
2001, and, to a lessor extent, strong angiography and ointment product sales.
The 2002 sales mix reflects the Company's shift in sales and marketing efforts
on these key product lines which generate higher margins. Injectable revenues
increased 89.1% compared to the same period in 2001 primarily due to the lower
level of chargebacks, rebates and returns in 2002 (See Note C to the condensed
consolidated financial statements) and a sharp reduction in anesthesia and
antidote product sales in 2001. Contract Services revenues decreased 41.5%
compared to the same period in 2001 due mainly to customer concerns about the
status of the Food and Drug Administration ("FDA") inspection ongoing at the
Company's Decatur facility. The Company anticipates that revenues from the
Contract Services segment will continue to lag historical sales levels until the
issues surrounding the FDA warning letter are resolved.

20

Consolidated gross profit was $17,171,000 for the nine month period
ended September 30, 2002, as compared to $1,112,000 for the nine months ended
September 30, 2001, reflecting the effects of the aforementioned increase in
revenues in 2002, as compared to 2001, as well as an increase in the reserve for
slow-moving, unsaleable and obsolete inventory items recorded in 2001, (See Note
D to the condensed consolidated financial statements). Improvements in gross
margin also resulted from the Company's continued focus on shifting the product
mix to higher gross margin products in the angiography, antidote and ointment
product lines.

SG&A expenses increased 8.5% during the nine month period ended
September 30, 2002 as compared to the same period in 2001. The increase was
primarily due to the $1,559,500 JHU/APL intangible asset write-off in the second
quarter of 2002, additional intangible asset write-offs of $257,000 in the third
quarter of 2002, $545,000 of fixed asset writedowns in the third quarter of 2002
and higher legal and consulting costs partially offset by $1,117,000 of
restructuring related costs incurred in 2001.

The year to date provision for bad debts was a net recovery of $30,000
versus a $4,670,000 expense in 2001, due to the Company's increased efforts to
collect past due receivables.

Amortization of intangibles decreased from $1,075,000 to $1,057,000, or
1.7% over the comparable period in the prior year, reflecting the exhaustion of
certain product intangibles which was offset by inception of the intangible
amortization related to the product launch of Paremyd.

R&D expense decreased 36.4% in the nine month period ended September
30, 2002, to $1,480,000 from $2,328,000 for the same period in 2001. The Company
has scaled back its research activities, to preserve capital and to focus on
strategic product niches such as controlled substances and ophthalmic products
which it believes will add greater value. The lower level of R&D also reflects
the Company's refocusing of resources away from R&D to resolve issues in the
FDA's Form 483 notification.

Interest expense of $2,477,000 was 4.7% lower than the $2,600,000,
recorded in 2001, due to lower interest rates and a lower debt balance in 2002.

An income tax provision of $6.2 million was recorded for the nine
months ended September 30, 2002. The income tax provision primarily relates to
the valuation allowance recorded of $7.7 million. In performing the analysis of
whether a valuation allowance to reduce the deferred tax asset was necessary,
the Company considered both negative and positive evidence, which could be
objectively verified. Based upon this analysis, the negative evidence, primarily
the three consecutive years of operating losses, outweighed the positive
evidence in determining the amount of the deferred tax assets that is more
likely than not to be realized. Based upon its analysis, the Company established
a valuation allowance to reduce the deferred tax assets to zero as of December
31, 2002. The expense of $7.7 million related to establishing the deferred tax
assets valuation allowance has been recorded in the income tax provision
(benefit). Without the valuation allowance, the Company's effective tax rate for
the period was 39.5% compared to 37.7% for the prior-year period.

The Company reported a net loss of $10,018,000 or $0.51 per share, for
the nine months ended September 30, 2002, compared to a net loss of $15,187,000,
or $0.79 per share, for the comparable prior year quarter.

FINANCIAL CONDITION AND LIQUIDITY

The Company experienced losses from operations in 2001 and 2000 and had
a working capital deficiency of $28.2 million as of September 30, 2002.

As of September 30, 2002, the Company had cash and cash equivalents of
$2,871,000. Working capital at September 30, 2002 was a deficit of $28.2 million
compared to a deficit of $24.4 million at December 31, 2001. Working capital was
a deficit primarily due to the $39.5 million in long-term debt that is due
within twelve months of the balance sheet reporting date of September 30, 2002.
Future working capital needs will be highly dependent upon the Company's ability
to control expenses and manage its accounts receivables. Management believes
that existing cash and cash flow from operations will be sufficient to meet the
cash needs of the business for the immediate future, but the Company will need
to refinance or extend the maturity of the bank credit agreement as it does not
anticipate sufficient cash to make the June 30, 2003 scheduled payment.

For the nine month period ended September 30, 2002, the Company
provided $7,451,000 in cash from operations to finance its working capital
requirements, primarily due to the receipt of a $5,600,000 refund from the
Internal Revenue Service and an decrease in trade accounts receivable. Investing
activities, which primarily relate to purchase of equipment and construction in
progress, required $4,520,000 in cash. Financing activities used $5,415,000 in
cash, primarily reflecting the payment of $5,600,000 against the outstanding
debt owed to the Company's Senior Lenders.

The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. Accordingly, the financial
statements do not include any adjustments relating to the recoverability and
classification of recorded asset amounts or the amounts and classification of
liabilities that might be necessary should the Company be unable to continue as
a going concern.

As described more fully herein, the Company has had three consecutive
years of operating losses (including the projected losses in 2002), is in
default under its existing credit agreement and is a party to governmental
proceedings and potential claims by the FDA that could have a material adverse
effect on the Company. Although the Company has entered into a Forbearance
Agreement (as defined below) with its senior lenders and obtained extensions
thereof through June 30, 2003, is working with the FDA to favorably resolve such
proceedings, has appointed a new interim chief executive officer and implemented
other management changes and has taken additional steps to return to
profitability, there is substantial doubt about the Company's ability to
continue as a going concern. The Company's ability to continue as a going
concern is dependent upon its ability to (i) continue to finance it current cash
needs, (ii) continue to obtain extensions of the Forbearance Agreement, (iii)
successfully resolve the ongoing governmental proceeding with the FDA and (iv)
ultimately refinance its senior bank debt and obtain new financing for future
operations and capital expenditures. If it is unable to do so, it may be
required to seek protection from its creditors under the federal bankruptcy
code.

