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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1996 Commission file No. 1-10113
HALSEY DRUG CO., INC.
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(Exact name of registrant as specified in its charter)
New York 11-0853640
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(State of Incorporation) (I.R.S. Employer Identification No.)
1827 Pacific Street, Brooklyn, New York) 11233
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (718) 467-7500
Securities registered pursuant to Section 12(b) of the Act:
Title of each class: Name of each exchange
on which registered:
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Common Stock, Par Value $0.01 The American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No |_|
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 19, 1997, the registrant had 13,944,521 shares of Common
stock, par value $0.01, outstanding. Based on the average of the high and low
sales prices of the common stock on March 19, 1997 ($4.87), the aggregate market
value of the voting stock held by non-affiliates of the registrant was
approximately $65,262,953.
Documents Incorporated by Reference
Document Where Incorporated
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Proxy Statement for the Annual Meeting Part III
to be held on June 4, 1997
C O N T E N T S
Page
Part I
Item 1. Business 3
Item 2. Properties 14
Item 3. Legal Proceedings 15
Item 4. Submission of Matters to a Vote of Security Holders 19
Part II
Item 5. Market for Registrant's Equity and Related Shareholder 20
Matters
Item 6. Selected Financial Data 21
Item 7. Management's Discussion and Analysis of Financial 23
Condition and Results of Operations
Item 8. Financial Statements and Supplementary Data 30
Item 9. Changes in and Disagreement with Accountants on
Accounting and Financial Disclosure 30
Part III
Item 10. Directors and Executive Officers of the Registrant 31
Item 11. Executive Compensation 31
Item 12. Security Ownership of Certain Beneficial Owners and 31
Management
Item 13. Certain Relationships and Related Transactions 31
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 32
Signatures 37
Index to Consolidated financial Statements
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this Report under the captions Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations," Item
1, "Business" and elsewhere in this Report constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995 (the "Reform Act"). Such forward-looking statements involve known and
unknown risks, uncertainties and other factors which may cause the actual
results, performance or achievements of Halsey Drug Co., Inc. ("Halsey" or the
"Company"), or industry results, to be materially different from any future
results, performance, or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, the following:
changes in general economic and business conditions; loss of market share
through competition; introduction of competing services by other companies;
changes in industry capacity; pressure on prices from competition or from
purchasers of the Company's products; regulatory changes in the generic
pharmaceutical manufacturing industry; regulatory obstacles to the introduction
of new services that are important to the Company's growth; availability of
qualified personnel; the loss of any significant customers; and other factors
both referenced and not referenced in this Report. When used in this Report,
the words "estimate," "project," "anticipate," "expect," "intend," "believe,"
and similar expressions are intended to identify forward-looking statements.
Item 1. Business.
GENERAL
The Company, a New York corporation established in 1935, and its subsidiaries,
are engaged in the manufacture, sale and distribution of generic drugs. A
generic drug is the chemical and therapeutic equivalent of a brand-name drug for
which patent protection has expired. A generic drug may only be manufactured and
sold if patents (and any additional government-granted exclusivity periods)
relating to the brand-name equivalent of the generic drug have expired. A
generic drug is usually marketed under its generic chemical name or under a
brand name developed by the generic manufacturer. The Company sells its generic
drug products under its Halsey label and under private-label arrangements with
drugstore chains and drug wholesalers. While subject to the same governmental
standards for safety and efficacy as its brand-name equivalent, a generic drug
is usually sold at a price substantially below that of its brand-name
equivalent.
Halsey's wholly-owned subsidiaries include Blue Cross Products, Inc., a New York
corporation (currently inactive), Houba, Inc. ("Houba"), an Indiana corporation,
Halsey Pharmaceutical, Inc. ("Halsey Pharmaceutical"), a Delaware corporation,
The Medi-Gum Corporation, a Delaware corporation (currently inactive), and
Indiana Fine Chemicals Corporation ("Indiana Chemicals"), a Delaware
corporation. Halsey has two additional subsidiaries: H.R. Cenci Laboratories,
Inc., a California corporation (97% owned), and Cenci Powder Products, Inc.
("Cenci Powder"), a Delaware corporation (100% owned).
3
The Company manufactures its products at facilities in New York, Indiana and
California. During 1995, in connection with the sale of its Oxycodone with
acetaminophen Tablet business, the Company began manufacturing Oxycodone with
acetaminophen Tablets for a third party. See "Business-- Dispositions," below.
During the last several years, the Company has sought to diversify its
businesses through strategic acquisitions and through the development,
manufacture and sale of bulk chemical products used by others as raw materials
in the manufacture of finished drug forms.
During the past several years, the Company's business has been adversely
affected by the discovery of various manufacturing and record keeping problems
identified with certain products manufactured at its Brooklyn, New York plant.
