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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, 2003
[ ] 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 Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ ] No [X]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
Yes [ ] No [X]
The financial statements included in this Form 10-Q have not been reviewed
by independent public accountants in accordance with Rule 10-01 (d) of
Regulation S-X. See explanatory Note on Page 2.
At November 10, 2003 there were 19,821,046 shares of common stock, no par
value, outstanding.
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EXPLANATORY NOTE
On April 24, 2003, Deloitte and Touche LLP ("Deloitte") notified the
Company that it would decline to stand for re-election as the Company's
independent accountants after completion of the audit of the Company's
consolidated financial statements as of and for the year ending December 31,
2002. Deloitte completed its audit and delivered its auditors' report on May 20,
2003, and has advised the Company that the client-auditor relationship between
the Company and Deloitte has ceased. On October 22, 2003, the Company engaged
BDO Siedman, LLP as the Company's principal accountants to audit the financial
statements of the Company for its fiscal year ending December 31, 2003 and to
review the Company's financial statements for the fiscal quarters ended March
31, June 30, and September 30, 2003. BDO Siedman has informed the Company that
it will not be able to complete the review of the Company's quarterly financial
statements until December 2003. As a result, independent accountants have not
reviewed the financial statements and notes thereto included in this Form 10-Q
in accordance with rule 10-01(d) of Regulation S-X and this Form 10-Q does not
comply with other requirements of Section 13(a) of the Securities and Exchange
Act of 1934 ("Exchange Act") relating to independent accountants or auditors.
The Company believes that the unaudited financial statements and notes to the
consolidated financial statements included therein contain all of the
information and necessary adjustments for a fair presentation of these financial
statements and accompanying notes.
PAGE
----
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets-September 30, 2003
and December 31, 2002...................................... 3
Condensed Consolidated Statements of Operations-Three
months and nine months ended September 30, 2003 and 2002... 4
Condensed Consolidated Statements of Cash Flows-Nine
months ended September 30, 2003 and 2002................... 5
Notes to Condensed Consolidated Financial Statements....... 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................ 20
ITEM 3. Quantitative and Qualitative Disclosures about
Market Risk................................................ 29
ITEM 4. Controls and Procedures................................ 29
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings...................................... 29
ITEM 2. Changes in Securities and Use of Proceeds.............. 32
ITEM 3. Default Upon Senior Securities......................... 32
ITEM 4. Submission of Matters to a Vote of Security Holders.... 32
ITEM 5. Other Information...................................... 32
ITEM 6. Exhibits and Reports on Form 8-K....................... 32
2
AKORN, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
IN THOUSANDS
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents ...................... $ 304 $ 364
Trade accounts receivable (less allowance
for doubtful accounts of $520 and $1,200) ... 3,167 1,421
Inventory ...................................... 8,714 10,401
Deferred income taxes .......................... -- --
Income taxes recoverable ....................... -- 670
Prepaid expenses and other current assets ...... 1,278 383
------------- -------------
TOTAL CURRENT ASSETS ...................... 13,463 13,239
OTHER ASSETS
Intangibles, net ............................... 13,094 14,142
Investment in Novadaq Technologies, Inc. ....... 713 713
Deferred income taxes .......................... -- --
Other .......................................... 130 130
------------- -------------
TOTAL OTHER ASSETS .......................... 13,937 14,985
PROPERTY, PLANT AND EQUIPMENT, NET ................ 34,226 35,314
------------- -------------
TOTAL ASSETS ................................ $ 61,626 $ 63,538
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current installments of long-term debt ......... $ 6,120 $ 35,859
Trade accounts payable ......................... 7,232 5,756
Accrued compensation ........................... 575 836
Accrued expenses and other current liabilities.. 866 1,352
------------- -------------
TOTAL CURRENT LIABILITIES ................... 14,793 43,803
LONG-TERM DEBT .................................... 40,575 7,799
OTHER LONG-TERM LIABILITIES ....................... -- 584
------------- -------------
TOTAL LIABILITIES ........................... 55,368 52,186
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY
Common stock ................................... 26,866 26,866
Accumulated deficit ............................ (20,608) (15,514)
------------- -------------
TOTAL SHAREHOLDERS' EQUITY .................. 6,258 11,352
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY .. $ 61,626 $ 63,538
============= =============
See notes to condensed consolidated financial statements.
3
AKORN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
IN THOUSANDS, EXCEPT PER SHARE DATA
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Revenues ...................................... $ 13,498 $ 12,121 $ 35,120 $ 39,729
Cost of sales ................................. 9,274 7,665 24,518 22,558
---------- ---------- ---------- ----------
GROSS PROFIT ............................ 4,224 4,456 10,602 17,171
Selling, general and administrative expenses... 4,151 5,245 12,273 16,014
Provision, net of recoveries, for bad debts.... 21 370 (267) (30)
Amortization of intangibles ................... 349 359 1,047 1,057
Research and development expenses ............. 271 498 1,107 1,480
---------- ---------- ---------- ----------
TOTAL OPERATING EXPENSES ................ 4,792 6,472 14,160 18,521
---------- ---------- ---------- ----------
OPERATING INCOME (LOSS) ................. (568) (2,016) (3,558) (1,350)
Interest expense .............................. (626) (764) (1,882) (2,477)
Interest and other income (expense), net ...... -- 2 -- 2
---------- ---------- ---------- ----------
INTEREST EXPENSE AND OTHER .............. (626) (762) (1,882) (2,475)
---------- ---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES ....... (1,194) (2,778) (5,440) (3,825)
Income tax provision (benefit) ................ -- 6,609 (171) 6,193
---------- ---------- ---------- ----------
NET INCOME (LOSS) ....................... $ (1,194) $ (9,387) $ (5,269) $ (10,018)
========== ========== ========== ==========
NET INCOME (LOSS) PER SHARE:
BASIC ...................................... $ (0.06) $ (0.48) $ (0.27) $ (0.51)
========== ========== ========== ==========
DILUTED .................................... $ (0.06) $ (0.48) $ (0.27) $ (0.51)
========== ========== ========== ==========
SHARES USED IN COMPUTING NET LOSS PER SHARE:
BASIC ...................................... 19,754 19,610 19,721 19,567
========== ========== ========== ==========
DILUTED .................................... 19,754 19,610 19,721 19,567
========== ========== ========== ==========
See notes to condensed consolidated financial statements.
4
AKORN, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
IN THOUSANDS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2003 2002
---------- ----------
OPERATING ACTIVITIES
Net income (loss) ......................................... $ (5,269) $ (10,018)
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization .......................... 3,376 3,396
Deferred income taxes .................................. -- 5,919
Write-down of long-lived assets ....................... -- 2,362
Amortization of debt discounts ......................... 546 389
Changes in operating assets and liabilities:
Accounts receivable ................................. (1,745) 2,306
Income taxes recoverable ............................ 663 5,874
Inventory ........................................... 1,687 (2,467)
Prepaid expenses and other current assets ........... (890) (925)
Trade accounts payable .............................. 1,471 2,132
Accrued compensation ................................ (260) 98
Income taxes payable ................................ -- --
Accrued expenses and other liabilities .............. (505) (1,615)
---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES (927) 7,451
INVESTING ACTIVITIES
Purchases of property, plant and equipment ................ (1,302) (4,645)
Cash received for intangibles ............................. 125
NET CASH (USED IN) INVESTING ACTIVITIES ................... (1,302) (4,520)
FINANCING ACTIVITIES
Repayment of long-term debt ............................... (129) (5,802)
Borrowings under bank credit agreement .................... 2,235 --
Proceeds from employee stock purchase plan/exercise
of stock options ........................................ 63 387
---------- ----------
NET CASH PROVIDED BY FINANCING ACTIVITIES ................. 2,169 (5,415)
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS .......... (60) (2,484)
Cash and cash equivalents at beginning of period .......... 364 5,355
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD ................ $ 304 $ 2,871
========== ==========
Amount paid for interest
(net of capitalized interest) ........................... $ 699 $ 2,474
Amount paid (recovered) for income taxes .................. $ (834) $ (5,609)
See notes to condensed consolidated financial statements.
5
AKORN, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION
Business: Akorn, Inc. ("Akorn" or the "Company") 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.
Consolidation: The accompanying unaudited condensed consolidated financial
statements include the accounts of Akorn, Inc. and its wholly owned subsidiary
(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.
Adjustments: 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, 2003 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, 2002 included
in the Company's Annual Report on Form 10-K.
As discussed in Note A to the Company's consolidated financial statements for
the year ended December 31, 2002 and for the Company's condensed consolidated
financial statements for the periods ending March 31, 2003 and June 30, 2003,
the Company's losses from operations in recent years and working capital
deficiencies, together with the need to refinance or extend its senior debt and
successfully resolve its ongoing compliance matters with the Food and Drug
Administration ("FDA"), raised substantial doubt about the Company's ability to
continue as a going concern.
On October 7, 2003, the Company consummated a transaction with a group of
investors that resulted in the extinguishment of the Company's then outstanding
senior bank debt in the amount of approximately $37,801,000 in exchange for
shares of the Company's convertible preferred stock, warrants to purchase shares
of the Company's common stock, subordinated promissory notes in the aggregate
amount of $2,767,139 and a new credit facility under which approximately
$7,000,000 was outstanding as of the date of the transaction, $5,473,862 of
which was paid to the investors in the transaction. For more information
regarding this transaction, see Note O - "Subsequent Events" - to the Condensed
Consolidated Financial Statements. As a result, the Company has addressed its
working capital deficiencies and the need to refinance its debt on a long-term
basis. The Company also has developed and is continuing to implement a plan for
comprehensive corrective actions to address FDA compliance matters at its
Decatur, Illinois facility. For more information on the Company's ongoing FDA
compliance matters, see Note M - "Legal Proceedings" - to the Condensed
Consolidated Financial Statements.
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 carrying value of intangible assets and the carrying
value of deferred tax assets.
NOTE C - REVENUE RECOGNITION
The Company recognizes product sales for its ophthalmic and injectable
business segments upon the shipment of goods for customers whose terms are FOB
shipping point. The Company has several customers whose terms are FOB
destination point and recognizes revenue upon delivery of the product to these
customers. Revenue is recognized when all obligations of the Company have been
fulfilled and collection of the related receivable is probable. Provision for
estimated chargebacks, rebates, discounts and product returns is made at the
time of sale and is analyzed and adjusted, if necessary, at each balance sheet
date.
6
The contract services segment, which produces products for third party
customers, based upon their specification, at a pre-determined price, also
recognizes sales upon the shipment of goods or upon delivery of the product as
appropriate. Revenue is recognized when all obligations of the Company have been
fulfilled and collection of the related receivable is probable.
Royalty revenue is recognized in the period to which such revenue relates
based upon when the Company receives notification (monthly or quarterly) from
the counterparty that such counterparty has sold product for which Akorn is
entitled to a royalty.