While there can be no guarantee that the Company will be able to
continue to finance its current cash needs, the Company generated positive cash
flow from operations in 2002. In addition, as of April 30, 2003, the Company had
approximately $400,000 in cash and equivalents and approximately $1.4 million of
undrawn availability under the second line of credit described below.

There also can be no guarantee that the Company will successfully
resolve the ongoing governmental proceedings with the FDA. However, the Company
has submitted to the FDA and begun to implement a plan for comprehensive
corrective actions at its Decatur, Illinois facility.

Moreover, there can be no guarantee that the Company will be successful
in obtaining further extensions of the Forbearance Agreement or in refinancing
the senior debt and obtaining new financing for future operations. However, the
Company is current on its interest payment obligations to its senior lenders,
management believes that the Company has a good relationship with its senior
lenders and, as required, the Company has retained a consulting firm, submitted
a restructuring plan and engaged an investment banker to assist in raising
additional financing and explore other strategic alternatives for repaying the
senior bank debt. The Company has also added key management personnel, including
the appointment of a new interim chief executive officer, and additional
personnel in critical areas, such as quality assurance. Management has reduced
the Company's cost structure, improved the Company's processes and systems and
implemented strict controls over capital spending. Management believes these
activities have improved the Company's profitability and cash flow from
operations and improved its prospects for refinancing its senior debt and
obtaining additional financing for future operations.

As a result of all of the factors cited in the preceding three
paragraphs, management believes that the Company should be able to sustain its
operations and continue as a going concern. However, the ultimate outcome of
this uncertainty cannot be presently determined and, accordingly, there remains
substantial doubt as to whether the Company will be able to continue as a going
concern. Further, even if the Company's efforts to raise additional financing
and explore other strategic alternatives result in a transaction that repays the
senior bank debt, there can be no assurance that the current common stock will
have any value following such a transaction. In particular, if any new financing
is obtained, it likely will require the granting of rights, preferences or
privileges senior to those of the common stock and result in substantial
dilution of the existing ownership interests of the common stockholders.

The Credit Agreement

In 1997, the Company entered into a $15 million revolving credit
arrangement with The Northern Trust Company, increased to $25 million in 1998,
and subsequently increased to $45 million in 1999, subject to certain financial
covenants and secured by substantially all of the assets of the Company. This
credit agreement, as amended effective January 1, 2002 (the "Credit Agreement"),
requires the Company to maintain certain financial covenants. These covenants
include minimum levels of cash receipts, limitations on capital expenditures, a
$750,000 per quarter limitation on product returns and required amortization of
the loan principal. The agreement also prohibits the Company from declaring any
cash dividends on its common stock and identifies certain conditions in which
the principal and interest on the Credit Agreement would become immediately due
and payable. These conditions include: (a) an action by the FDA which results in
a partial or total suspension of production or shipment of products, (b) failure
to invite the FDA in for re-inspection of the Decatur manufacturing facilities
by June 1, 2002, (c) failure to make a written response, within 10 days, to the
FDA, with a copy to the lender, to any written communication received from the
FDA after January 1, 2002 that raises any deficiencies, (d) imposition of fines
against the Company in an aggregate amount greater than $250,000, (e) a
cessation in public trading of the Company's stock other than a cessation of
trading generally in the United States securities market, (f) restatement of or
adjustment to the operating results of the Company in an amount greater than
$27,000,000, (g) failure to enter into an engagement letter with an investment
banker for the underwriting of an offering of equity securities by June 15,
2002, (h) failure to not be party to such an engagement letter at any time after
June 15, 2002 or (i) experiencing any material adverse action taken by the FDA,
the SEC, the DEA or any other governmental authority based on an alleged failure
to comply with laws or regulations. The amended Credit Agreement required a
minimum payment of $5.6 million, which relates to an estimated federal tax
refund, with the balance of $39.2 million due June 30, 2002. The Company
remitted the $5.6 million payment on May 8, 2002. The Company is also obligated
to remit any additional federal tax refunds received above the estimated $5.6
million.

The Company's senior lenders agreed to extend the Credit Agreement to
July 31, 2002 and then again to August 31, 2002. These two extensions contain
the same covenants and reporting requirements except that the Company is not
required to comply with conditions (g) and (h) above which relate to the
offering of equity securities. In both instances, the balance of $39.2 million
was due at the end of the extension term.

On September 16, 2002, the Company was notified by its senior lenders
that it was in default due to failure to pay the principal and interest owed as
of August 31, 2002 under the then most recent extension of the Credit Agreement.
The senior lenders also notified the Company that they would forbear from
exercising their remedies under the Credit Agreement until January 3, 2003 if a
forbearance agreement could be reached. On September 20, 2002, the Company and
its senior lenders entered into an agreement under which the senior lenders
would agree to forbear from exercising their remedies (the "Forbearance
Agreement") and the Company acknowledged its current default. The Forbearance
Agreement provides a second line of credit allowing the Company to borrow the
lesser of (i) the difference between the Company's outstanding indebtedness to
the senior lenders and $39,200,000, (ii) the Company's borrowing base and (iii)
$1,750,000, to fund the Company's day-to-day operations. The Forbearance
Agreement requires that, except for then-existing defaults, the Company continue
to comply with all of the covenants in its Credit Agreement and provides for
certain additional restrictions on operations and additional reporting
requirements. The Forbearance Agreement also requires automatic application of
cash from the Company's operations to repay borrowings under the new revolving
loan, and to reduce the Company's other obligations to the senior lenders. In
the event that the Company is not in compliance with the continuing covenants
under the Credit Agreement and does not negotiate amended covenants or obtain a
waiver thereof, then the senior lenders, at their option, may demand immediate
payment of all outstanding amounts due and exercise any and all available
remedies, including, but not limited to, foreclosure on the Company's assets.
This could result in the Company seeking protection from its creditors and a
reorganization under the federal bankruptcy code.