On June 21, 1993, the Company entered into a plea agreement with the United
States Department of Justice (the "DOJ") to resolve the DOJ's investigation into
the manufacturing and record keeping practices at the Company's Brooklyn plant.
Under the terms of the plea agreement, the Company agreed to plead guilty to
five counts of adulteration of a single drug product shipped in interstate
commerce and related record keeping violations. The plea agreement also requires
the Company to pay a fine of $2,500,000 over five years in quarterly
installments of $125,000 commencing in September 1993. Two installments have
been paid to date. From April 1995 through December 1996, the Company made
additional partial payments to the DOJ aggregating $100,000. The agreement with
the DOJ stipulates that if any payments are not made in a timely fashion the
entire amount of the fine shall become due and payable immediately. Such
nonpayment also constituted a default under the Company's Credit Agreement with
its banks (the "Bank Group") (which expires on June 30, 1997). As a result, the
entire amount of the settlement has been classified as current. As of the date
of this Report, no action has been initiated to require payment of the entire
outstanding amount of the fine.
On June 29, 1993, the Company entered into a consent decree with the U.S.
Attorney for the Eastern District of New York on behalf of the U.S. Food and
Drug Administration (the "FDA") that resulted from the FDA's investigation into
the Brooklyn plant's compliance with the FDA's Current Good Manufacturing
Practices ("CGMP") regulations. Under the terms of the consent decree, the
Company was enjoined from shipping any solid dosage drug products (i.e.,
excluding liquid drug formulations) manufactured at the Brooklyn plant until the
Company established, to the satisfaction of the FDA, that the methods used in,
and the facilities and controls to be used for, manufacturing, processing,
packing, labeling and holding any drug, are established, operated, and
administered in conformity with the Federal Food, Drug, and Cosmetic Act and all
CGM Regulations. As part of satisfying these requirements, the Company was
required to validate the manufacturing processes for each solid dosage drug
product prior to manufacturing and shipping the drug product.
During 1995, the Company sold its Oxycodone with Acetaminophen Tablet business
to an affiliate of Mallinckrodt Chemical Products, Inc. (collectively,
"Mallinckrodt"). Under a tolling arrangement with Mallinckrodt, the Company
manufactured such tablets for Mallinckrodt for at least two years. Mallinckrodt
can, at its option, continue to have the Company manufacture tablets after March
1997 for an additional year. See "Business - Dispositions," below.
4
On October 23, 1996, the Company withdrew four of its Abbreviated New Drug
Application ("ANDA"), including its ANDA (the "Capsule ANDA") for
acetaminophen/oxycodone capsules, and halted sales of the affected products. Net
sales pursuant to the withdrawn Capsule ANDA were approximately $3 million and
$8 million for the years ended December 31, 1996 and December 31, 1995,
respectively, and accounted for approximately 24% and 40% of the Company's total
net sales during such twelve month periods. The Company instituted the
withdrawal at the suggestion of the FDA and in anticipation of its release from
the FDA's Application Integrity Policy list and its restrictions (collectively,
the "AIP"). The FDA had placed the Company on the AIP, in October, 1991, in
connection with its investigation of the Company's operations which culminated
in the 1993 consent decree. Under the AIP, the FDA suspended all of the parent
company's (i.e., Halsey Drug Co.'s) applications for new drug approvals,
including ANDAs and supplements to ANDAs. At the FDA's suggestion, the Company
retained outside consultants to perform validity assessments of its drug
applications. Thereafter, in October, 1996, the FDA recommended that several
applications, including the Capsule ANDA, be withdrawn. As a basis for its
decision, the FDA cited questionable and incomplete data submitted in connection
with the applications. The FDA indicated that withdrawal of the four ANDAs was
necessary for the release of the Company from the AIP. The FDA further required
submission by the Company of a Corrective Action Plan. Said Plan was prepared
and submitted by the Company and accepted by the FDA.
On December 19, 1996 the FDA released the Company from the AIP. Release from the
AIP permits the Company to submit ANDA applications to the FDA for review, for
the first time since October,1991. At or about the time of such release, the
Company submitted five new ANDAS to the FDA for its review. In addition, the
Company had previously submitted a new ANDA with respect to the Capsules, which
the Company anticipates will be reviewed in the near future. However, there can
be no assurance any of its new ANDAs, including the new Capsule ANDA, will be
approved by the FDA. The Company will not be able to market these new products
unless and until the FDA approves the new underlying ANDAs. Failure to obtain
FDA approval for the new ANDAs, or a significant delay in obtaining such
approval, would materially adversely affect the Company's business operations
and financial condition.