NOTE D - ACCOUNTS RECEIVABLE ALLOWANCES
The nature of the Company's business inherently involves, in the ordinary
course, significant amounts and substantial volumes of accounting activity
(i.e., transactions and estimates) relating to allowances for product returns,
chargebacks, rebates and discounts given to customers. This is a natural
circumstance of the pharmaceutical industry and not specific to the Company and
inherently lengthens the collection process. Depending on the product, the
end-user customer, the specific terms of national supply contracts and the
particular arrangements with the Company's wholesaler customers, certain
rebates, chargebacks and other credits are deducted from the Company's accounts
receivable. The process of claiming these deductions depends on wholesalers
reporting to the Company the amount of deductions that were earned under the
respective terms with end-user customers. The amount of the deduction (if any)
depends on the identity of the end-user customer and the specific pricing
arrangements that Akorn has with that customer. This process can lead to
"partial payments" against outstanding invoices as the wholesalers take the
claimed deductions at the time of payment.
Allowance for Chargebacks and Rebates
The Company maintains allowances 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.
Management obtains wholesaler inventory reports to aid in analyzing the
reasonableness of the chargeback allowance. The Company assesses 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.
Similarly, the Company maintains an allowance for rebates related to
contract and other programs with certain customers. 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 its rebate-eligible
customers. Rebate percentages vary by product and by volume purchased by each
eligible customer. The Company tracks sales by product number for each eligible
customer and then applies the applicable rebate percentage, using both
historical trends and actual experience to estimate its rebate allowance. The
Company reduces gross sales and increases the rebate allowance by the estimated
rebate amount for each product sold to an eligible customer. The Company reduces
the rebate allowance when it processes a customer request for a rebate. At each
balance sheet date, the Company evaluates the allowance against actual rebates
processed and such amount can vary materially from period to period.
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 contracts and programs. For the three-month periods ended September
30, 2003 and 2002, the Company recorded chargeback and rebate expense of
$4,332,000, and $4,693,000, respectively. For the nine months ended September
30, 2003 and 2002, the Company recorded chargeback and rebate expense of
$10,637,000, and $12,247,000, respectively. The allowance for chargebacks and
rebates was $5,407,000 and $4,302,000 as of September 30, 2003 and December 31,
2002, respectively.
Allowance for Product Returns
7
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. 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. Actual
returns processed can vary materially from period to period. For the three-month
periods ending September 30, 2003 and 2002 the Company recorded a provision for
product returns of $453,000, and $790,000, respectively. For the nine-month
periods ending September 30, 2003 and 2002 the Company recorded a provision for
product returns of $1,790,000, and $1,822,000, respectively. The allowance for
potential product returns was $1,459,000 and $1,166,000 at September 30, 2003
and December 31, 2002, respectively.
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, factors that affect particular
distribution channels, 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)
other information such as buying patterns and payment patterns,
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 factors that might
affect collectibility of outstanding balances - based upon information
available at the time.
For the three-month periods ending September 30, 2003 and 2002, the Company
recorded a provision, net of recoveries, for doubtful accounts of $21,000 and
$370,000, respectively. For the nine-month periods ending September 30, 2003 and
2002, the Company recorded a provision, net of recoveries, for doubtful accounts
of ($267,000) and ($30,000), respectively. The allowance for doubtful accounts
was $520,000 and $1,200,000 as of September 30, 2003 and December 31, 2002,
respectively. As of September 30, 2003, the Company had a total of $3,439,000 of
past due gross accounts receivable, of which $118,000 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 $520,000, the portion related to the
wholesaler customers is $415,000 with the remaining $105,000 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-month periods ending September 30, 2003 and 2002, the Company recorded a
provision for discounts of $230,000 and $246,000, respectively. For the nine
months ending September 30, 2003 and 2002, the Company recorded a provision for
discounts of $588,000 and $759,000, respectively. The allowance for discounts
was $184,000 and $172,000 as of September 30, 2003 and December 31, 2002,
respectively.
NOTE E - INVENTORY
The components of inventory are as follows (in thousands):
8
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
Finished goods ............. $ 3,954 $ 3,460
Work in process ............ 2,113 1,877
Raw materials and supplies.. 2,647 5,064
---------- ----------
$ 8,714 $ 10,401
========== ==========
Inventory at September 30, 2003 and December 31, 2002 is reported net of
reserves for slow-moving, unsaleable and obsolete items of $1,118,000 and
$1,206,000, respectively, primarily related to finished goods. For the three and
nine-month periods ended September 30, 2003, the Company recorded a provision of
$263,000 and $671,000, respectively. For the nine months ended September 30,
2002, the Company recorded a provision of $493,000. There was no expense
recorded in the third quarter of 2002.
NOTE F - INTANGIBLE ASSETS
Intangible assets consist of product licenses 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. The Company assesses the impairment of intangibles based on
several factors, including estimated fair market value and anticipated cash
flows. 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, 2003 is as follows (in
thousands):
AS OF SEPTEMBER 30, 2003
------------------------------------------------
GROSS CARRYING ACCUMULATED NET CARRYING
AMOUNT AMORTIZATION AMOUNT
-------------- -------------- --------------
Product Licenses.... $ 22,685 $ 9,591 $ 13,094
The amortization expense of the above-listed acquired intangible assets for
each of the five years ending December 31, 2007 will be as follows (in
thousands):
For the year ended 12/31/03 (a)..... $ 1,419
For the year ended 12/31/04......... 1,404
For the year ended 12/31/05......... 1,357
For the year ended 12/31/06......... 1,304
For the year ended 12/31/07......... 1,281
(a) Amortization expense for the three months and nine months ended
September 30, 2003 amounted to $349,000 and $1,047,000, respectively.
NOTE G - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (in thousands):
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- -----------
Land..................................... $ 396 $ 396
Buildings and leasehold improvements..... 8,890 8,890
Furniture and equipment.................. 27,741 27,390
Automobiles.............................. 55 55
------------- ----------
37,082 36,731
Accumulated depreciation................. (21,518) (19,236)
------------- ----------
15,564 17,495
Construction in progress................. 18,662 17,819
------------- ----------
$ 34,226 $ 35,314
============= ==========
Construction in progress primarily represents capital expenditures related
to the Company's Lyophilization project that, upon completion, is expected to
enable the Company to perform processes in-house that are currently being
performed by a sub-contractor. The Company capitalized interest expense related
to the Lyophilization project of $307,000 and $303,000 during the three-month
periods ended September 30, 2003 and 2002, respectively. For the nine-month
periods ended September 30, 2003 and 2002, the Company capitalized interest
expense related to the Lyophilization project of $909,000 and $847,000,
respectively.
9
NOTE H - 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 was
secured by substantially all of the assets of the Company and its subsidiaries
and contained a number of restrictive covenants. There were outstanding
borrowings of $37,801,000 as of September 30, 2003 and $39,200,000 as of
September 30, 2002. The interest rate as of September 30, 2003 was 7.25%.
As previously disclosed, the Company went into default under the Northern
Trust Credit Agreement in 2002 and thereafter operated under an agreement under
which Northern Trust would agree to forbear from exercising its remedies (the
"Forbearance Agreement") and the Company acknowledged its then-current default.
The Forbearance Agreement provided a second line of credit that originally
allowed the Company to borrow the lesser of (i) the difference between the
Company's outstanding indebtedness to the senior lender and $39,200,000, and
(ii) $1,750,000, to fund the Company's day-to-day operations. The Forbearance
Agreement was extended on numerous occasions throughout the first and second
quarters of 2003.
On July 3, 2003, Northern Trust extended the expiration date of the
Forbearance Agreement from June 30, 2003 until July 31, 2003 and agreed to make
up to an additional $1,000,000 available to the Company under its current line
of credit, increasing the maximum amount available under the line of credit from
$1,750,000 to $2,750,000. Thereafter, Northern Trust agreed to further
extensions to the Forbearance Agreement, the most recent of which was on
September 22, 2003 and extended the expiration date of the Forbearance Agreement
until October 10, 2003.
On October 7, 2003, a group of investors (the "Investors") purchased all of
the Company's then outstanding senior bank debt from The Northern Trust Company
and exchanged such debt with the Company (the "Exchange Transaction") for (i)
257,172 shares of Series A 6.0% Participating Convertible Preferred Stock of the
Company, (ii) subordinated promissory notes in the aggregate principal amount of
$2,767,139.03 (the "2003 Subordinated Notes") issued by the Company to (a) The
John N. Kapoor Trust dtd 9/20/89 (the "Kapoor Trust"), the sole trustee and sole
beneficiary of which is Dr. John N. Kapoor, the Company's Chairman of the Board
of Directors and the holder of a significant stock position in the Company, (b)
Arjun Waney, a newly-elected director and the holder of a significant stock
position in the Company, and (c) Argent Fund Management Ltd., for which Mr.
Waney serves as Chairman and Managing Director and 51% of which is owned by Mr.
Waney, (iii) warrants to purchase an aggregate of 8,572,400 shares of the
Company's common stock with an exercise price of $1.00 per share, and (iv)
$5,473,862 in cash from the proceeds of the term loan under the New Credit
Facility described in the next paragraph. The Company also issued to the holders
of the 2003 Subordinated Notes warrants to purchase an aggregate of 276,714
shares of common stock with an exercise price of $1.10 per share. As a result of
the Exchange Transaction, the Company will record a gain in the fourth quarter
of 2003 of approximately $3,800,000 due to the extinguishment of the senior bank
debt. This gain will be reduced by the transaction costs related to the debt
extinguishment.
Simultaneously with the consummation of the Exchange Transaction, the
Company entered into a credit agreement with LaSalle Bank National Association
("LaSalle Bank") providing the Company with a $7,000,000 term loan and a
revolving line of credit of up to $5,000,000 to provide for working capital
needs (collectively, the "New Credit Facility") secured by substantially all of
the assets of the Company and its subsidiaries. The obligations of the Company
under the New Credit Facility have been guaranteed by the Kapoor Trust and Arjun
Waney. In exchange for this guaranty, the Company issued additional warrants to
purchase 880,000 and 80,000 shares of common stock to the Kapoor Trust and Arjun
Waney, respectively, and has agreed to issue to each of them, on each
anniversary of the date of the consummation of the Exchange Transaction,
warrants to purchase an additional number of shares of common stock equal to
0.08 multiplied by the principal dollar amount of the Company's indebtedness
then guaranteed by them under the New Credit Facility. The warrants issued in
exchange for these guarantees have an exercise price of $1.10 per share.
As a result of the Exchange Transaction, the Company has classified
$6,120,000 of the outstanding $37,801,000 debt owed to The Northern Trust
Company as of September 30, 2003 as short-term debt. The remaining $31,681,000
is classified as long-term debt.
The New Credit Facility with LaSalle Bank consists of a $5,500,000 term loan
A, a $1,500,000 term loan B (collectively, the "Term Loans") as well as a
revolving line of credit of up to $5,000,000 (the "Revolver") secured by
substantially all of the assets of the Company and its subsidiaries. The New
Credit Facility matures on October 7, 2005. The Term Loans bear interest at
prime plus 1.75% and require principal payments of $195,000 per month commencing
October 31, 2003, with the payments first to be applied to term loan B. The
Revolver bears interest at prime plus 1.50%. Availability under the Revolver is
determined by the sum of (i) 80% of eligible accounts receivable, (ii) 30% of
raw material, finished goods and component inventory excluding packaging items,
not to exceed $2.5 million and (iii) the difference between 90% of the forced
liquidation value of machinery and equipment ($4,092,000) and the sum of
$1,750,000 and the outstanding balance under term loan B. The New Credit
Facility contains certain restrictive covenants
10
including but not limited to certain financial covenants such as minimum EDITDA
levels, Fixed Charge Coverage Ratios, Senior Debt to EBITDA ratios and Total
Debt to EBITDA ratios.