The Company, as required in the Forbearance Agreement, agreed to
provide the senior lenders with a plan for restructuring its financial
obligations on or before December 1, 2002 and agreed to retain a consulting firm
by September 27, 2002, and, in furtherance of that commitment, on September 26,
2002, the Company entered into an agreement (the "Consulting Agreement") with a
consulting firm (AEG Partners, LLC (the "Consultant")) whereby the Consultant
would assist in the development and execution of this restructuring plan and
provide oversight and direction to the Company's day-to-day operations. On
November 18, 2002, the Consultant notified the Company of its intent to resign
from the engagement effective December 2, 2002, based upon the Company's alleged
failure to cooperate with the Consultant, in breach of the Consulting Agreement.
The Company's senior lenders, upon learning of the Consultant's action, notified
the Company by letter dated November 18, 2002, that, as a result of the
Consultant's resignation, the Company was in default under terms of the
Forbearance Agreement and the Credit Agreement and demanded payment of all
outstanding principal and interest on the loan. This notice was followed by a
second letter dated November 19, 2002, in which the senior lenders gave notice
of their exercise of certain remedies available under the Credit Agreement
including, but not limited to, their setting off the Company's deposits with the
senior lenders against the Company's obligations to the senior lenders. The
Company immediately entered into discussions with the Consultant which led, on
November 21, 2002, to the Consultant rescinding its notification of resignation
and to the senior lenders withdrawing their demand for payment and restoring the
Company's accounts.

During the Company's discussions with the Consultant, the Company
agreed to establish a special committee of the Board (the "Corporate Governance
Committee") consisting of Directors Ellis and Bruhl, with Mr. Ellis serving as
Chairman. The Consultant will interface with the Corporate Governance Committee
regarding the Company's restructuring actions. The Company also agreed that the
Consultant will oversee the Company's interaction with all regulatory agencies
including, but not limited to, the FDA. In addition, the Company has agreed to a
"success fee" arrangement with the Consultant. Under terms of the arrangement,
if the Consultant is successful in obtaining an extension to January 1, 2004 or
later on the Company's senior debt, the Consultant will be paid a cash fee equal
to 1 1/2% of the amount of the senior debt which is refinanced or restructured.
Additionally, the success fee arrangement provides that the Company will issue
1,250,000 warrants to purchase common stock at an exercise price of $1.00 per
warrant share to the Consultant upon the date on which each of the following
conditions have been met or waived by the Company: (i) the Forbearance Agreement
shall have been terminated, (ii) the Consultant's engagement pursuant to the
Consulting Agreement shall have been terminated and (iii) the Company shall have
executed a new or restated multi-year credit facility. All unexercised warrants
shall expire on the fourth anniversary of the date of issuance.

As required by the Forbearance Agreement, a restructuring plan was
developed by the Company and the Consultant and presented to the Company's
senior lenders in December 2002. The restructuring plan requested that the
senior lenders convert the Company's senior debt to a term note that would
mature no earlier than February 2004 and increase the current line of credit
from $1.75 million to $3 million to fund operations and capital expenditures. In
light of the FDA's re-inspection of the Decatur facility in early December 2002,
the Company and the senior lenders agreed to defer further discussions of that
request until completion of the re-inspection and the Company's response
thereto. As a result, the senior lenders have agreed to successive short-term
extensions of the Forbearance Agreement, the latest of which is an eleventh
amendment to the Forbearance Agreement expiring on June 30, 2003. Following
completion of the FDA inspection of the Decatur facility on February 6, 2003 and
issuance of the FDA findings, the senior lenders have indicated that they are
not willing to convert the senior debt to a term loan but discussions continue
regarding a possible increase in the revolving line of credit. As required by
the Company's senior lenders, on May 9, 2003, the Company engaged Leerink Swann,
an investment banking firm, to assist in raising additional financing and
explore other strategic alternatives for repaying the senior bank debt. Subject
to the absence of any additional defaults and subject to the senior lenders'
satisfaction with the Company's progress in resolving the matters raised by the
FDA and in obtaining additional financing and exploring other strategic
alternatives, the Company expects to continue obtaining short-term extensions of
the Forbearance Agreement. However, there can be no assurances that the Company
will be successful in obtaining further extensions of the Forbearance Agreement
beyond June 30, 2003.

FDA Proceeding

As discussed above, the Company is also a party to a governmental
proceeding by the FDA (See Note N "Legal Proceedings"). While the Company is
cooperating with the FDA and seeking to resolve the pending matter, an
unfavorable outcome such proceeding may have a material impact on the Company's
operations and its financial condition, results of operations and/or cash flows
and, accordingly, may constitute a material adverse action that would result in
a covenant violation under the Credit Agreement or cause the Company's senior
lenders to refuse to further extend the forbearance agreement, any or all of
which could have a material adverse effect on the Company's Liquidity.

21

Facility Expansion

The Company is in the process of completing an expansion of its
Decatur, Illinois facility to add capacity to provide Lyophilization
manufacturing services, which manufacturing capability the Company currently
does not have. Subject to the Company's ability to refinance its senior debt and
obtain new financing for future operations and capital expenditures, the Company
anticipates the completion of the Lyophilization expansion in the second half of
2004. As of December 31, 2002, the Company had spent approximately $16.4 million
on the expansion and anticipates the need to spend approximately $1.0 million of
additional funds (excluding capitalized interest) to complete the expansion. The
majority of the additional spending will be focused on validation testing of the
Lyophilization facility as the major capital equipment items are currently in
place. Once the Lyophilization facility is validated, the Company will proceed
to produce stability batches to provide the data necessary to allow the
Lyophilization facility to be inspected and approved by the FDA.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 2001, the FASB issued three statements, SFAS No. 141, "Business
Combinations," SFAS No. 142, "Goodwill and Other Intangible Assets," and SFAS
No. 143, "Accounting for Asset Retirement Obligations."