PRODUCTS AND PRODUCT DEVELOPMENT
Generic Drug Products
The Company historically has manufactured and sold a broad range of prescription
and over-the-counter drug products. The Company's pharmaceutical product list
currently includes a total of approximately 24 products, consisting of 9 dosage
forms and strengths of prescription drugs and 15 dosage forms and strengths of
over-the-counter drugs. Each dosage form and strength of a particular drug is
considered in the industry to be a separate drug product. The Company's drug
products are sold in various forms, including liquid and powder preparations,
compressed tablets and two-piece, hard-shelled capsules.
5
Most of the generic drug products manufactured by the Company can be classified
within one of the following categories:
1. Antibiotics,
2. Anti-infective and anti-tubercular drugs,
3. Neuropharmacological drugs,
4. Antihistamines and antihistaminic decongestants, or
5. Antitussives.
Upon the release of the Company from the AIP program on December 19, 1996, the
FDA resumed review of the parent company's (i.e., Halsey's) applications for new
drug approvals, as well as supplemental approvals. Although the Company has
filed five new ANDAS with the FDA for its review since the lifting of the
suspension, the Company is unable to predict whether it will receive FDA
approval to market any new products during 1997. However, on March 11, 1997, the
Company has received a supplemental approval from the FDA on two of its
products.
The Company's development strategy for new drug products has been to focus on
the development of a broad range of generic form drugs, each of which (i) has
developed a solid market acceptance with a wide base of customers, (ii) can be
sold on a profitable basis notwithstanding intense competition from other drug
manufacturers, and (iii) is no longer under patent protection. The Company has
also diversified its current product line to include some less widely prescribed
drugs as to which limited competition might be expected. In addition, the
Company will continue to pursue the development of its existing pharmaceutical
business as well as the development of the chemical products business of its
Houba subsidiary.
Development activities for each new generic drug product begin several years in
advance of the patent expiration date of the brand-name drug equivalent. This is
because the profitability of a new generic drug usually depends on the ability
of the Company to obtain FDA approval to market that drug product upon or
immediately after the patent expiration date of the equivalent brand-name drug
so that the Company will be among the first to market the new generic drug
product. As other off-patent drug manufacturers receive FDA approvals on
competing products, prices and revenues typically decline. Accordingly, the
Company's ability to attain its previous levels of profitability depends on the
Company's ability to develop and introduce new products, the timing of FDA
approval of such products and the number and timing of FDA approvals for
competing products.
6
Dispositions
On March 21, 1995 (the "Closing Date"), the Company sold its Tablets ANDA for 5
mg Oxycodone HCl/325 mg Acetaminophen tablets ("Tablets"), and certain pieces of
equipment utilized in connection with its production activities under the
Tablets ANDA for up to $5.4 million (the "Purchase Price") to Mallinckrodt.
Mallinckrodt paid the Company $2 million of the Purchase Price on the Closing
Date, having previously paid $500,000 in July 1994. The balance (the "Deferred
Payment") of the Purchase Price was payable as follows. Mallinckrodt paid $1
million, on January 9, 1997, following the Company's release from the AIP
program. Mallinckrodt will pay the Company the $1.9 million balance of the
Deferred Payment when Mallinckrodt receives certain authorizations (the
"Mallinckrodt Authorizations") from the FDA, but in no event later than March
21, 1998.
In connection with the transaction, Mallinckrodt agreed to defer $1.2 million of
the Company's trade debt due to an affiliate of Mallinckrodt. The deferred
indebtedness is evidenced by a promissory note (the "Note") with interest
accruing at a rate of 8% per annum. The Note, which may be prepaid at any time,
is due and payable on the earlier of the date of the Mallinckrodt Authorization
or September 21, 1997. Mallinckrodt may offset its Deferred Payment obligations
against the amount due on the Note, provided certain conditions are met. The
Company may also offset the amount due to Mallinckrodt on the Note against the
Deferred Payment obligations when such obligations mature. However, the Company
has agreed with its banks (see Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operation") not to exercise its right of
offset until the Company has repaid in full the amounts due to its banks. The
Note, which is subordinate to future bank indebtedness of up to $8,000,000, is
secured by substantially all of the Company's and Houba's assets.