On July 12, 2001, the Company entered into a $5,000,000 subordinated debt
transaction with the Kapoor Trust. The transaction is evidenced by a Convertible
Bridge Loan and Warrant Agreement (the "Trust Loan Agreement") in which the
Kapoor 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 Kapoor Trust for the subordinated debt, the
Company issued the Kapoor Trust two warrants which allow the Kapoor 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 Kapoor Trust's commitment to provide the subordinated debt.
All unexercised warrants expire on December 20, 2006.
Under the terms of the Trust Loan Agreement, the subordinated debt bears
interest at prime plus 3%, but interest payments are currently prohibited under
the terms of the subordination arrangements described below. The convertible
feature of the Trust Loan 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 APB Opinion No. 14, recorded the
subordinated debt under the Trust Loan Agreement 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. Prior to its amendment and
restatement in connection with the Exchange Transaction, the Promissory Note,
dated December 20, 2001 (the "NeoPharm Promissory Note"), provided for interest
to accrue at the initial rate of 3.6% and 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 NeoPharm Promissory Note
also provided for all principal and accrued interest to be due and payable on or
before maturity on December 20, 2006, and required the Company to use the
proceeds of the loan solely to validate and complete the lyophilization facility
located in Decatur, Illinois. The NeoPharm Promissory 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. As of September 30, 2003, the Company was in default under
the NeoPharm Promissory Note as a result of its failure to remove all FDA
warning letter sanctions related to the Company's Decatur, Illinois facility by
June 30, 2003. Dr. John N. Kapoor, the Chairman of the Company's Board of
Directors, is also chairman of NeoPharm and holds a substantial stock position
in NeoPharm as well as in the Company.
In connection with the Exchange Transaction, NeoPharm waived all existing
defaults under the NeoPharm Promissory Note and the Company and NeoPharm entered
into an Amended and Restated Promissory Note dated October 7, 2003 (the "Amended
NeoPharm Note") and as such the outstanding amount due under the Amended
NeoPharm Note is classified as long-term debt. Interest under the Amended
NeoPharm Note accrues at 1.75% above LaSalle Bank's prime rate, but interest
payments are currently prohibited under the terms of the subordination
arrangements described below. The Amended NeoPharm Note also requires the
Company to make quarterly payments of $150,000 beginning on the last day of the
calendar quarter during which all indebtedness under the New Credit Facility has
been paid. All remaining amounts owed under the Amended NeoPharm Note are
payable at maturity on December 20, 2006. The NeoPharm subordinated debt is
subordinated to the Company's bank debt under the New Credit Facility and is
senior to the Company's debt to the Kapoor Trust and to the 2003 Subordinated
Notes.
Contemporaneous with the completion of the NeoPharm Promissory Note between
the Company and NeoPharm, the Company entered into an agreement with the Kapoor
Trust, which amended the Trust Loan Agreement. The amendment extended the
maturity of the Trust Loan Agreement from July 12, 2004 to terminate
concurrently with the NeoPharm Promissory Note on December 20, 2006. The
amendment also made it possible for the Kapoor Trust to convert the interest
accrued on the $3,000,000 tranche, as well as interest on the $2,000,000 tranche
after the original maturity of the Tranche B note, into common stock of the
Company. Previously,
11
the Kapoor Trust could only convert the interest accrued on the $2,000,000
tranche through the original maturity of the Tranche B note. As of September 30,
2003, the Company was in default under the Trust Loan Agreement as a result of a
cross-default to the NeoPharm Promissory Note.
In connection with the Exchange Transaction, the Kapoor Trust waived all
existing defaults under the Trust Loan Agreement and the Company and the Kapoor
Trust entered into an amendment to the Trust Loan Agreement and as such the
outstanding amount due under the Trust Loan Agreement is classified as long-term
debt. That amendment did not change the interest rate or the maturity date of
the loans made under the Trust Loan Agreement. The debt owed under the Trust
Loan Agreement is subordinated to the Company's bank debt under the New Credit
Facility, the subordinated debt under the Amended NeoPharm Note and the 2003
Subordinated Notes issued in connection with the Exchange Transaction.
As part of the Exchange Transaction, the Company issued the 2003
Subordinated Notes to the Kapoor Trust, Arjun Waney and Argent Fund Management,
Ltd. The 2003 Subordinated Notes mature on April 7, 2006 and bear interest at
prime plus 1.75%, but interest payments are currently prohibited under the terms
of the subordination arrangements described below. The 2003 Subordinated Notes
are subordinated to the New Credit Facility and the Amended NeoPharm Note but
senior to Trust Loan Agreement with the Kapoor Trust. The Company also issued to
the holders of the 2003 Subordinated Notes warrants to purchase an aggregate of
276,714 shares of common stock with an exercise price of $1.10 per share.
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
$1,389,000 and $1,917,000 at September 30, 2003 and December 31, 2002,
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 I - NON-CASH TRANSACTIONS
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
reached on January 25, 2002. The Company had previously advanced $690,000 to
Novadaq for development costs and recorded these advances as an intangible
asset. Based on the settlement, the Company has reclassified these advances as
an Investment in Novadaq Technologies, Inc. The Company has determined this
investment should be valued using the cost method as described in Accounting
Principles Board ("APB") Opinion No. 18, "The Equity Method of Accounting for
Investments in Common Stock."
NOTE J - EARNINGS PER COMMON SHARE
Basic net income (loss) per common share is based upon weighted average
common shares outstanding. Diluted net income per common share is based upon the
weighted average number of common shares outstanding, including the dilutive
effect of stock options, warrants and convertible debt using the treasury stock
method.
The following table shows basic and diluted earnings per share computations
for the three and nine-month periods ended September 30, 2003 and 2002 (in
thousands, except per share information):
FOR THE THREE MONTHS ENDED FOR THE NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2002 2003 2002
---------- --------- --------- ---------
Net loss per share - basic:
Net loss.................................................... ($ 1,194) ($ 9,387) ($ 5,269) ($10,019)
Weighted average number of shares outstanding............... 19,754 19,610 19,721 19,567
Net loss per share - basic..................................... ($ 0.06) ($ 0.48) ($ 0.27) ($ 0.51)
======== ======== ======== ========
Net loss per share - diluted:
Net loss.................................................... ($ 1,194) ($ 9,387) ($ 5,269) ($10,019)
Net loss adjustment for interest on convertible debt
and convertible interest on debt......................... -- -- -- --
-------- -------- -------- --------
Net loss, as adjusted....................................... ($ 1,194) ($ 9,387) ($ 5,269) ($10,019)
-------- -------- -------- --------
Weighted average number of shares outstanding............... 19,754 19,610 19,721 19,567
Additional shares assuming conversion of convertible debt
and convertible interest on debt......................... -- -- -- --
Additional shares assuming exercise of warrants............. -- -- -- --
12
Additional shares assuming exercise of options -- -- -- --
Weighted average number of shares outstanding, as adjusted 19,754 19,610 19,721 19,545
Net loss per share - diluted ($ 0.06) ($ 0.48) ($ 0.27) ($ 0.51)
======= ======= ======= -------
Certain warrants, options and conversion rights are not included in the
earnings per share calculation when the exercise price or conversion price is
greater that the average market price for the period. The number of shares
subject to warrants, options and conversion rights excluded in each period is
reflected in the following table.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2002 2003 2002
------ ------ ------ ------
Shares subject to anti-dilutive warrants and conversion rights not
included in earnings per share calculation............................... 4,522 4,235 4,522 4,235
Shares subject to anti-dilutive options not included in earnings per
share calculation........................................................ 3,685 3,870 3,685 3,870
NOTE K - STOCK BASED COMPENSATION
The Company applies APB Opinion No. 25 "Accounting for Stock Issued to
Employees" in accounting for qualifying options granted to its employees under
its 1988 Incentive Compensation Program and applies Statement of Financial
Accounting Standards No. 123 "Accounting for Stock Issued Employees" ("SFAS
123") for disclosure purposes only. The SFAS 123 disclosures include pro forma
net income and earnings per share as if the fair value-based method of
accounting had been used.
If compensation for employee options had been determined based on SFAS 123,
the Company's pro forma net income and pro forma income per share for the nine
months ended September 30, 2003 and 2002 would have been as follows:
2003 2002
------------ ------------
Net loss, as reported ($ 5,269,000) ($10,018,000)
Add stock-based employee compensation
expense included in reported net income -- --
Deduct total stock-based employee
compensation expense determined
under fair-value-based method for
all awards (285,000) (216,000)
------------ ------------
Pro forma net income (loss) ($ 5,554,000) ($ 10,234,000)
============ ============
Basic and diluted income (loss) per share
of common stock
Basic as reported $ (0.27) $ (0.51)
Basic pro forma $ (0.28) $ (0.52)
Diluted as reported N/A N/A
Diluted pro forma N/A N/A
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. 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. Selected financial information by
industry segment is presented below (in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- -------------
2003 2002 2003 2002
-------- -------- -------- --------
REVENUES
Ophthalmic .......................... $ 8,406 $ 7,734 $ 19,658 $ 21,520
Injectable .......................... 3,033 3,203 10,482 11,401
Contract Services ................... 2,059 1,184 4,980 6,808
-------- -------- -------- --------
Total revenues ................ $ 13,498 $ 12,121 $ 35,120 $ 39,729
======== ======== ======== ========
GROSS PROFIT
13
Ophthalmic ............................ $ 3,068 $ 3,407 $ 6,135 $ 10,670
Injectable ............................ 809 1,514 4,588 5,934
Contract Services ..................... 347 (465) (121) 567
-------- -------- -------- --------
Total gross profit .............. 4,224 4,456 10,602 17,171
Operating expenses .................... 4,792 6,472 14,160 18,521
-------- -------- -------- --------
Total operating income (loss) ... (568) (2,016) (3,558) (1,350)
Interest and other income (expense) ... (626) (762) (1,882) (2,475)
-------- -------- -------- --------
Income (loss) before income taxes... $ (1,194) $ (2,778) $ (5,440) $ (3,825)
======== ======== ======== ========
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.
NOTE M - LEGAL PROCEEDINGS
On March 27, 2002, the Company received a letter informing it that the staff
of the regional office of the Securities and Exchange Commission ("SEC") 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 September 25, 2003, the Company consented to the entry of an
administrative cease and desist order to resolve the issues arising from the
staff's investigation and proposed enforcement action as discussed above.