SFAS No. 141 supercedes APB Opinion No. 16, "Business Combinations,"
and eliminates the pooling-of-interests method of accounting for business
combinations, thus requiring all business combinations be accounted for using
the purchase method. In addition, in applying the purchase method, SFAS No. 141
changes the criteria for recognizing intangible assets apart from goodwill. The
following criteria is to be considered in determining the recognition of the
intangible assets: (1) the intangible asset arises from contractual or other
legal rights, or (2) the intangible asset is separable or dividable from the
acquired entity and capable of being sold, transferred, licensed, rented, or
exchanged. The requirements of SFAS No. 141 are effective for all business
combinations completed after June 30, 2001. The adoption of this new standard
did not have an effect on the Company's financial statements.

SFAS No. 142 supercedes APB Opinion No. 17, "Intangible Assets," and
requires goodwill and other intangible assets that have an indefinite useful
life to no longer be amortized; however, these assets must be reviewed at least
annually for impairment. The Company has adopted SFAS No. 142 as of January 1,
2002 and no impairments were recognized upon adoption.

SFAS No. 143 requires entities to record the fair value of a liability for
an asset retirement obligation in the period in which it is incurred. When the
liability is initially recorded, the entity capitalizes a cost by increasing the
carrying amount of the related long-lived asset. Over time, the liability is
accreted to its present value each period, and the capitalized cost is
depreciated over the useful life of the related asset. Upon settlement of the
liability, an entity either settles the obligation for its recorded amount or
incurs a gain or loss upon settlement. The Company has adopted SFAS No. 143 as
of January 1, 2002. The adoption of this new standard did not have an effect on
the Company's financial statements.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long- Lived Assets." This statement addresses
financial accounting and reporting for the impairment or disposal of long-lived
assets. This statement supercedes SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This
statement also supercedes the accounting and reporting provisions of APB Opinion
No. 30, "Reporting the Results of Operations -- Reporting the Effects of
Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions," for the disposal of a segment of a business
(as previously defined in that Opinion). SFAS No. 144 is effective January 1,
2002. The adoption of this new standard did not have any effect on the Company's
financial statements upon adoption.

In April 2002, the FASB issued SFAS No. 145 "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." This statement updates, clarifies and simplifies existing
accounting pronouncements. SFAS No. 145 rescinds SFAS No. 4, "Reporting Gains
and Losses from Extinguishments of Debt", which requires all gains and losses
from extinguishments of debt to be aggregated and, if material, classified as an
extraordinary item, net of related income tax effect. As a result, the criteria
in APB Opinion No. 30 will now be used to classify those gains and losses. SFAS
No. 64, "Extinguishment of Debt Made to Satisfy Sinking-Fund Requirements",
amended SFAS No. 4, is no longer necessary because SFAS No. 4 has been
rescinded. SFAS No. 145 amends SFAS No. 13 "Accounting for Leases", to require
that certain lease modifications that have economic effects similar to
sale-leaseback transaction be accounted for in the same manner as sale-leaseback
transactions. Certain provisions of SFAS No. 145 are effected for fiscal years
beginning after May 15, 2002, while other provisions are effected for
transactions occurring after May 15, 2002. The adoption of SFAS No. 145 did not
have a significant impact on the Company's financial statements.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 requires the Company
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal plan.
The Company will adopt SFAS No. 146 for exit or disposal activities initiated
after December 31, 2002. The adoption of this standard did not have a material
effect on its financial statements.

In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation -- Transition and Disclosure, an amendment of FASB
Statement No. 123". This Statement amends SFAS No. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
SFAS No. 123 to require prominent disclosure in both annual and interim
financial statements. Certain of the disclosure requirements are required for
fiscal years ending after December 15, 2002.

In November 2002, the FASB issued Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirement for Guarantees, Including
Indirect Guarantees of Indebtedness to Others, an interpretation of FASB
Statements No. 5, 57 and 107 and a rescission of FASB Interpretation No. 34."
This Interpretation elaborates on the disclosure to be made by a guarantor in
its interim and annual financial statements about its obligations under
guarantees issued. The Interpretation also clarifies that a guarantor is
required to recognize, at inception of a guarantee, a liability for the fair
value of the obligation undertaken. The initial recognition and measurement
provisions of the Interpretation are applicable to guarantees issued or modified
after December 31, 2002 and are not expected to have a material effect on the
Company's financial statements. The disclosure requirements are effective for
financial statements of interim or annual periods ending after December 15,
2002. The Company has determined that FIN 45 will not have an effect on the
Company's financial condition, results of operations or cash flows.

In January, 2003, the FASB issued Interpretation No. 46 ("FIN 46"),
"Consolidation of Variable Interest Entities", with the objective of improving
financial reporting by companies involved with variable interest entities. A
variable interest entity is a corporation, partnership, trust, or 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 equity to support its activities.
Historically, entities generally were not consolidated unless the entity was
controlled through voting interests. FIN 46 changes that by requiring a variable
interest entity to be consolidated by a company if that company is subject to a
majority of risk of loss from the variable interest entity's activities or
entitled to receive a majority of the entity's residual returns, or both. A
company that consolidates a variable interest entity is called the "primary
beneficiary" of that entity. FIN 46 also requires disclosures about variable
interest entities that a company is not required to consolidate but in which it
has significant variable interest. The consolidation requirements of FIN 46
apply immediately to variable interest entities created after January 1, 2003.
The consolidation requirements of FIN 46 apply to existing entities in the first
fiscal year or interim period beginning after June 15, 2003. Also, certain
disclosure requirements apply to all financial statements issued after January
31, 2003, regardless of when the variable interest entity was established. The
Company has determined that FIN 46 will not have an impact on its financial
condition, results of operations or cash flows.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Mr. John N. Kapoor, Ph.D., the Company's current Chairman of the Board and
Chief Executive Officer from March 2001 to December 2002, and a principal
shareholder, is affiliated with EJ Financial Enterprises, Inc., a health care
consulting investment company ("EJ Financial"). EJ Financial is involved in the
management of health care companies in various fields, and Dr. Kapoor is
involved in various capacities with the management and operation of these
companies. The John N. Kapoor Trust, the beneficiary and sole trustee of which
is Dr. Kapoor, is a principal shareholder of each of these companies. As a
result, Dr. Kapoor does not devote his full time to the business of the Company.
Although such companies do not currently compete directly with the Company,
certain companies with which EJ Financial is involved are in the pharmaceutical
business. Discoveries made by one or more of these companies could render the
Company's products less competitive or obsolete. In addition, one of these
companies, NeoPharm, Inc. of which Dr. Kapoor is Chairman and a major
stockholder, recently entered into a loan agreement with the Company. The
Company also owes EJ Financial $18,000 in consulting fees for each of 2002 and
2001, as well as expense reimbursements of $2,000 and $182,000 for 2002 and
2001, respectively. Further, The John N. Kapoor Trust has loaned the Company
$5,000,000 resulting in Dr. Kapoor becoming a major creditor of the Company as
well as a major shareholder.