In connection with the sale of the Tablets ANDA, the Company agreed to
manufacture Tablets for Mallinckrodt for a period of three years and
Mallinckrodt agreed to order a minimum number of Tablets from the Company for
the two year period following the Closing Date. Mallinckrodt may terminate the
manufacturing agreement after March 1997. The Company and Mallinckrodt also
entered into a non-competition agreement pursuant to which the Company agreed
not to compete with Mallinckrodt and its affiliates in the United States with
respect to the Tablets ANDA until March 21, 2000. If, prior to the time it is
possible for Mallinckrodt to commence production under the Tablets ANDA or any
new Tablets ANDA at its own facility, the Company ceases or is forced to cease
or substantially curtail production under the Tablets ANDA, as a consequence
of(i) any action or communication by the FDA or any other regulatory or
governmental authority or (ii) any financial or other business difficulty, then
Mallinckrodt has the right to cancel payment of any yet unpaid portion of the
Deferred Payment ($1.9 million) and shall further have the right to a full
refund of any portion of the Deferred Payment already made to the Company. On
January 9, 1997, Mallinckrodt paid to the Company $1,000,000, pursuant to the
release of the Company from the AIP. The funds were applied to the outstanding
Bank Group loan balance.
7
During the fiscal years ended December 31, 1994, 1993 and 1992, the Company
derived net revenues from Tablets of approximately $6,600,000, $5,600,000 and
$4,200,000, respectively. Management anticipated that Tablet sales would decline
during 1995 as a result of increasing competition. Management's determination
that an integrated supplier such as Mallinckrodt would be better suited to
increasingly competitive market conditions than the Company was an important
factor in the decision to proceed with the sale of the Tablets ANDA.
In connection with the sale of the Tablets ANDA, the Company issued to
Mallinckrodt an option exercisable at any time until March 21, 1998, to purchase
the Capsule ANDA at an exercise price (the "Option Price") equal to 75% of Net
Capsule Revenue, subject to downward adjustment in the event of a decline in
pricing levels. Net Capsule Revenue is defined to mean all revenue (net of
rebates, adjustments, discounts, allowances, expenses incurred in product
recalls and similar items) derived from sales of Capsules during the twelve
month period immediately prior to the date the option is exercised. The Option
Price is payable as follows: $200,000 on the later of (i) exercise and (ii) the
date when Mallinckrodt or an affiliate qualifies as the new source for certain
raw materials, with the remainder of the Option Price due when Mallinckrodt
obtains certain authorizations from the FDA or such earlier date as the parties
agree. Upon exercise Mallinckrodt will purchase from the Company equipment used
to manufacture the capsules for the greater of $250,000 or the appraised value
of the equipment. At such time the Company and Mallinckrodt will enter into
agreements pursuant to which the Company will (a) manufacture
acetaminophen/oxycodone capsules for Mallinckrodt for a period of time and (b)be
prohibited from competing with Mallinckrodt and its affiliates with respect to
the production of capsules.
Acquisitions
The Company has engaged Penick Corporation ("Penick") to process certain of the
raw materials utilized in the production of acetaminophen/oxycodone capsules. In
order to ensure the continued viability of Penick, the Company's Houba
subsidiary purchased a 25% equity interest in Penick in mid-1993. In addition,
in September 1995, Houba purchased an 8.3% equity interest in Penick
Pharmaceutical, Inc., which owns the other 75% of Penick. In June 1994 both
Penick Corporation and Penick Pharmaceutical, Inc, filed petitions under Chapter
11 of the United States Bankruptcy Code.
OTHER TRANSACTIONS
Agreements with Zatpack, Inc.
On March 30, 1995, the Company signed an agreement (the "Zatpack Agreement")
with Zatpack, Inc. ("Zatpack"), an affiliate of Zuellig Group N.A.,Inc.
("Zuellig"). The Zatpack Agreement provided for the purchase of 500,000 shares
of Common Stock (the "Zatpack Shares") by Zatpack, a British Virgin Islands
Company, in consideration of $1,000,000. The $1,000,000 purchase price was
comprised of a combination of cancellation of indebtedness (primarily incurred
by subsidiaries of Halsey for the purchase of raw materials previously delivered
and in the process of being delivered from affiliates of Zuellig), purchase of
inventory, and surrender of shares of Indiana Fine Chemicals. As a result of
this transaction, the Company owns 100% of Indiana Fine Chemicals.
8
Pursuant to the Zatpack Agreement, the Company issued the Zatpack Note to
Zatpack as consideration for cancellation of additional indebtedness. This
indebtedness resulted from trade payables and advances to the Company by Zuellig
and certain of its subsidiaries. The Zatpack Note is in the original principal
amount of $1,292,242, with accrued interest of $243,110. The Zatpack Note has
been converted into 642,407 shares of Common Stock (the "Note Shares"), in
March, 1997, at an adjusted conversion price of $2.39 per share, thereby
canceling the indebtedness.