Without the Company admitting or denying the findings set forth therein, the
consent order finds that the Company failed to promptly and completely record
and reconcile cash and credit remittances, including those from its top five
customers, to invoices posted in its accounts receivable sub-ledger. According
to the findings in the 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 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 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 consent order does not impose a monetary penalty against the Company or
require any additional restatement of the Company's financial statements. The
consent order contains an additional commitment by the Company to do the
following: (A) appoint a special committee comprised entirely of outside
directors, (B) within 30 days after entry of the order, have the special
committee retain a qualified independent consultant ("consultant") acceptable to
the staff to perform a test of the Company's material internal controls,
practices, and policies related to accounts receivable, and (C) within 180 days,
have the consultant present his or her findings to the commission for review to
provide assurance that the Company is keeping accurate books and records and has
devised and maintained a system of adequate internal accounting controls with
respect to the Company's accounts receivables. On October 27, 2003, the Company
engaged Jefferson Wells, International to serve as consultant in this capacity.
The Company intends to continue to work with the consultant and the SEC through
this review process. As a result, the Company may incur additional costs and
expenses in connection with this proceeding.
In October 2000, the FDA issued a warning letter to the Company following
the FDA's routine cGMP inspection of the Company's Decatur manufacturing
facilities. This letter addressed several deviations from regulatory
requirements including cleaning validations and general documentation issues 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 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 another
inspection of the Decatur facility, which also identified deviations from
14
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 December 10, 2002 to February 6, 2003. This
inspection also 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 and
has provided progress reports to the FDA on April 15, May 15 and June 15, 2003.
The Company continues to have discussions with the FDA relating to its
ongoing compliance matters and expects that the Company will complete its
current corrective plan for the Decatur facility in the fourth quarter of 2003.
The Company expects that the FDA will reinspect its Decatur facility during the
fourth quarter of 2003 or first quarter of 2004.
Upon completion of the reinspection, the FDA may take any of the following
actions: (i) find that the Decatur facility is in substantial compliance; (ii)
require the Company to undertake further corrective actions, which could include
a recall of certain products, and then conduct another inspection to assess the
success of those 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.
FDA approval is required before any drug can be manufactured and marketed.
New drugs require the filing of a New Drug Application ("NDA"), including
clinical studies demonstrating the safety and efficacy of the drug. Generic
drugs, which are equivalents of existing, off-patent brand name drugs, require
the filing of an Abbreviated New Drug Application ("ANDA"). The Company believes
that 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 for products to be manufactured at its Decatur facility. 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 and could result in a
covenant violation under 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 August 9, 2003, Novadaq notified the Company that it had requested
arbitration with the International Court of Arbitration ("ICA") related to a
dispute between the Company and Novadaq regarding the issuance of a Right of
Reference to Novadaq from Akorn for Novadaq's NDA and Drug Master File ("DMF")
for specified indications for Akorn's drug IC Green. In its request for
arbitration, Novadaq asserts that Akorn is obligated to provide the Right of
Reference as described above pursuant to an amendment dated September 26, 2002
to the January 4, 2002 Supply Agreement between the two companies. Akorn does
not believe it is obligated to provide the Right of Reference which, if
provided, would likely reduce the required amount of time for clinical trials
and reduce Novadaq's cost of developing a product for macular degeneration. The
Company also is contemplating the possible development of a separate product for
macular degeneration which, if developed, could face competition from any
product developed by Novadaq. Even if the Right of Reference is provided, the
approval process for such a product is expected to take several years. On
October 17, 2003, the ICA notified the Company that it decided that this matter
shall proceed to arbitration. The Company is in the process of preparing for
arbitration on this matter and will defend itself vigorously.
In connection with the request for arbitration described above, on August
22, 2003, Novadaq filed a lawsuit and a Notice of Emergency Motion in the
Circuit Court of Cook County, Illinois, County Department, Chancery Division for
interim relief related to the issuance of the Right of Reference from Akorn to
Novadaq. On September 22, 2003, Akorn and Novadaq entered into an Agreed Order
whereby Akorn would provide the requested Right of Reference to Novadaq. The
Agreed Order terminates upon the settlement of the dispute between the parties
or in the event that the final disposition of the arbitration filed with the ICA
results in a final decision against Novadaq or a failure to hold that Novadaq
has a right to the Right of Reference.
On October 8, 2003, the Company, pursuant to the terms of the Letter
Agreement dated September 26, 2002 between the Company and AEG Partners LLC, as
amended (the "AEG Letter Agreement"), terminated its consultant AEG Partners LLC
("AEG"). AEG contends that, as a result of the Exchange Transaction, the Company
must pay it a "success fee" consisting of $686,000 and a warrant to purchase
1,250,000 shares of the Company's common stock at $1.00 per share, and adjust
the terms of the warrant, pursuant to certain anti-dilution provisions, to take
into account the impact of the convertible preferred stock issued in connection
with the
15
Exchange Transaction. The Company disputes that AEG is owed this success fee.
Pursuant to the AEG Letter Agreement, the Company and AEG are trying to resolve
the dispute. If this fails, the AEG Letter Agreement provides for mandatory and
binding arbitration. If this matter proceeds to arbitration, the Company will
vigorously defend itself and assert any appropriate counterclaims in regards to
this matter.
On October 14, 2003, Leerink Swann & Co., Inc. ("Leerink") filed a complaint
in the Supreme Court of the State of New York alleging a breach of contract for
the payment of fees by the Company for investment banking services. Leerink
alleged the Company was obligated to pay $1,765,032 pursuant to a written
agreement dated May 8, 2003 between Leerink and the Company (the "Leerink
Agreement"). The Company disputed that Leerink was owed $1,765,032. On November
14, 2003, Leerink and the Company reached a tentative settlement where, among
other things, the Company will pay $750,000 to Leerink, and the Company will
extend the Leerink Agreement for an additional year. The settlement is
contingent upon the execution of a written settlement agreement, at which time
Leerink will dismiss the complaint.
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.
NOTE N - 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 to 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 initiated after June 30, 2001. The adoption of this new standard
did not have any 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. Subsequent to the
adoption, the Company recorded an impairment charge of $257,000 related to
product license intangibles in the third quarter of 2002.
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 any 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. Subsequent to the adoption of this standard,
the Company recorded a charge of $545,000 in the third quarter of 2002 related
to abandoned construction projects.
In April 2002, the FASB issued SFAS No. 145 "Recission 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 Extinguishment of Debt", which requires all gains and losses from
16
extinguishment 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 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 a sale-leaseback transaction
be accounted for in the same manner as a sale-leaseback transaction. Certain
provisions of SFAS No. 145 are effective for the fiscal years beginning after
May 15, 2002, while other provisions are effective for transactions occurring
after May 15, 2002. The adoption of SFAS No. 145 has not had a material impact
on the Company's financial statements but will have an impact on the gain from
extinguishment of debt resulting from the Exchange Transaction.
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 Company does not anticipate that adoption of this
standard will 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 FASB Statement 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
Statement 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 and are included in the Notes to the
Consolidated Financial Statements.
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 did not have any effect on the
Company's financial statements.
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.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. SFAS 150
establishes standards for how entities classify and measure in their statement
of financial position certain financial instruments with characteristics of
both liabilities and equity. The provisions of SFAS 150 are effective for
financial statements entered into or modified after May 31, 2003. The Company
is currently evaluating the impact of SFAS 150 on the accounting for its
Exchange Transaction.
NOTE O - SUBSEQUENT EVENTS
On October 7, 2003, the Investors purchased all of the Company's then
outstanding senior bank debt from The Northern Trust Company and exchanged such
debt with the Company in the Exchange Transaction for (i) 257,172 shares of
Series A 6.0% Participating Convertible Preferred Stock ("Preferred Stock") of
the Company, (ii) the 2003 Subordinated Notes, (iii) warrants to purchase an
aggregate of 8,572,400 shares of the Company's common stock ("Common Stock")
with an exercise price of $1.00 per share, and (iv) $5,473,862 in cash from the
New Credit Facility which the Company entered into simultaneously with the
Exchange Transaction. For more information on the New Credit Facility, see Note
H - "Financing Arrangements" - to the Condensed Consolidated Financial
Statements. The Company also issued to the holders of the 2003 Subordinated
Notes warrants to purchase an aggregate of 276,714 shares of Common Stock with
an exercise price of $1.10 per share.
17
The Preferred Stock accrues dividends at a rate of 6.0% per annum, which
rate is fully cumulative, accrues daily and compounds quarterly, provided that
in the event stockholder approval authorizing sufficient shares of Common Stock
to be authorized and reserved for conversion of all of the Preferred Stock and
warrants issued in connection with the Exchange Transaction ("Stockholder
Approval") has not been received by October 7, 2004, such rate is to increase to
10.0% until Stockholder Approval has been received and sufficient shares of
Common Stock are authorized and reserved. Subject to certain limitations, on
October 31, 2011, the Company is required to redeem all shares of Preferred
Stock for an amount equal to $100 per share, as may be adjusted from time to
time as set forth in the Articles of Incorporation (the "Articles of
Incorporation") of the Company (the "Stated Value"), plus all accrued but unpaid
dividends on such share. Shares of Preferred Stock have liquidation rights in
preference over junior securities, including the Common Stock, and have certain
antidilution protections. The Preferred Stock is convertible at any time into a
number of shares of Common Stock equal to the quotient obtained by dividing (x)
the Stated Value plus any accrued but unpaid dividends by (y) $0.75, as such
numbers may be adjusted from time to time pursuant to the terms of the Articles
of Amendment. Provided that Stockholder Approval has been received and
sufficient shares of Common Stock are authorized and reserved for conversion,
all shares of Preferred Stock shall convert to shares of Common Stock on the
earlier to occur of (i) October 8, 2006 and (ii) the date on which the closing
price per share of Common Stock for at least 20 consecutive trading days
immediately preceding such date exceeds $4.00 per share.
Holders of Preferred Stock have full voting rights, with each holder
entitled to a number of votes equal to the number of shares of Common Stock into
which its shares can be converted. Holders of Preferred Stock and Common Stock
shall vote together as a single class on all matters submitted to a shareholder
vote, except in cases where a separate vote of the holders of Preferred Stock is
required by law or by the Articles of Incorporation. The Articles of
Incorporation provide that the Company cannot take certain actions, including
(i) issuing additional Preferred Stock or securities senior to or on par with
the Preferred Stock, (ii) amending the Company's Articles of Incorporation or
By-laws to alter the rights of the Preferred Stock, (iii) effecting a change of
control or (iv) effecting a reverse split of the Preferred Stock, without the
approval of the holders of 50.1% of the Preferred Stock.
The 2003 Subordinated Notes accrue interest at a rate of prime plus 1.75%
and are due and payable on April 7, 2006. The warrants issued in connection with
the Exchange Transaction (the "Warrants") are currently exercisable and expire
on October 7, 2006.
As part of the Exchange Transaction, the Company and the Investors also
entered into a Registration Rights Agreement (the "Registration Rights
Agreement") pursuant to which the Investors were granted certain registration
rights with respect to the Preferred Stock and Warrants, including three (3)
demand registrations for holders of more than 5,000,000 shares of Common Stock,
incidental or piggy-back registrations upon a registration by the Company on
Form S-1, S-2 or S-3 and shelf registration rights. The Company further agreed
not to enter into any new agreement with more preferential registration rights.