On March 21, 2001, in consideration of Dr. Kapoor assuming the positions of
President and interim CEO of the Company, the Compensation Committee of the
Board of Directors agreed to issue Dr. Kapoor 500,000 options under the Amended
and Restated Akorn, Inc. 1988 Incentive Compensation Program in lieu of cash
compensation.

On July 12, 2001, the Company entered into a $5,000,000 subordinated debt
transaction with the John N. Kapoor Trust dtd. 9/20/89 (the "Trust"), the sole
trustee and sole beneficiary of which is Dr. John N. Kapoor, the Company's
Chairman of the Board of Directors. The transaction is evidenced by a
Convertible Bridge Loan and Warrant Agreement (the "Trust Agreement") in which
the Trust agreed to provide two separate tranches of funding in the amounts of
$3,000,000 ("Tranche A" which was received on July 13, 2001) and $2,000,000
("Tranche B" which was received on August 16, 2001). As part of the
consideration provided to the Trust for the subordinated debt, the Company
issued the Trust two warrants which allow the Trust to purchase 1,000,000 shares
of common stock at a price of $2.85 per share and another 667,000 shares of
common stock at a price of $2.25 per share. The exercise price for each warrant
represented a 25% premium over the share price at the time of the Trust's
commitment to provide the subordinated debt. All unexercised warrants will
expire on December 20, 2006.

Under the terms of the Trust Agreement, the subordinated debt bears
interest at prime plus 3%, which is the same rate the Company pays on its senior
debt. Interest cannot be paid to the Trust until the repayment of the senior
debt pursuant to the terms of a subordination agreement, which was entered into
between the Trust and the Company's senior lenders. Should the subordination
agreement be terminated, interest may be paid sooner. The convertible feature of
the Trust Agreement, as amended, allows for conversion of the subordinated debt
plus interest into common stock of the Company, at a price of $2.28 per share of
common stock for Tranche A and $1.80 per share of common stock for Tranche B.

In December 2001, the Company entered into a $3,250,000 five-year loan with
NeoPharm, Inc. ("NeoPharm") to fund Akorn's efforts to complete its
lyophilization facility located in Decatur, Illinois. Under the terms of the
promissory note, dated December 20, 2001, evidencing the loan (the Promissory
Note") interest will accrue at the initial rate of 3.6% and will be reset
quarterly based upon NeoPharm's average return on its cash and readily tradable
long and short-term securities during the previous calendar quarter. The
principal and accrued interest is due and payable on or before maturity on
December 20, 2006. The note provides that Akorn will use the proceeds of the
loan solely to validate and complete the lyophilization facility located in
Decatur, Illinois. In consideration for the loan, under a separate manufacturing
agreement between the Company and NeoPharm, the Company, upon completion of the
lyophilization facility, agrees to provide NeoPharm with access to at least 15%
of the capacity of Akorn's lyophilization facility each year. The Promissory
Note is subordinated to Akorn's senior debt owed to The Northern Trust Company
but is senior to Akorn's subordinated debt owed to the Trust. Dr. John N.
Kapoor, the Company's chairman is also chairman of NeoPharm and holds a
substantial stock position in that company as well as in the Company.

Commensurate with the completion of the Promissory Note between the Company
and NeoPharm, the Company entered into an agreement with the Trust, which
amended the Trust Agreement. The amendment extended the Trust Agreement to
terminate concurrently with the Promissory Note on December 20, 2006. The
amendment also made it possible for the Trust to convert the interest accrued on
the $3,000,000 tranche into common stock of the Company. Previously, the Trust
could only convert the interest accrued on the $2,000,000 tranche. The change
related to the convertibility of the interest accrued on the $3,000,000 tranche
requires that shareholder approval be received by August 31, 2002, which date
has been extended to June 30, 2003.

The Company has an equity ownership interest in Novadaq Technologies, Inc.
("Novadaq") of 4,132,000 common shares, representing approximately 16.9% of the
outstanding stock of Novadaq. Previously, the Company had entered into a
marketing agreement with Novadaq, which was terminated in early 2002. The
Company, as part of the termination settlement, received the aforementioned
shares and entered into an agreement with Novadaq to be the exclusive future
supplier of Indocyanine Green for use in Novadaq's diagnostic procedures. The
Company also has the right to appoint one individual to the Board of Directors
of Novadaq. Ben J. Pothast, the Company's Chief Financial Officer, currently
serves in this capacity.