GOVERNMENT REGULATION
General
All pharmaceutical manufacturers, including the Company, are subject to
extensive regulation by the federal government, principally by the FDA, and, to
a lesser extent, by state and local governments. The Company cannot predict the
extent to which it may be affected by legislative and other regulatory
developments concerning its products and the healthcare industry generally. The
Federal Food, Drug, and Cosmetic Act, the Generic Drug Enforcement Act of 1992,
the Controlled Substance Act and other federal statutes and regulations govern
or influence the testing, manufacture, safe labeling, storage, record keeping,
approval, pricing, advertising, promotion, sale and distribution of
pharmaceutical products. Noncompliance with applicable requirements can result
in fines, recall or seizure of products, criminal proceedings, total or partial
suspension of production, and refusal of the government to enter into supply
contracts or to approve new drug applications. The FDA also has the authority to
revoke approvals of new drug applications. Recent changes in FDA procedures have
increased the time and expense involved in obtaining ANDA approvals and in
complying with the FDA's CGMP standards. The ANDA drug development and approval
process now averages approximately eight months to two years. The approval
procedures are generally costly and time consuming.
FDA approval is required before any "new drug," prescription or
over-the-counter, can be marketed. A "new drug" is one not generally recognized
by qualified experts as safe and effective for its intended use. Such general
recognition must be based on published adequate and well controlled clinical
investigations. Generally, a drug which is the generic equivalent of a
previously approved prescription drug will be treated as a new drug requiring
FDA approval. Furthermore, each dosage form of a specific generic drug product
requires separate approvals by the FDA. However, as discussed below, less costly
and time consuming approval procedures may be used for generic equivalents.
Among the requirements for drug approval is that the prospective manufacturer's
methods must conform to the CGMPs. CGMPs apply to the manufacture, receiving,
holding and shipping of all drugs, whether or not approved by the FDA. CGMPs
must be followed at all times during which the drug is manufactured. To ensure
full compliance with the standards, some of which are set forth in regulations,
the Company must continue to expend time, money and effort in the areas of
production and quality control. Failure to so comply risks delays in approval of
drugs, disqualification from eligibility to sell to the government, and possible
FDA enforcement action such as an injunction against shipment of the Company's
products or the seizure of noncomplying drug products, and/or, in serious cases,
criminal prosecution. See also "Government Regulation--FDA Investigations" below
and Item 3, "Legal Proceedings."
9
In addition, products marketed outside the United States, but which are
manufactured inside the United States, are subject to certain FDA regulations,
as well as regulation by the country in which the products are to be sold.
The Company also is governed by federal, state and local laws of general
applicability, such as those regulating working conditions. In addition, the
Company is subject, as are manufacturers generally, to various federal, state
and local environmental protection laws and regulations, including those
governing the discharge of materials into the environment. Compliance with these
laws is not expected to have any material effect upon the Company's capital
expenditures, earnings or competitive position.
Drug Approvals
There are currently three ways to obtain FDA approval of a new drug.
1. New Drug Applications ("NDA"). Unless one of the procedures
discussed in paragraph 2 or 3 below is available, a prospective
manufacturer must conduct and submit to the FDA complete clinical
studies to prove a drug's safety and efficacy, in addition to the
bioavailability and/or bioequivalence studies discussed below, and
must also submit to the FDA information about manufacturing
practices, the chemical make-up of the drug and labeling.
2. Abbreviated New Drug Applications ("ANDA"). The Drug Price
Competition and Patent Term Restoration Act of 1984 (the "1984 Act")
established the ANDA procedure for obtaining FDA approval for those
drugs that are off-patent or whose exclusivity has expired and that
are bioequivalent to brand-name drugs. An ANDA is similar to an NDA,
except that the FDA waives the requirement of conducting complete
clinical studies of safety and efficacy, although it may require
expanded clinical bioavailability and/or bioequivalence studies.
"Bioavailability" means the rate of absorption and levels of
concentration of a drug in the blood stream needed to produce a
therapeutic effect. "Bioequivalence" means equivalence in
bioavailability between two drug products. In general, an ANDA will
be approved only upon a showing that the generic drug covered by the
ANDA is bioequivalent to the previously approved version of the
drug, i.e., that the rate of absorption and the levels of
concentration of a generic drug in the body are substantially
equivalent to those of a previously approved equivalent drug. The
principal advantage of this approval mechanism is that an ANDA
applicant is not required to conduct the same preclinical and
clinical studies to demonstrate that the product is safe and
effective for its intended use.
The 1984 Act, in addition to establishing the ANDA procedure,
created new statutory protections for approved brand-name drugs. In
general, under the 1984 Act, approval of an ANDA for a generic drug
may not be made effective until all relevant product and use patents
for the equivalent brand name drug have expired or have been
determined to be invalid. The only exceptions are situations in
which the ANDA applicant challenges the validity or applicability of
the patent and either the patent holder does not file suit or
litigation extends more than 30 months after notice of the challenge
was received by the patent holder. Prior to enactment of the 1984
10
Act, the FDA gave no consideration to the patent status of a
previously approved drug. Additionally, under the 1984 Act, if
specific criteria are met, the term of a product or use patent
covering a drug may be extended up to five years to compensate the
patent holder for the reduction of the effective market life of that
patent due to federal regulatory review. With respect to certain
drugs not covered by patents, the 1984 Act sets specified time
periods of two to ten years during which approvals of ANDAs for
generic drugs cannot become effective or, under certain
circumstances, ANDAs cannot be filed if the equivalent brand-name
drug was approved after December 31, 1981.