The obligations of the Company under the New Credit Facility have been
guaranteed by the Kapoor Trust and Arjun Waney. In exchange for this guaranty,
the Company issued additional warrants to purchase 880,000 and 80,000 shares of
Common Stock to the Kapoor Trust and Arjun Waney, respectively, and has agreed
to issue to each of them, on each anniversary of the date of the consummation of
the Exchange Transaction, warrants to purchase an additional number of shares of
Common Stock equal to 0.08 multiplied by the principal dollar amount of the
Company's indebtedness then guaranteed by them under the New Credit Facility.
The warrants issued in exchange for these guarantees have an exercise price of
$1.10 per share.
After giving effect to the Exchange Transaction, the Investors hold
approximately 75% of the aggregate voting rights represented by outstanding
shares of Common and Preferred Stock. After giving effect to the Exchange
Transaction and to the exercise of all outstanding conversion rights, warrants
and options to acquire Common Stock, the Investors would hold approximately 77%
of the Common Stock, on a fully-diluted basis. Prior to the Exchange
Transaction, the Investors held approximately 35% of the outstanding voting
securities and would have held approximately 42% of the Common Stock on a
fully-diluted basis.
On October 8, 2003, the Company, pursuant to the terms of the AEG Letter
Agreement, terminated its consultant AEG. AEG contends that, as a result of the
Exchange Transaction, the Company must pay it a "success fee" consisting of
$686,000 and a warrant to purchase 1,250,000 shares of the Company's common
stock at $1.00 per share, and adjust the terms of the warrant, pursuant to
certain anti-dilution provisions, to take into account the impact of the
convertible preferred stock issued in connection with the Exchange Transaction.
For further discussion, refer to Note M - "Legal Proceedings" - to the Condensed
Consolidated Financial Statements.
On October 14, 2003, Leerink filed a complaint in the Supreme Court of the
State of New York alleging a breach of contract for the payment of fees by the
Company for investment banking services. For further discussion, refer to Note M
- - "Legal Proceedings" - to the Condensed Consolidated Financial Statements.
18
On October 22, 2003, the Company, upon recommendation of the Audit Committee
of its Board of Directors and approval by its Board of Directors, engaged BDO
Seidman, LLP as the Company's principal accountants to audit the financial
statements of the Company for its fiscal year ending December 31, 2003, and to
review the financial statements of the Company for the fiscal quarters ended
March 31, June 30 and September 30, 2003. BDO Siedman has informed the Company
that it will not be able to complete the review of the Company's quarterly
financial statements until December 2003.
19
Item 2.
AKORN, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CRITICAL ACCOUNTING POLICIES
REVENUE RECOGNITION
The Company recognizes product sales for its ophthalmic and injectable
business segments upon the shipment of goods for customers whose terms are FOB
shipping point. The Company has several customers whose terms are FOB
destination point and recognizes revenue upon delivery of the product to these
customers. Revenue is recognized when all obligations of the Company have been
fulfilled and collection of the related receivable is probable. Provision for
estimated chargebacks, rebates, discounts and product returns is made at the
time of sale and is analyzed and adjusted, if necessary, at each balance sheet
date.
The contract services segment, which produces products for third party
customers, based upon their specification, at a pre-determined price, also
recognizes sales upon the shipment of goods or upon delivery of the product as
appropriate. Revenue is recognized when all obligations of the Company have been
fulfilled and collection of the related receivable is probable.
Royalty revenue is recognized in the period to which such revenue relates
based upon when the Company receives notification (monthly or quarterly) from
the counterparty that such counterparty has sold product for which Akorn is
entitled to a royalty.
ALLOWANCE FOR CHARGEBACKS AND REBATES
The Company maintains allowances 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.
Management obtains wholesaler inventory reports to aid in analyzing the
reasonableness of the chargeback allowance. The Company assesses 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.
Similarly, the Company maintains an allowance for rebates related to
contract and other programs with certain customers. 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 its rebate-eligible
customers. Rebate percentages vary by product and by volume purchased by each
eligible customer. The Company tracks sales by product number for each eligible
customer and then applies the applicable rebate percentage, using both
historical trends and actual experience to estimate its rebate allowance. The
Company reduces gross sales and increases the rebate allowance by the estimated
rebate amount for each product sold to an eligible customer. The Company reduces
the rebate allowance when it processes a customer request for a rebate. At each
balance sheet date, the Company evaluates the allowance against actual rebates
processed and such amount can vary materially from period to period.
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 contracts and programs. For the three-month periods ended September
30, 2003 and 2002, the Company recorded chargeback and rebate expense of
$4,332,000, and $4,693,000, respectively. For the nine months ended September
30, 2003 and 2002, the Company recorded chargeback and rebate expense of
$10,637,000, and $12,247,000, respectively. The
20
allowance for chargebacks and rebates was $5,407,000 and $4,302,000 as of
September 30, 2003 and December 31, 2002, respectively.
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. 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. Actual
returns processed can vary materially from period to period. For the three-month
periods ending September 30, 2003 and 2002 the Company recorded a provision for
product returns of $453,000, and $790,000, respectively. For the nine-month
periods ending September 30, 2003 and 2002 the Company recorded a provision for
product returns of $1,790,000, and $1,822,000, respectively. The allowance for
potential product returns was $1,459,000 and $1,166,000 at September 30, 2003
and December 31, 2002, respectively.
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, factors that affect particular distribution channels,
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) other
information such as buying patterns and payment patterns, 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 factors that might
affect collectibility of outstanding balances - based upon information
available at the time.
For the three-month periods ending September 30, 2003 and 2002, the Company
recorded a provision, net of recoveries, for doubtful accounts of $21,000 and
$370,000, respectively. For the nine-month periods ending September 30, 2003 and
2002, the Company recorded a provision, net of recoveries, for doubtful accounts
of ($267,000) and ($30,000), respectively. The allowance for doubtful accounts
was $520,000 and $1,200,000 as of September 30, 2003 and December 31, 2002,
respectively. As of September 30, 2003, the Company had a total of $3,439,000 of
past due gross accounts receivable, of which $118,000 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 $520,000, the portion related to the
wholesaler customers is $415,000 with the remaining $105,000 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-month periods ending September 30, 2003 and 2002, the Company recorded a
provision for discounts of $230,000 and $246,000, respectively. For the nine
months ending September 30, 2003 and 2002, the Company recorded a provision for
discounts of $588,000 and $759,000, respectively. The allowance for discounts
was $184,000 and $172,000 as of September 30, 2003 and December 31, 2002,
respectively.
21
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.
For the three and nine-month periods ended September 30, 2003, the Company
recorded a provision of $263,000 and $671,000, respectively. For the nine months
ended September 30, 2002, the Company recorded a provision of $493,000. There
was no expense recorded in the third quarter of 2002. The allowance for
inventory obsolescence at September 30, 2003 and December 31, 2002 was
$1,118,000 and $1,206,000, respectively.
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 is necessary, the Company considers both negative
and positive evidence, which can be objectively verified. Based upon its
analysis, the Company established a valuation allowance in 2002 against
previously established deferred tax assets and for the first nine months of 2003
to reduce the deferred tax asset to zero.
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, 2003
and December 31, 2002 was $9,590,000 and $8,543,000, respectively. The Company
annually assesses the impairment of intangibles based on several factors,
including estimated fair market value and anticipated cash flows.
FORWARD-LOOKING STATEMENTS AND FACTORS AFFECTING FUTURE RESULTS
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:
- the Company's ability to resolve its Food and Drug Administration
("FDA") compliance issues at its Decatur, Illinois facility;
- the Company's ability to avoid defaults under the covenants contained in
its new bank credit agreement with LaSalle Bank National Association
("LaSalle Bank");
- the Company's ability to generate cash from operations sufficient to
meet its working capital requirements;
- the Company's ability to obtain additional funding to grow its business;
- the effects of federal, state and other governmental regulation of the
Company's business;
- the Company's success in developing, manufacturing and acquiring new
products;
- the Company's ability to bring new products to market and the effects of
sales of such products on the Company's financial results;
- the effects of competition from generic pharmaceuticals and from other
pharmaceutical companies;
- availability of raw materials needed to produce the Company's products;
22
- other factors referred to in the Company's other Securities and Exchange
Commission filings including " Item 7. Managements Discussion and
Analysis of Financial Conditions and Results of Operations - Factors
that May Affect Future Results" in the Company's Form 10-K for 2002.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO 2002
The following table sets forth, for the periods indicated, revenues by
segment, excluding intersegment sales (in thousands):
THREE MONTHS ENDED SEPTEMBER 30,
----------------------------------
2003 2002
--------- ------------
Ophthalmic segment.......... $ 8,406 $ 7,734
Injectable segment.......... 3,053 3,203
Contract Services segment... 2,059 1,184
--------- ------------
Total revenues.............. $ 13,498 $ 12,121
========= ============
Consolidated revenues increased 11.4% in the quarter ended September 30,
2003 compared to the same period in 2002.
Ophthalmic segment revenues increased 8.7%, due to higher volume of the
Company's diagnostic products, particularly AK Dilate and IC Green. Injectable
segment revenues decreased 4.7% for the quarter because of shortfalls in the
antidote segment resulting from a decrease in demand compared to the prior year.
Those shortfalls were partially offset by the introduction of a new product,
Lidocaine Jelly, during the quarter. Lidocaine Jelly is produced in the
Company's Somerset, New Jersey facility. Contract services revenues increased by
73.9% due to the Company's current customer base increasing inventory levels of
products manufactured by the Company.
The Company anticipates that revenues from all of its product segments are
not likely to grow until the issues surrounding the FDA review are resolved. The
FDA compliance matters are not anticipated to be resolved prior to the first
quarter of 2004. See Part II - Item 1 - "Legal Proceedings". Although one of the
production rooms at the Company's Decatur, Illinois facility has recently been
requalified for aseptic processing of opthalmic products, production of Fluress
and Flouracaine, two of the Company's opthalmic products, remains suspended
pending development of a new container closure system for those products. The
Company does not expect to resume production of Fluress and Flouracaine prior to
the second quarter of 2004. As a result, the Company expects that revenues and
cash flow from operations for the remainder of 2003 and the first quarter of
2004 will be adversely impacted and that revenues and cash flows in the second
quarter of 2004 and beyond could be adversely impacted if the Company is unable
to resume production of Fluress and Flouracaine in the second quarter of 2004.
Consolidated gross margin was 31.3% for the third quarter as compared to a
gross margin of 36.8% in the same period a year ago, mainly due to the volume
decrease in high margin antidote products as well as lower production levels due
to the aseptic production rooms being closed. Additionally, increased costs
associated with addressing the Company's current FDA compliance matters had a
negative margin impact for the quarter.
Selling, general and administrative (SG&A) expenses decreased 20.9%, to
$4,151,000 from $5,245,000, during the quarter ended September 30, 2003 as
compared to the same period in 2002. Included in 2002 results were a $257,000
and $545,000 asset impairment charge related to intangible assets and
construction-in-progress. Excluding these charges, SG&A decreased by 6.6% due to
lower personnel and marketing costs partially offset by higher senior debt
restructuring costs.
Provision, net of recoveries, for bad debts was $21,000 for the quarter,
versus $370,000 for the third quarter of 2002. The lower provision is driven
mainly by lower past due wholesaler receivables.