23

FORWARD LOOKING STATEMENTS

Certain statements in this Form 10-Q constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act.
When used in this document, the words "anticipate," "believe," "estimate" and
"expect" and similar expressions are generally intended to identify
forward-looking statements. Any forward-looking statements, including statements
regarding the intent, belief or expectations of the Company or its management
are not guarantees of future performance. These statements involve risks and
uncertainties and actual results may differ materially from those in the
forward-looking statements as a result of various factors, including but not
limited to:

o the Company's ability to restructure or refinance its debt to its senior
lenders, which is currently in default, but subject to a forbearance
agreement;

o the Company's ability to obtain further extensions of the forbearance
agreement which originally expired on January 3, 2003, but has subsequently
been extended for successive short-term periods, the latest of which expires
on June 30, 2003;

o the Company's ability to avoid further defaults under debt covenants;

o the Company's ability to generate cash from operations sufficient to meet
its working capital requirements;

o the Company's ability to obtain additional funding to operate and grow its
business;

o the Company's ability to resolve its Food and Drug Administration compliance
issues at its Decatur, Illinois facility;

o the effects of federal, state and other governmental regulation of the
Company's business;

o the Company's success in developing, manufacturing and acquiring new
products;

o the Company's ability to bring new products to market and the effects of
sales of such products on the Company's financial results;

o the effects of competition from generic pharmaceuticals and from other
pharmaceutical companies;

o availability of raw materials needed to produce the Company's products; and

o other factors referred to in this Form 10-Q and the Company's other
Securities and Exchange Commission filings.

The Company does not intend to update these forward looking statements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company is subject to market risk associated with changes in
interest rates. The Company's interest rate exposure involves three debt
instruments. The Credit Agreement with the Senior Lenders and the subordinated
convertible debentures issued to the John N. Kapoor Trust bear the same interest
rate, which fluctuates at prime plus 300 basis points. The third debt
instrument, the promissory note issued to NeoPharm, Inc. ("NeoPharm"), bears
interest at an initial rate of 3.6% and is reset quarterly based upon NeoPharm's
average return on its cash and readily tradable long and short-term securities
during the previous calendar quarter. All of the Company's remaining long-term
debt is at fixed interest rates. Management estimates that a change of 100 basis
points in its variable rate debt from the interest rates in effect at September
30, 2002 would result in a $316,000 change in annual interest expense.

The Company's financial instruments consist mainly of cash, accounts
receivable, accounts payable and debt. The carrying amounts of these
instruments, except debt, approximate fair value due to their short-term nature.
The carrying amounts of the Company's bank borrowings under its credit facility
approximate fair value because the interest rates are reset periodically to
reflect current market rates.

The fair value of the credit agreement and convertible subordinated
debenture approximated the recorded value as of September 30, 2002. The
promissory note between the Company and NeoPharm, Inc. bears interest at a rate
that is lower than the Company's current borrowing rate with its Senior Lenders.
Accordingly, the computed fair value of the debt, which the Company estimates to
be approximately $2,650,000, would be lower than the current carrying value of
$3,250,000.

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the Company's
Exchange Act reports is recorded, processed, summarized and reported within the
periods specified in the SEC's rules and forms and that such information is
accumulated and communicated to the Company's management including its Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure.

25

Within 90 days of this report, the Company carried out an evaluation, under
the supervision and with the participation of our 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. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the evaluation date, the disclosure
controls and procedures are effective in timely communicating to them the
material information relating to the Company required to be included in the
Company's periodic SEC filings.

As discussed in greater detail in the Company's Report on Form 8-K dated
May 1, 2003, Deloitte & Touche LLP ("Deloitte") informed the Company that, in
connection with its audit of the Company's consolidated financial statements for
the year ended December 31, 2002, it noted certain matters involving the
Company's internal controls that Deloitte considered to be material weaknesses.
Although the Company does not necessarily agree with Deloitte's judgment that
there existed material weaknesses in the Company's internal controls, the
Company is in the process of implementing procedures designed to address all
relevant internal control issues.

To date, the Company has expanded its interim evaluation of accounts
receivable for purposes of determining the allowance for doubtful accounts and
has reassigned certain personnel to strengthen the accounting for fixed assets.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On March 27, 2002, the Company received a letter informing it that the
staff of the SEC's regional office in Denver, Colorado, would recommend to the
SEC that it bring an enforcement action against the Company and seek an order
requiring the Company to be enjoined from engaging in certain conduct. The staff
alleged that the Company misstated its income for fiscal years 2000 and 2001 by
allegedly failing to reserve for doubtful accounts receivable and overstating
its accounts receivable balance as of December 31, 2000. The staff alleged that
internal control and books and records deficiencies prevented the Company from
accurately recording, reconciling and aging its accounts receivable. The Company
also learned that certain of its former officers, as well as a then current
employee had received similar notifications. Subsequent to the issuance of the
Company's consolidated financial statements for the year ended December 31,
2001, management of the Company determined it needed to restate the Company's
financial statements for 2000 and 2001 to record a $7.5 million increase to the
allowance for doubtful accounts as of December 31, 2000, which it had originally
recorded as of March 31, 2001.

On February 27, 2003, the Company reached an agreement in principle with
the staff of the SEC's regional office in Denver, Colorado, that would resolve
the issues arising from the staff's investigation and proposed enforcement
action as discussed above. The Company has offered to consent to the entry of an
administrative cease and desist order as proposed by the staff, without
admitting or denying the findings set forth therein. The proposed consent order
finds that the Company failed to promptly and completely record and reconcile
cash and credit remittances, including from its top five customers, to invoices
posted in its accounts receivable sub-ledger. According to the findings in the
proposed consent order, the Company's problems resulted from, among other
things, internal control and books and records deficiencies that prevented the
Company from accurately recording, reconciling and aging its receivables. The
proposed consent order finds that the Company's 2000 Form 10-K and first quarter
2001 Form 10-Q misstated its account receivable balance or, alternatively,
failed to disclose the impairment of its accounts receivable and that its first
quarter 2001 Form 10-Q inaccurately attributed the increased accounts receivable
reserve to a change in estimate based on recent collection efforts, in violation
of Section 13(a) of the Exchange Act and rules 12b-20, 13a-1 and 13a-13
thereunder. The proposed consent order also finds that the Company failed to
keep accurate books and records and failed to devise and maintain a system of
adequate internal accounting controls with respect to its accounts receivable in
violation of Sections 13(b)(2)(A) and 13(b)(2)(B) of the Exchange Act. The
proposed consent order does not impose a monetary penalty against the Company or
require any additional restatement of the Company's financial statements. The
Company has recently become aware of and informed the SEC staff of certain
weaknesses in its internal controls, which it is in the process of addressing.
It is uncertain at this time what effect these actions will have on the
agreement in principle currently pending with the SEC staff. The proposed
consent order does not become final until it is approved by the SEC.
Accordingly, the Company may incur additional costs and expenses in connections
with this proceeding.