3. Alternative New Drug Applications. An alternative NDA procedure is
provided by the 1984 Act whereby the applicant may rely on published
literature and more limited testing requirements. That alternative
seldom provides advantages over the ANDA procedure, however, and is
accordingly rarely used.
Generic Drug Enforcement Act
As a result of hearings and investigations concerning the activities of the
generic drug industry and the FDA's generic drug approval process, Congress
enacted the Generic Drug Enforcement Act of 1992 (the "Generic Drug Act"). The
Generic Drug Act confers significant new authority upon the FDA to impose
debarment and civil penalties for individuals and companies who commit certain
illegal acts relating to the generic drug approval process.
The Generic Drug Act requires the mandatory debarment of companies or
individuals convicted of a federal felony for conduct relating to the
development or approval of any ANDA, and gives the FDA discretion to debar
corporations or individuals for similar conduct resulting in a federal
misdemeanor or state felony conviction. The FDA may not accept or review during
the period of debarment (one to ten years in the case of mandatory, or up to
five years in the case of permissive, debarment of a corporation) any ANDA
submitted by or with the assistance of the debarred corporation or individual.
The Generic Drug Act also provides for temporary denial of approval of generic
drug applications during the investigation of crimes that could lead to
debarment. In addition, in more limited circumstances, the Generic Drug Act
provides for suspension of the marketing of drugs under approved generic drug
applications sponsored by affected companies. The Generic Drug Act also provides
for fines and confers authority on the FDA to withdraw, under certain
circumstances, approval of a previously granted ANDA if the FDA finds that the
ANDA was obtained through false or misleading statements. The Company has not
been debarred as a result of the FDA investigation and settlement and the
consent decree with the FDA makes no provision therefor.
11
Healthcare Reform
Several legislative proposals to address the rising costs of healthcare have
been introduced in Congress and several state legislatures. Many of such
proposals include various insurance market reforms, the requirement that
businesses provide health insurance coverage for all their employees,
significant reductions in the growth of future Medicare and Medicaid
expenditures, and stringent government cost controls that would directly control
insurance premiums and indirectly affect the fees of hospitals, physicians and
other healthcare providers. Such proposals could adversely affect the Company's
business by, among other things, reducing the demand, and the prices paid, for
pharmaceutical products such as those produced and marketed by the Company.
Additionally, other developments, such as (i) the adoption of a nationalized
health insurance system or a single payor system, (ii) changes in needs-based
medical assistance programs, or (iii) greater prevalence of capitated
reimbursement of healthcare providers, could adversely affect the demand for the
Company's products.
RESEARCH AND DEVELOPMENT
The Company conducts research and development activities at each of its Brooklyn
and Indiana facilities. The Company's research and development activities
consist primarily of new generic drug product development efforts and
manufacturing process improvements, as well as the development for sale of new
chemical products. New drug product development activities are primarily
directed at conducting research studies to develop generic drug formulations,
reviewing and testing such formulations for therapeutic equivalence to brand
name products and additional testing in areas such as bioavailability,
bioequivalence and shelf-life. For fiscal years 1996, 1995 and 1994, total
research and development expenditures were $1,854,000, $818,000 and $491,000,
respectively. During 1997 the Company intends to concentrate its research and
development efforts in the following areas:
1. Reintroduction of products suspended as a result of the consent
decree which require prior FDA validation;
2. Reintroduction of products which will require changes in formulation
and submission for prior approval from the FDA; and
3. Development of new products.
The Company currently maintains a full-time staff of eight in its Research and
Development Departments.
12
MARKETING AND CUSTOMERS
A key element of the Company's marketing strategy is to maintain sufficient raw
material and finished good inventories to enable the Company to fill customer
orders promptly. This strategy requires a substantial amount of working capital
to maintain inventories at a level sufficient to meet anticipated demand.
The Company sells its products primarily through three salaried employees and to
a lesser extent through two independent sales representatives, each of whom are
compensated on a commission basis. Sales of drugs in dosage form are made
primarily to drug wholesalers, drugstore chains, distributors and other
manufacturers and are not concentrated in any specific region.