Research and development (R&D) expense decreased 45.6% in the quarter, to
$271,000 from $498,000 for the same period in 2002 due to refocusing resources
away from R&D activities to resolve issues related to FDA compliance.
Interest and other expense for the third quarter of 2003 was $626,000, a
17.8% decrease compared to the same period in the prior year, primarily due to
lower interest rates as well as a lower debt balance.
23
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 asset to the amount that is more likely than not to
be realized. Beginning with the third quarter of 2002, the Company recorded a
valuation allowance to reduce the deferred tax asset to zero, and the Company
has continued to do so at the end of each subsequent quarter. The Company
established a valuation allowance of $484,000 in the third quarter of 2003,
which offset the deferred tax asset recorded in that quarter. This resulted in a
net tax provision of $0 for the third quarter of 2003, compared to a net tax
provision of $6,609,000 for the third quarter of 2002. The net tax provision for
the third quarter of 2002 includes a $7,700,000 deferred tax valuation allowance
established against deferred tax assets recorded in the third quarter of 2002
and in prior periods.
The Company reported a net loss of $1,194,000 or $0.06 per weighted average
share for the three months ended September 30, 2003, versus a loss of $9,387,000
or $0.48 per weighted average share for the comparable prior year quarter. This
decrease in net loss was due primarily to the year to date impact of the
deferred tax valuation allowance established in 2002 against previously recorded
tax assets, as well as lower expenditures in SG&A and research and development
costs.
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO 2002
The following table sets forth, for the periods indicated, revenues by
segment, excluding intersegment sales (in thousands):
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------
2003 2002
--------- ------------
Ophthalmic segment.......... $ 19,658 $ 21,520
Injectable segment.......... 10,482 11,401
Contract Services segment... 4,980 6,808
--------- ------------
Total revenues.............. $ 35,120 $ 39,729
========= ============
Consolidated revenues decreased 11.6% for the nine months ended September
30, 2003 compared to the same period in 2002.
Ophthalmic segment revenues decreased 8.7%, primarily due to the temporary
suspension in late 2002 of production of Fluress and Flouracaine, as well as
increased customer purchases of angiography and ointment products in the fourth
quarter of 2002, which resulted in surplus customer inventory during the first
six months of 2003. Injectable segment revenues decreased 8.1% year to date due
to lower volumes of anesthesia and antidote products in the third quarter
partially offset by sales of the newly introduced product, Lidocaine Jelly.
Contract services revenues decreased by 26.9% due mainly to customer concerns
about the status of the ongoing FDA compliance matters at the Company's Decatur
facility as well as the temporary closure of an aseptic production room at that
same facility.
The Company anticipates that revenues from all of its product segments are
not likely to grow until the issues surrounding the FDA review are resolved. The
FDA compliance matters are not anticipated to be resolved prior to the first
quarter of 2004. See Part II - Item 1 - "Legal Proceedings". Although one of the
production rooms at the Company's Decatur, Illinois facility has recently been
requalified for aseptic processing of opthalmic products, production of Fluress
and Flouracaine, two of the Company's opthalmic products, remains suspended
pending development of a new container closure system for those products. The
Company does not expect to resume production of Fluress and Flouracaine prior to
the second quarter of 2004. As a result, the Company expects that revenues and
cash flow from operations for the remainder of 2003 and the first quarter of
2004 will be adversely impacted and that revenues and cash flows in the second
quarter of 2004 and beyond could be adversely impacted if the Company is unable
to resume production of Fluress and Flouracaine in the second quarter of 2004.
The chargeback and rebate expense for the nine months ended September 30,
2003 declined to $10,637,000 from $12,247,000 in the comparable period in the
prior year, due to the increase in the product sales mix of lower chargeback and
rebate percentage items.
Year to date consolidated gross margin was 30.2% for 2003 as compared to a
gross margin of 43.2% in the same period a year ago. This is driven by the
decrease in volume across all revenue categories as well as increased costs
associated with the resolution of the Company's current FDA compliance matters.
Selling, general and administrative (SG&A) expenses decreased 25.0%, to
$12,006,000 from $16,014,000, for the year to date period ended September 30,
2003 as compared to the same period in 2002. Included in 2002 results were
$1,559,500, $257,000 and $545,000 asset impairment charges related to the Johns
Hopkins patents, intangible assets and construction-in-progress. Excluding
24
these charges, SG&A decreased by 10.1% due to lower personnel and marketing
costs partially offset by higher senior debt restructuring costs.
Provision, net of recoveries, for bad debts was a $267,000 net recovery year
to date, reflecting a $369,000 provision, which was offset by $636,000 in
recoveries for the same period. The bad debt expense net of recoveries for 2002
was a net $30,000 recovery.
Research and development (R&D) expense decreased 25.2% in 2003, to
$1,107,000 from $1,480,000 for the same period in 2002 due to refocusing
resources away from R&D activities to resolve issues related to FDA compliance.
Interest and other expense for the nine-month period ending September 30,
2003 was $1,882,000, a 24.0% decrease compared to the same period in the prior
year, primarily due to lower interest rates as well as a lower debt balance.
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. Beginning with the third quarter of 2002, the Company recorded a
valuation allowance to reduce the deferred tax asset to zero, and the Company
has continued to do so at the end of each subsequent quarter. The Company
recorded a valuation allowance of $2,100,000 for the first nine months of 2003,
which offset the deferred tax asset recorded in that period. The net tax benefit
of $171,000 for the nine months ending September 30, 2003 relates to state tax
refunds. The net tax provision of $6,193,000 for the same period in 2002
includes a $7,700,000 deferred tax valuation allowance established against
deferred tax assets recorded in the third quarter of 2002 and in prior periods.
The Company reported a net loss of $5,269,000 or $0.27 per weighted average
share for the nine months ended September 30, 2003, versus $10,018,000 or $0.51
per weighted average share for the comparable prior year quarter. The decrease
in net loss was due primarily to the year to date impact of the deferred tax
valuation allowance established in 2002 against previously recorded tax assets,
as well as reduced SG&A, R&D and interest expenses offset by lower sales and
gross profit.
FINANCIAL CONDITION AND LIQUIDITY
Overview
As of September 30, 2003, the Company had cash and cash equivalents of
$304,000 and net accounts receivable of $3,167,000. The net working capital
deficiency at September 30, 2003 was $1,328,000 versus $30,564,000 at December
31, 2002. The significant improvement in working capital is due to the
reclassification of a portion of the Company's senior debt obligation to
long-term debt due to the Exchange Transaction discussed below. See Note H -
"Financing Arrangements" - to the Condensed Consolidated Financial Statements.
For the nine months ended September 30, 2003, the Company used $927,000 in
cash from operations, primarily due to an increase in accounts receivable
partially offset by a decrease in inventory. The increase in receivables was due
to the increase in sales for the quarter. Inventory decreased due to strict
controls over purchases of raw materials and components. Investing activities
during the period ended September 30, 2003 used $1,302,000 in cash, including
$1,152,000 related to the lyophilized (freeze-dried) pharmaceuticals
manufacturing line expansion. Financing activities generated $2,169,000 in cash
during the period ended September 30, 2003, as the company utilized its line of
credit to meet its working capital needs.
On October 7, 2003, a group of investors (the "Investors") purchased all of
the Company's then outstanding senior bank debt from The Northern Trust Company
and exchanged such debt with the Company (the "Exchange Transaction") for (i)
257,172 shares of Series A 6.0% Participating Convertible Preferred Stock
("Preferred Stock") of the Company, (ii) subordinated promissory notes in the
aggregate principal amount of $2,767,139 (the "2003 Subordinated Notes") issued
by the Company to (a) The John N. Kapoor Trust dtd 9/20/89 (the "Kapoor Trust"),
the sole trustee and sole beneficiary of which is Dr. John N. Kapoor, the
Company's Chairman of the Board of Directors and the holder of a significant
stock position in the Company, (b) Arjun Waney, a newly-elected director and the
holder of a significant stock position in the Company, and (c) Argent Fund
Management Ltd., for which Mr. Waney serves as Chairman and Managing Director
and 51% of which is owned by Mr. Waney, (iii) warrants to purchase an aggregate
of 8,572,400 shares of the Company's common stock with an exercise price of
$1.00 per share, and (iv) $5,473,862 in cash from the proceeds of the term loan
under the New Credit Facility described in the next paragraph. The Company also
issued to the holders of the 2003 Subordinated Notes warrants to purchase an
aggregate of 276,714 shares of common stock with an exercise price of $1.10 per
share.
25
Simultaneously with the consummation of the Exchange Transaction, the
Company entered into a credit agreement with LaSalle Bank providing the Company
with a $7,000,000 term loan and a revolving line of credit of up to $5,000,000
to provide for working capital needs (collectively, the "New Credit Facility")
secured by substantially all of the assets of the Company and its subsidiaries.
The obligations of the Company under the New Credit Facility have been
guaranteed by the Kapoor Trust and Arjun Waney. In exchange for this guaranty,
the Company issued additional warrants to purchase 880,000 and 80,000 shares of
common stock to the Kapoor Trust and Arjun Waney, respectively, and has agreed
to issue to each of them, on each anniversary of the date of the consummation of
the Exchange Transaction, warrants to purchase an additional number of shares of
common stock equal to 0.08 multiplied by the principal dollar amount of the
Company's indebtedness then guaranteed by them under the New Credit Facility.
The warrants issued in exchange for these guarantees have an exercise price of
$1.10 per share.
The primary impact of the Exchange Transaction and New Credit Facility on
the Company's liquidity and capital resources was as follows:
- The Company's then-existing default on its senior bank debt with
Northern Trust was eliminated;
- The Company's then-existing defaults on its subordinated loans from
NeoPharm, Inc. and the Kapoor Trust were waived;
- The total amount of the Company's senior bank debt was reduced from
$37,801,000 as of September 30, 2003 to $7,000,000 as of the closing of
those transactions;
- The interest rate on the Company's senior bank debt was reduced from
prime plus 3.0% to prime plus 1.75% for the new term loans and prime
plus 1.50% for the new revolving line of credit;
- The Company obtained a revolving line of credit of up to $5,000,000 and
an additional $1,000,000 pursuant to the term loan under the New Credit
Facility to meet working capital needs and fund future operations;
- The Company issued additional subordinated debt with an aggregate
principal amount of $2.767 million, which accrues interest at a rate of
prime plus 1.75% per annum;
- The Company issued preferred stock with an aggregate initial stated
value of $25.717 million, which accrues dividends at a rate of 6.0% per
annum; and
- The Investors acquired preferred stock and warrants that, as of the
closing, had the right to acquire approximately 44.1 million shares of
the Company's common stock, or more than 220% of the outstanding shares
of common stock prior to the closing.
As of November 18, 2003, the Company had approximately $1.0 million in
cash and approximately $5.0 million of undrawn availability under the new line
of credit with LaSalle Bank.
Akorn believes that its new line of credit and cash flow from operations
will be sufficient to operate its business for the foreseeable future. However,
the Company incurred operating losses for the last three years and the first
nine months of 2003. Although the Company was able to generate positive cash
flow from operations in 2002, cash flow from operations for the first nine
months of 2003 was ($927,000).