The Company was party to a License Agreement with JHU/APL effective April
26, 2000, and amended effective July 15, 2001. Pursuant to the License
Agreement, the Company licensed two patents from JHU/APL for the development and
commercialization of a diagnosis and treatment for age-related macular
degeneration ("AMD") using Indocyanine Green ("ICG"). A dispute arose between
the Company and JHU/APL concerning the License Agreement. Specifically, JHU/APL
challenged the Company's performance required by December 31, 2001 under the
License Agreement and alleged that the Company was in breach of the License
Agreement. The Company denied JHU/APL's allegations and contended that it had
performed in accordance with the terms of the License Agreement. As a result of
the dispute, on March 29, 2002, the Company commenced a lawsuit in the U.S.
District Court for the Northern District of Illinois, seeking declaratory and
other relief against JHU/APL. On July 3, 2002, the Company reached an agreement
with JHU/APL with regard to the dispute that had risen between the two parties.
The Company and JHU/APL mutually agreed to terminate their license agreement. As
a result, the Company no longer has any rights to the JHU/APL patent rights as
defined in the license agreement. In exchange for relinquishing its rights to
the JHU/APL patent rights, the Company received an abatement of the $300,000 due
to JHU/APL at March 31, 2002 and a payment of $125,000 to be received by August
3, 2002. The Company also has the right to receive 15% of all cash payments and
20% of all equity received by JHU/APL from any license of the JHU/APL patent
rights less any cash or equity returned by JHU/APL to such licensee. The
combined total of all such cash and equity payments are not to exceed
$1,025,000. The $125,000 payment is considered an advance towards cash payments
due from JHU/APL and will be credited against any future cash payments due the
Company as a result of JHU/APL's licensing efforts. As a result of the resolved
dispute discussed above, the Company recorded an asset impairment charge of
$1,559,500 in 2002. The impairment amount represents the net value of the asset
recorded on the balance sheet of the Company less the $300,000 payment abated by
JHU/APL and the $125,000 payment from JHU/APL. The $125,000 payment was received
on August 3, 2002.

26

In the fourth quarter of 2002, the Company learned that JHU/APL had
licensed their two patents related to the AMD to Novadaq. In connection with the
settlement of a prior dispute with Novadaq in January 2002 (as discussed below),
the Company had previously acquired an equity interest in Novadaq. Pursuant to
the settlement with JHU/APL, the Company is entitled to 20% of all equity
received by JHU/APL from any license of the patent rights. Therefore, the
Company received an additional 132,000 shares of Novadaq, valued at $23,000
which will be recorded as a gain in the fourth quarter of 2002.

In October 2000, the FDA issued a warning letter to the Company following
the FDA's routine cGMP the inspection of the Company's Decatur manufacturing
facilities. This letter addressed several deviations from regulatory
requirements including cleaning validations and general documentation and
requested corrective actions be undertaken by the Company. The Company initiated
corrective actions and responded to the warning letter. Subsequently, the FDA
conducted another inspection in late 2001 and identified additional deviations
from regulatory requirements including process controls and cleaning
validations. This led to the FDA leaving the warning letter in place and issuing
a Form 483 to document its findings. While no further correspondence was
received from the FDA, the Company responded to the inspectional findings. This
response described the Company's plan for addressing the issues raised by the
FDA and included improved cleaning validation, enhanced process controls and
approximately $2.0 million of capital improvements. In August 2002, the FDA
conducted an inspection of the Decatur facility and identified cGMP deviations.
The Company responded to these observations in September 2002. In response to
the Company's actions, the FDA conducted another inspection of the Decatur
facility during the period from December 10, 2002 to February 6, 2003. This
inspection identified deviations from regulatory requirements including the
manner in which the Company processes and investigates manufacturing
discrepancies and failures, customer complaints and the thoroughness of
equipment cleaning validations. Deviations identified during this inspection had
been raised in previous FDA inspections. The Company has responded to these
latest findings in writing and in a meeting with the FDA in March 2003. The
Company set forth its plan for implementing comprehensive corrective actions,
has provided a progress report to the FDA on April 15 and May 15, 2003 and has
committed to providing the FDA additional periodic reports of progress on June
15, 2003.

As a result of the latest inspection and the Company's response, the FDA
may take any of the following actions: (i) accept the Company's reports and
response and take no further action against the Company; (ii) permit the Company
to continue its corrective actions and conduct another inspection (which likely
would not occur before the fourth quarter of 2003) to assess the success of
these efforts; (iii) seek to enjoin the Company from further violations, which
may include temporary suspension of some or all operations and potential
monetary penalties; or (iv) take other enforcement action which may include
seizure of Company products. At this time, it is not possible to predict the
FDA's course of action.

The Company believes that unless and until the FDA chooses option (i) or,
in the case of option (ii), unless and until the issues identified by the FDA
have been successfully corrected and the corrections have been verified through
reinspection, it is doubtful that the FDA will approve any NDAs or ANDAs that
may be submitted by the Company. This has adversely impacted, and is likely to
continue to adversely impact the Company's ability to grow sales. However, the
Company believes that unless and until the FDA chooses option (iii) or (iv), the
Company will be able to continue manufacturing and distributing its current
product lines.

If the FDA chooses option (iii) or (iv), such action could significantly
impair the Company's ability to continue to manufacture and distribute its
current product line and generate cash from its operations, could result in a
covenant violation under the Company's senior debt or could cause the Company's
senior lenders to refuse further extensions of the Company's senior debt, any or
all of which would have a material adverse effect on the Company's liquidity.
Any monetary penalty assessed by the FDA also could have a material adverse
effect on the Company's liquidity.