During 1996, the Company had net sales to one customer in excess of 10% of total
sales, aggregating 10% of total sales. During 1995, the Company had net sales to
two customers in excess of 10% of total sales, each aggregating 25% and 11% of
total sales, respectively. During 1994, the Company had net sales to three
customers in excess of 10% of total sales, each aggregating 12% of total sales.
Balances due from these customers were approximately 0% and 25% of total
accounts receivable at December 31, 1996 and 1995, respectively. The Company
believes that the loss of either of these customers could have a material
adverse effect on the Company.
The estimated dollar amount of the backlog of orders for future delivery as of
February 28, 1997 was approximately $3,560,000 as compared with approximately
$1,070,000 as of March 31, 1996. Although these orders are subject to
cancellation, management expects to fill substantially all orders by the second
quarter of 1997.
COMPETITION
The Company competes in varying degrees with numerous companies in the health
care industry, including other manufacturers of generic drugs (among which are
divisions of several major pharmaceutical companies) and manufacturers of
brand-name drugs. Many of the Company's competitors have substantially greater
financial and other resources and are able to expend more money and effort than
the Company in areas such as marketing and product development. Although a
company with greater resources will not necessarily receive FDA approval for a
particular generic drug before its smaller competitors, relatively large
research and development expenditures enable a company to support many FDA
applications simultaneously, thereby improving the likelihood of being among the
first to obtain approval of at least some generic drugs.
One of the principal competitive factors in the generic pharmaceutical market is
the ability to introduce generic versions of brand-name drugs promptly after a
patent expires. The Company believes that it was at a competitive disadvantage
until its release from the AIP program and the FDA's resumption of review of
ANDAs submitted by the Company's Brooklyn plant. See "Government
Regulation--Generic Drug Enforcement Act" above. Other competitive factors in
the generic pharmaceutical market are price, quality and customer service
(including maintenance of sufficient inventories for timely deliveries).
13
RAW MATERIALS
The raw materials essential to the Company's business are bulk pharmaceutical
chemicals purchased from numerous sources. Raw materials are generally available
from several sources. As a result of the Company's release from the AIP, by the
FDA, the Company is now able to submit Supplements to the FDA, thereby allowing
the Company to purchase raw materials from alternate sources. See Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations- -Liquidity and Capital Resources."
The United States Drug Enforcement Administration (the "DEA") limits the
quantity of the Company's inventories of certain raw materials used in the
production of controlled substances based on historical sales data. These
limitations could increase the likelihood of raw material shortages and of
manufacturing delays in the event the Company was required to find new suppliers
of these raw materials.
EMPLOYEES
As of December 31, 1996, the Company had approximately 200 full-time employees.
Approximately 80 are administrative and professional personnel and the balance
are in production and shipping. Among the professional personnel, eight are
engaged in product development. Approximately 90 employees at the Company's
Brooklyn plant are represented by a local collective bargaining unit whose
agreement with the Company expires on July 1, 1997. Management believes that its
relations with its employees and unions are generally satisfactory; however, the
Company has been involved in litigation with respect to certain aspects of its
collective bargaining agreement. See Item 7, "Legal Proceedings - Other Pending
Legal Proceedings."
Item 2. Properties
Halsey leases, as sole tenant, a total of approximately 112,300 square feet, in
three buildings on Pacific Street and Dean Street in Brooklyn, New York. Each of
these leases is between Halsey and unaffiliated lessors. The approximate
aggregate minimum rental commitments under these operating leases are as
follows: $884,000 for the year 1995, $928,000 for the year 1996 and $975,000 for
the year 1997. These leases expire on December 31, 2005. The buildings leased by
Halsey in Brooklyn house research and development and manufacturing facilities
and corporate offices.
Houba owns approximately 45,000 square feet of building space on approximately
30 acres of land in Culver, Indiana, which includes a modern 15,000 square foot
manufacturing facility. This manufacturing complex houses separate plants for
the production of Doxycycline raw materials, Doxycycline capsules and tablets
and Biotin raw materials. In 1996, in conjunction with a settlement with two
former employees, the Company acquired real property, improved by a residential
property, in Culver, Indiana adjacent to the manufacturing facility. The Company
became the lessor of the residential property upon closing of the acquisition.
14
Cenci Laboratories and Cenci Powder together own approximately 6,700 square feet
of manufacturing and distribution building space on approximately one-half acre
of land in Fresno, California. In early 1992, the Company acquired additional
land adjoining this property for the purpose of expanding the manufacturing
facilities and distribution space located on such property. In addition, Cenci
Laboratories and Cenci Powder lease approximately 18,000 square feet of space in
a building located in Fresno, California used for manufacturing and corporate
offices. During the years ended December 31, 1996, 1995 and 1994, Cenci and
Cenci Powders paid an aggregate of $90,000, $86,000 and $99,000, respectively,
to a former officer of Cenci Laboratories and Cenci Powder in respect to this
lease.