If the new line of credit and cash flow from operations are not sufficient
to fund the operation and growth of Akorn's business, Akorn may be required to
seek additional financing. Such additional financing may not be available when
needed or on terms favorable to Akorn and its shareholders. Any such additional
financing, if obtained, will likely require the granting of rights, preferences
or privileges senior to those of the common stock and result in additional
dilution of the existing ownership interests of the common stockholders.
The Company continues to be subject to potential claims by the FDA that
could have a material adverse effect on the Company. See part II - Item 1
- -"Legal Proceedings". There can be no guarantee that the Company will
successfully resolve the ongoing compliance matters 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.
New Credit Agreement
As discussed in Note H - "Financing Arrangements" - to the Condensed
Consolidated Financial Statements, the Company has entered into a New Credit
Facility with LaSalle Bank. The New Credit Facility with LaSalle Bank consists
of a $5,500,000 term loan A, a $1,500,000 term loan B (collectively, the "Term
Loans") as well as a revolving line of credit of up to $5,000,000 (the
"Revolver") secured by substantially all of the assets of the Company and its
subsidiaries. The New Credit Facility matures on October 7, 2005. The Term Loans
bear interest at prime plus 1.75% and require principal payments of $195,000 per
month commencing October 31, 2003, with the payments first to be applied to term
loan B. The Revolver bears interest at prime plus 1.50%.
26
Availability under the Revolver is determined by the sum of (i) 80% of eligible
accounts receivable, (ii) 30% of raw material, finished goods and component
inventory excluding packaging items, not to exceed $2.5 million and (iii) the
difference between 90% of the forced liquidation value of machinery and
equipment ($4,092,000) and the sum of $1,750,000 and the outstanding balance
under term loan B. The New Credit Facility contains certain restrictive
covenants including but not limited to certain financial covenants such as
minimum EDITDA levels, Fixed Charge Coverage Ratios, Senior Debt to EBITDA
ratios and Total Debt to EBITDA ratios. If the Company is not in compliance with
the covenants of the New Credit Facility, LaSalle Bank has the right to declare
an event of default and all of the outstanding balances owed under the New
Credit Facility would become immediately due and payable.
FDA Compliance Matters
As described in more detail in Part II - Item 1 - "Legal Proceedings", the
Company continues to be subject to potential claims by the FDA. While the
Company is cooperating with the FDA and seeking to resolve its ongoing
compliance matters, an unfavorable outcome may have a material impact on the
Company's operations and its financial condition, results of operations and/or
cash flows and may constitute a covenant violation under the New Credit
Facility, any or all of which could have a material adverse effect on the
Company's liquidity.
Facility Expansion
In 2000, the Company began an expansion project at its Decatur, Illinois
facility to add capacity to provide Lyophilization manufacturing services, which
manufacturing capability the Company currently does not have. Subject to
satisfactory resolution of the FDA compliance matters, the Company currently
anticipates the completion of the Lyophilization expansion in 2005. 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.
Subordinated Debt
On July 12, 2001, the Company entered into a $5,000,000 subordinated debt
transaction with the Kapoor Trust. The transaction is evidenced by a Convertible
Bridge Loan and Warrant Agreement (the "Trust Loan Agreement") in which the
Kapoor 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 Kapoor Trust for the subordinated debt, the
Company issued the Kapoor Trust two warrants which allow the Kapoor 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 Kapoor Trust's commitment to provide the subordinated debt.
All unexercised warrants will expire on December 20, 2006.
Under the terms of the Trust Loan Agreement, the subordinated debt bears
interest at prime plus 3%, but interest payments are currently prohibited under
the terms of the subordination arrangements described below. The convertible
feature of the Trust Loan 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 the Company's efforts to complete its
lyophilization facility located in Decatur, Illinois. Prior to its amendment and
restatement in connection with the Exchange Transaction, the Promissory Note,
dated December 20, 2001 (the "NeoPharm Promissory Note"), provided for interest
to accrue at the initial rate of 3.6% and 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 NeoPharm Promissory Note
also provided for all principal and accrued interest to be due and payable on or
before maturity on December 20, 2006, and required the Company to use the
proceeds of the loan solely to validate and complete the lyophilization facility
located in Decatur, Illinois. The NeoPharm Promissory 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. As of September 30, 2003, the Company was in default under
the NeoPharm Promissory Note as a result of its failure to remove all FDA
warning letter sanctions related to the Company's Decatur, Illinois facility by
June 30, 2003. Dr. John N. Kapoor, the Chairman of the Company's Board of
Directors, is also chairman of NeoPharm and holds a substantial stock position
in NeoPharm as well as in the Company.
27
In connection with the Exchange Transaction, NeoPharm waived all existing
defaults under the NeoPharm Promissory Note and the Company and NeoPharm entered
into an Amended and Restated Promissory Note dated October 7, 2003 (the "Amended
NeoPharm Note"). Interest under the Amended NeoPharm Note accrues at 1.75% above
LaSalle Bank's prime rate, but interest payments are currently prohibited under
the terms of the subordination arrangements described below. The Amended
NeoPharm Note also requires the Company to make quarterly payments of $150,000
beginning on the last day of the calendar quarter during which all indebtedness
under the New Credit Facility has been paid. All remaining amounts owed under
the Amended NeoPharm Note are payable at maturity on December 20, 2006. The
NeoPharm subordinated debt is subordinated to the Company's bank debt under the
New Credit Facility and is senior to the Company's debt to the Kapoor Trust and
to the 2003 Subordinated Notes.
Contemporaneous with the completion of the NeoPharm Promissory Note between
the Company and NeoPharm in 2001, the Company entered into an agreement with the
Kapoor Trust, which amended the Trust Loan Agreement. The amendment extended the
maturity of the Trust Loan Agreement from July 12, 2004 to terminate
concurrently with the NeoPharm Promissory Note on December 20, 2006. The
amendment also made it possible for the Kapoor Trust to convert the interest
accrued on the $3,000,000 tranche, as well as interest on the $2,000,000 tranche
after the original maturity of the Tranche B note, into common stock of the
Company. Previously, the Kapoor Trust could only convert the interest accrued on
the $2,000,000 tranche through the original maturity of the Tranche B note.
In connection with the Exchange Transaction, the Kapoor Trust waived all
existing defaults under the Trust Loan Agreement and the Company and the Kapoor
Trust entered into an amendment to the Trust Loan Agreement. That amendment did
not change the interest rate or the maturity date of the loans made under the
Trust Loan Agreement. The debt owed under the Trust Loan Agreement is
subordinated to the Company's bank debt under the New Credit Facility, the
subordinated debt under the Amended NeoPharm Note and the 2003 Subordinated
Notes issued in connection with the Exchange Transaction.
As part of the Exchange Transaction, the Company issued the 2003
Subordinated Notes to the Kapoor Trust, Arjun Waney and Argent Fund Management,
Ltd. The 2003 Subordinated Notes mature on April 7, 2006 and bear interest at
prime plus 1.75%, but interest payments are currently prohibited under the terms
of the subordination arrangements described below. The 2003 Subordinated Notes
are subordinated to the New Credit Facility and the Amended NeoPharm Note but
senior to Trust Loan Agreement with the Kapoor Trust. The Company also issued to
the holders of the 2003 Subordinated Notes warrants to purchase an aggregate of
276,714 shares of common stock with an exercise price of $1.10 per share.
Other Indebtedness
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
$1,389,000 and $1,917,000 at September 30, 2003 and December 31, 2002,
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.
Preferred Stock and Warrants
In connection with the Exchange Transaction, the Company issued 257,172
shares of Preferred Stock. The Preferred Stock accrues dividends at a rate of
6.0% per annum, which rate is fully cumulative, accrues daily and compounds
quarterly, provided that in the event stockholder approval authorizing
sufficient shares of Common Stock to be authorized and reserved for conversion
of all of the Preferred Stock and warrants issued in connection with the
Exchange Transaction ("Stockholder Approval") has not been received by October
7, 2004, such rate is to increase to 10.0% until Stockholder Approval has been
received and sufficient shares of Common Stock are authorized and reserved.
Subject to certain limitations, on October 31, 2011, the Company is required to
redeem all shares of Preferred Stock for an amount equal to $100 per share, as
may be adjusted from time to time as set forth in the Articles of Incorporation
(the "Articles of Incorporation") of the Company (the "Stated Value"), plus all
accrued but unpaid dividends on such share. Shares of Preferred Stock have
liquidation rights in preference over junior securities, including the Common
Stock, and have certain antidilution protections. The Preferred Stock is
convertible at any time into a number of shares of Common Stock equal to the
quotient obtained by dividing (x) the Stated Value plus any accrued but unpaid
dividends by (y) $0.75, as such numbers may be adjusted from time to time
pursuant to the terms of the Articles of Amendment. Provided that Stockholder
Approval has been received and sufficient shares of Common Stock are authorized
and reserved for conversion, all shares of Preferred Stock shall convert to
shares of Common Stock on the earlier to occur of (i) October 8, 2006 and (ii)
the date on which the closing price per share of Common Stock for at least 20
consecutive trading days immediately preceding such date exceeds $4.00 per
share. For more information regarding the Preferred Stock, including the voting
rights of the Preferred Stock, see Note O - "Subsequent Events" - to the
Condensed Consolidated Financial Statements.
28
The warrants issued in connection with the Exchange Transaction are
exercisable at any time prior to expiration on October 7, 2006. Of those
warrants, warrants for 8,572,400 shares of common stock have an exercise price
of $1.00 per share and warrants for the remaining 1,236,714 shares of common
stock have an exercise price of $1.10 per share.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to market risk associated with changes in interest
rates. As previously disclosed, all debt under the Company's Credit Agreement
with The Northern Trust Company, which bore interest at prime plus 3.0%, was
retired as part of the Exchange Transaction. The Company's interest rate
exposure currently involves four debt instruments. Term loan debt under the New
Credit Agreement, as well as debt under the Amended NeoPharm Note and the 2003
Subordinated Promissory Notes, bears interest at prime plus 1.75%. Revolver debt
under the New Credit Agreement bears interest at prime plus 1.50%. The
subordinated convertible debentures issued to the Kapoor Trust under the Trust
Loan Agreement bear interest at prime plus 3.0%. All of the Company's remaining
long-term debt is at fixed interest rates. Management estimates that a change of
1.0% in its variable rate debt from the interest rates in effect at September
30, 2003 would result in a $230,000 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 debt instruments
approximate fair value because the interest rates are reset periodically to
reflect current market rates.
The fair value of the debt obligations approximated the recorded value as of
September 30, 2003.
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.
Based on their evaluation of the Company's disclosure controls and
procedures, as required by Rule 13a-15(b) under the Exchange Act, the Chief
Executive Officer and Chief Financial Officer concluded that the Company's
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. In the second quarter of 2003, the Company
updated its internal control policies and procedures, expanded its interim
evaluation of accounts receivable for purposes of determining the allowance for
doubtful accounts and reassigned certain personnel to strengthen the accounting
for fixed assets. In the third quarter of 2003, the Company completed a detailed
inventory of its fixed assets and began the process of reconciling this
inventory. There were no other changes in the Company's internal control over
financial reporting that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting.