On March 6, 2002, the Company received a letter from the United States
Attorney's Office, Central District of Illinois, Springfield, Illinois, advising
the Company that the DEA had referred a matter to that office for a possible
civil legal action for alleged violations of the Comprehensive Drug Abuse
Prevention Control Act of 1970, 21 U.S.C. sec. 801, et. seq. and regulations
promulgated under the Act. The alleged violations relate to record keeping and
controls surrounding the storage and distribution of controlled substances. On
November 6, 2002, the Company entered into a Civil Consent Decree with the DEA.
Under terms of the Consent Decree, the Company, without admitting any of the
allegations in the complaint from the DEA, has agreed to pay a fine of $100,000,
upgrade its security system and to remain in substantial compliance with the
Comprehensive Drug Abuse Prevention Control Act of 1970. If the Company does not
remain in substantial compliance during the two-year period following the entry
of the civil consent decree, the Company, in addition to other possible
sanctions, may be held in contempt of court and ordered to pay an additional
$300,000 fine.

On April 4, 2001, the International Court of Arbitration (the "ICA") of the
International Chamber of Commerce notified the Company that Novadaq had filed a
Request for Arbitration with the ICA on April 2, 2001. Akorn and Novadaq had
previously entered into an Exclusive Cross-Marketing Agreement dated July 12,
2000 (the "Agreement"), providing for their joint development and marketing of
certain devices and procedures for use in fluorescein angiography (the
"Products"). Akorn's drug indocyanine green ("ICG") would be used as part of the
angiographic procedure. The FDA had requested that the parties undertake
clinical studies prior to obtaining FDA approval. In its Request for
Arbitration, Novadaq asserted that under the terms of the Agreement, Akorn
should be responsible for the costs of performing the requested clinical trials,
which were estimated to cost approximately $4,400,000. Alternatively, Novadaq
sought a declaration that the Agreement should be terminated as a result of
Akorn's alleged breach. Finally, in either event, Novadaq sought unspecified
damages as a result of the alleged failure or delay on Akorn's part in
performing its obligations under the Agreement. In its response, Akorn denied
Novadaq's allegations and alleged that Novadaq had breached the agreement. On
January 25, 2002, the Company and Novadaq reached a settlement of the dispute.
Under terms of a revised agreement entered into as part of the settlement,
Novadaq will assume all further costs associated with development of the
technology. The Company, in consideration of foregoing any share of future net
profits, obtained an equity ownership interest in Novadaq, the right to be the
exclusive supplier of ICG for use in Novadaq's diagnostic procedures and the
right to designate a representative on the Novadaq Board of Directors. In
addition, Antonio R. Pera, Akorn's then President and Chief Operating Officer,
was named to Novadaq's Board of Directors. In conjunction with the revised
agreement, Novadaq and the Company each withdrew their respective arbitration
proceedings. Subsequent to the resignation of Mr. Pera on June 7, 2002, the
Company named Ben J. Pothast, its Chief Financial Officer, to fill the vacancy
on the Novadaq Board of Directors created by his departure.

On December 19, 2002 and January 22, 2003, the Company received demand
letters regarding claimed wrongful deaths allegedly associated with the use of
the drug Inapsine, which the Company produced. The total amount of the claims
asserted is $3.8 million. The Company has just begun the investigation of the
facts and circumstances surrounding these claims and cannot as of yet determine
the potential liability, if any, from these claims. The Company has submitted
these claims to its product liability insurance carrier. The Company intends to
vigorously defend itself in regards to these claims.

The Company is a party to legal proceedings and potential claims arising in
the ordinary course of its business. The amount, if any, of ultimate liability
with respect to such matters cannot be determined. Despite the inherent
uncertainties of litigation, management of the Company at this time does not
believe that such proceedings will have a material adverse impact on the
financial condition, results of operations, or cash flows of the Company.

27

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULT UPON SENIOR SECURITIES

The Company is currently in default under certain covenants on its
senior credit facility, including the failure to make a $39,200,000 principal
payment that was due on August 31, 2002. There have been no defaults on interest
payments due on the loan. As long as the Company is in compliance with the terms
of the Forbearance Agreement entered into with the Senior Lenders on September
20, 2002, the Senior Lenders have agreed to forbear from exercising their
remedies under the credit facility until January 3, 2003 which was subsequently
extended until June 30, 2003. See Part I, Item 1, "Financial Statements" Note G
- - Financing Arrangements.

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

No matters were submitted to a vote of security holders during the
quarter ended September 30, 2002.

ITEM 5. OTHER INFORMATION

On September 23, 2002, Mr. Arthur S. Pryzbyl, formerly Senior Vice
President for sales and marketing of the Company, was named President and COO of
the Company.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Exhibits

(10.28) Amendment #1 to the Pre-Negotiation Agreement by and among the
Company, Akorn (NJ) Inc. and The Northern Trust Company dated as of
October 18, 2002.

(10.39) Engagement Letter by and among the Company and AEG Partners LLC
dated as of September 26, 2002.

(99.1) Certifications of Chief Executive Officer and Chief Financial
Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.

28

(b) Reports on Form 8-K

There were no filings during the third quarter, 2002.

29

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.

AKORN, INC.

/s/ BEN J. POTHAST
-----------------------------------
Ben J. Pothast
Vice President, Chief Financial
Officer and Secretary
(Duly Authorized and Principal
Financial Officer)

Date: May 21, 2003

30

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Arthur S. Przybyl, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Akorn, Inc.;

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

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and have:

A) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;

B) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and

C) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of the registrant's board of directors
(or persons performing the equivalent function):

A) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weakness in internal controls; and

B) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and

6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.

Date: May 21, 2003 /s/ ARTHUR S. PRZYBYL
--------------------------------------
Name: Arthur S. Przybyl
Title: Interim Chief Executive Officer

31

CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Ben J. Pothast, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Akorn, Inc.;

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

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;

4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and have:

A) Designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this quarterly report is being prepared;

B) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this quarterly report (the "Evaluation
Date"); and

C) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;

5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of the registrant's board of directors (or
persons performing the equivalent function):

A) All significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weakness in internal controls; and

B) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and

6. The registrant's other certifying officer and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.

Date: May 21, 2003 /s/ BEN J. POTHAST
---------------------------------------
Name: Ben J. Pothast
Title: Chief Financial Officer

32