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,
29
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 September 25, 2003, the Company consented to the entry of an
administrative cease and desist order to resolve the issues arising from the
staff's investigation and proposed enforcement action as discussed above.
Without the Company admitting or denying the findings set forth therein, the
consent order finds that the Company failed to promptly and completely record
and reconcile cash and credit remittances, including those from its top five
customers, to invoices posted in its accounts receivable sub-ledger. According
to the findings in the 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 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 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 consent order does not impose a monetary penalty against the Company or
require any additional restatement of the Company's financial statements. The
consent order contains an additional commitment by the Company to do the
following: (A) appoint a special committee comprised entirely of outside
directors, (B) within 30 days after entry of the order, have the special
committee retain a qualified independent consultant ("consultant") acceptable to
the staff to perform a test of the Company's material internal controls,
practices, and policies related to accounts receivable, and (C) within 180 days,
have the consultant present his or her findings to the commission for review to
provide assurance that the Company is keeping accurate books and records and has
devised and maintained a system of adequate internal accounting controls with
respect to the Company's accounts receivables. On October 27, 2003, the Company
engaged Jefferson Wells, International to serve as consultant in this capacity.
The Company intends to continue to work with the consultant and the SEC through
this review process. As a result, the Company may incur additional costs and
expenses in connection with this proceeding.
In October 2000, the FDA issued a warning letter to the Company following
the FDA's routine cGMP 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 issues 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
controls. 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 another inspection of the Decatur facility, which also 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 December 10, 2002 to February 6, 2003.
This inspection also 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 and has provided progress reports to the FDA on April 15, May
15 and June 15, 2003.
The Company continues to have discussions with the FDA relating to its
ongoing compliance matters and expects that the Company will complete its
current corrective plan for the Decatur facility in the fourth quarter of 2003.
The Company expects that the FDA will reinspect its Decatur facility during the
fourth quarter of 2003 or first quarter of 2004.
Upon completion of the reinspection, the FDA may take any of the following
actions: (i) find that the Decatur facility is in substantial compliance; (ii)
require the Company to undertake further corrective actions, which could include
a recall of certain products, and then conduct another inspection to assess the
success of those efforts; (iii) seek to enjoin the Company from further
violations, which may include temporary suspension of
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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.
FDA approval is required before any drug can be manufactured and marketed.
New drugs require the filing of a New Drug Application ("NDA"), including
clinical studies demonstrating the safety and efficacy of the drug. Generic
drugs, which are equivalents of existing, off-patent brand name drugs, require
the filing of an Abbreviated New Drug Application ("ANDA"). The Company believes
that 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 for products to be manufactured at its Decatur facility. 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 and could result in a
covenant violation under 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 August 9, 2003, Novadaq Technologies, Inc. ("Novadaq") notified the
Company that it had requested arbitration with the International Court of
Arbitration ("ICA") related to a dispute between the Company and Novadaq
regarding the issuance of a Right of Reference to Novadaq from Akorn for
Novadaq's NDA and Drug Master File ("DMF") for specified indications for Akorn's
drug IC Green. In its request for arbitration, Novadaq asserts that Akorn is
obligated to provide the Right of Reference as described above pursuant to an
amendment dated September 26, 2002 to the January 4, 2002 Supply Agreement
between the two companies. Akorn does not believe it is obligated to provide the
Right of Reference which, if provided, would likely reduce the required amount
of time for clinical trials and reduce Novadaq's cost of developing a product
for macular degeneration. The Company also is contemplating the possible
development of a separate product for macular degeneration which, if developed,
could face competition from any product developed by Novadaq. Even if the Right
of Reference is provided, the approval process for such a product is expected to
take several years. On October 17, 2003, the ICA notified the Company that it
decided that this matter shall proceed to arbitration. The Company is in the
process of preparing for arbitration on this matter and will defend itself
vigorously.
In connection with the request for arbitration described above, on August
22, 2003, Novadaq filed a lawsuit and a Notice of Emergency Motion in the
Circuit Court of Cook County, Illinois, County Department, Chancery Division for
interim relief related to the issuance of the Right of Reference from Akorn to
Novadaq. On September 22, 2003, Akorn and Novadaq entered into an Agreed Order
whereby Akorn would provide the requested Right of Reference to Novadaq. The
Agreed Order terminates upon the settlement of the dispute between the parties
or in the event that the final disposition of the arbitration filed with the ICA
results in a final decision against Novadaq or a failure to hold that Novadaq
has a right to the Right of Reference.
On October 8, 2003, the Company, pursuant to the terms of the Letter
Agreement dated September 26, 2002 between the Company and AEG Partners LLC, as
amended (the "AEG Letter Agreement"), terminated its consultant AEG Partners LLC
("AEG"). AEG contends that, as a result of the Exchange Transaction, the Company
must pay it a "success fee" consisting of $686,000 and a warrant to purchase
1,250,000 shares of the Company's common stock at $1.00 per share, and adjust
the terms of the warrant, pursuant to certain anti-dilution provisions, to take
into account the impact of the convertible preferred stock issued in connection
with the Exchange Transaction. The Company disputes that AEG is owed this
success fee. Pursuant to the AEG Letter Agreement, the Company and AEG are
trying to resolve the dispute. If this fails, the AEG Letter Agreement provides
for mandatory and binding arbitration. If this matter proceeds to arbitration,
the Company will vigorously defend itself and assert any appropriate
counterclaims in regards to this matter.
On October 14, 2003, Leerink Swann & Co., Inc. ("Leerink") filed a complaint
in the Supreme Court of the State of New York alleging a breach of contract for
the payment of fees by the Company for investment banking services. Leerink
alleged the Company was obligated to pay $1,765,032 pursuant to a written
agreement dated May 8, 2003 between Leerink and the Company (the "Leerink
Agreement"). The Company disputed that Leerink was owed $1,765,032. On November
14, 2003, Leerink and the Company reached a tentative settlement where, among
other things, the Company will pay $750,000 to Leerink, and the Company will
extend the Leerink Agreement for an additional year. The settlement is
contingent upon the execution of a written settlement agreement, at which time
Leerink will dismiss the complaint.
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
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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.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company did not issue any securities during the three months ended
September 30, 2003. For a discussion of the Company's Exchange Transaction
completed on October 7, 2003, see Note H - "Financing Arrangements" - to the
Condensed Consolidated Financial Statements.
ITEM 3. DEFAULT UPON SENIOR SECURITIES
As of September 30, 2003, the Company was in default under certain covenants
in its senior credit facility with the Northern Trust Company, including the
failure to make a $39,200,000 principal payment that was due on August 31, 2002,
as well as under a cross-default to other indebtedness of the Company. That
default was eliminated on October 7, 2003 when the senior credit facility was
extinguished as a result of the Exchange Transaction.
As of September 30, 2003, the Company also was in default under (i) the
NeoPharm Promissory Note in the principal amount of $3,250,000 as a result of
the Company's failure to remove all FDA warning letter sanctions related to the
Company's Decatur, Illinois facility by June 30, 2003 and (ii) the Trust Loan
Agreement relating to the $5,000,000 subordinated loan made to the Company by
the Kapoor Trust as a result of a cross-default to the NeoPharm Promissory Note.
These defaults were waived in connection with the closing of the Exchange
Transaction.
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, 2003.
ITEM 5. OTHER INFORMATION
On November 6, 2003 the Board of Directors of the Company held a meeting at
the Company's principal office to, among other items, discuss the composition of
the Company's Board of Directors. At the meeting, the Board of Directors
increased the number of directors of the Company from five to six, accepted the
resignations of Doyle Gaw and Dan Bruhl as directors of the Company, and
appointed each of Arthur S. Przybyl, Jerry Treppel and Arjun C. Waney to fill
the vacancies on the Board of Directors until their earlier removal, resignation
or the selection of their successors. Mr. Przybyl is the Chief Executive Officer
of the Company. Mr. Waney may be deemed to beneficially own more than 10% of the
outstanding shares of common stock of the Company.
As previously disclosed by the Company in its Report on Form 8-K filed on
October 29, 2003, the Company, upon recommendation of the Audit Committee of its
Board of Directors and approval by its Board of Directors, engaged BDO Seidman,
LLP on October 22, 2003 as the Company's principal accountants to audit the
financial statements of the Company for its fiscal year ending December 31,
2003, and to review the financial statements of the Company for the fiscal
quarters ended March 31, June 30 and September 30, 2003.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(3.1) Composite Articles of Incorporation of the Company, incorporated by
reference to the Company's Form 8-K filed with the SEC on October 24, 2003
(10.1) Form of Indemnity Agreement dated October 7, 2003 between the Company
and each of the Directors
(10.2) Form of Amended and Restated Promissory Note dated October 7, 2003
issued to NeoPharm
(10.3) Form of Reaffirmation of Subordination and Intercreditor Agreement
from the Kapoor Trust to NeoPharm
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(10.4) Form of Subordination and Intercreditor Agreement dated October 7,
2003 among the Company, Akorn (New Jersey), Inc., LaSalle Bank and NeoPharm
(10.5) Form of Fourth Amendment to Convertible Bridge Loan and Warrant
Agreement dated October 7, 2003 between the Company and the Kapoor Trust
(10.6) Form of Acknowledgment of Subordination dated October 7, 2003 between
the Company and the Kapoor Trust
(10.7) Form of Subordination and Intercreditor Agreement dated October 7,
2003 among the Company, Akorn (New Jersey), Inc., LaSalle Bank and the
Kapoor Trust
(10.8) Form of Subordination and Intercreditor Agreement dated October 7,
2003 among the Company, Akorn (New Jersey), Inc., LaSalle Bank and the
Kapoor Trust
(10.9) Form of Subordination and Intercreditor Agreement dated October 7,
2003 among the Company, Akorn (New Jersey), Inc., LaSalle Bank and Arjun
Waney
(10.10) Form of Subordination and Intercreditor Agreement dated October 7,
2003 among the Company, Akorn (New Jersey), Inc., LaSalle Bank and Argent
Fund Management Ltd.
(31.1) Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934
(31.2) Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
under the Securities Exchange Act of 1934
(32.1) Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
During the quarterly period ended September 30, 2003, the Company filed the
following reports on Form 8-K:
On July 7, 2003, the Company filed a Form 8-K reporting that its senior
lenders intended to extend the forbearance agreement expiration from June 30,
2003 to July 31, 2003 and to make an additional $1.0 million available under the
Company's credit line.
On September 29, 2003 the Company filed a Form 8-K reporting that it had
entered into a Preferred Stock and Note Purchase Agreement with a group of
inside and outside investors to receive an infusion of up to $40.5 million in
new capital consisting of $25.7 million in Series A 6% Participating Convertible
Preferred Stock and Warrants, a $2.8 million subordinated promissory note and up
to $12.0 million in senior secured debt from LaSalle Bank.
33
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/ BERNARD J. POTHAST
--------------------------------
Bernard J. Pothast
Vice President, Chief Financial
Officer and Secretary
(Duly Authorized and Principal
Financial Officer)
Date: November 19, 2003
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