The Company also leases office space in Westwood, New Jersey for its marketing
and sales departments on a year-to-year basis.
Item 3. Legal Proceedings.
GOVERNMENT CONSENT DECREES
On June 21, 1993, the Company entered into a plea agreement with the DOJ to
resolve the DOJ's investigation into the manufacturing and record keeping
practices of the Company's Brooklyn plant. Under the terms of the plea
agreement, the Company agreed to plead guilty to five counts of adulteration of
drug products shipped in interstate commerce. Each count involved product
adulteration and record keeping deficiencies relating to a single drug product,
Quinidine Gluconate (324mg tablets), manufactured at the Brooklyn plant. The
plea agreement also requires the Company to pay a fine of $2,500,000 over five
years in quarterly installments of $125,000, commencing on or about September
15, 1993. The Company's plea was entered in and the terms of the plea agreement
approved by the United States District Court for the District of Maryland on
July 16, 1993. Two installments have been paid to date. Only additional partial
payments have been paid in the amount of $100,000. The agreement with the DOJ
stipulates that if any payments are not made in a timely fashion the entire
amount of the fine shall become due and payable immediately. As a result, the
entire amount of the settlement has been classified as current. Such nonpayment
also constituted a default under the Company's Credit Agreement with its banks.
As of the date of this Report, no action has been initiated to require payment
of the entire outstanding amount of the fine.
See Item 1, "Business - General" for information regarding release of the
Company from the FDA's AIP program and resumption by the FDA of review of ANDAs
filed by the Company.
SHAREHOLDER AND DERIVATIVE ACTIONS
On March 31, 1993, and April 1, 1993, five class-action lawsuits were filed in
Federal Court by shareholders against the Company and certain of its then
directors. Each of the actions alleged that the Company and its directors had
made misleading statements and omissions relating to the prospects of the
Company's business and products, including products under development, as well
as relating to the status of DOJ and FDA investigations. On May 20, 1993 and
October 14, 1993, two separate shareholders derivative lawsuits were filed in
New York State Court against the Company and certain of
15
its directors. Each of these lawsuits alleged that the Company and its directors
concealed certain government investigations by the FDA and the DOJ. These
actions also alleged that the directors breached their fiduciary duty in
connection with the dispositions by them of shares of Common Stock on the basis
of material information which was not publicly known. In June 1994, the Company
agreed to a settlement of these lawsuits. In November 1994, both the Federal and
State Courts approved the terms of the settlement, under which the Company
agreed to pay $1,000,000 in cash and, at the Company's option, either (I) to
issue shares of Common Stock having an aggregate market value, as of the date of
distribution, of $3,000,000, or (ii) to pay $3,000,000 in cash, or (iii) to
distribute any combination of shares or cash having a combined value as of the
date of distribution of $3,000,000. The initial payment of $1,000,000 was paid
by the Company's insurers. In November 1995 the Company satisfied the remainder
of its settlement obligations by issuing to approved class members a total of
824,742 shares of Common Stock at a per share price of $3.6375, or an aggregate
value of $3,000,000.
OTHER GOVERNMENTAL PROCEEDINGS
By letter dated November 12, 1993, the staff (the "Staff") of the Securities and
Exchange Commission (the "Commission") requested that the Company provide to the
staff on a voluntary basis, information and documents regarding the ingredients
and filings relating to the following drugs: quinidine gluconate,
propylthiourical, acetaminophen and codeine phosphate, metronidazole, quinidine
sulfate, and hydralazine hydrochloride. The Staff advised the Company that the
inquiry relates to public information disseminated by the Company and trading in
the Company's securities during the period August 1987 through July 1993. The
Company is cooperating with the Staff and has made available various documents.
These documents relate to the testing, formulations and sale of these drugs
which were maintained by the Company at a facility in Maryland. In April 1994,
the Staff requested additional documentation regarding these matters. The
Company has complied with the additional request. On July 5, 1994, the Company
made a formal submission to the Staff and outlined the parameters of a proposed
settlement. In May 1995, a formal Order of Investigation(the "Order") was issued
by the Commission covering the foregoing matters. In June 1995, additional
documents were submitted. Officers and Directors of the Company also testified
before the Staff.
On January 29, 1997, the Commission simultaneously instituted and settled an
administrative proceeding against the Company, pursuant to the Company's Offer
of Settlement, dated September 13, 1996, as modified by letters dated October
11, 1996 and January 10, 1997. The Order made the following findings, among
others, which the Company neither admitted nor denied. The Company's December
31, 1990 and December 31, 1991 Annual Reports on Form 10-K stated that the
Company had to follow Good Manufacturing Practices ("CGMP") regulations at all
times during which an FDA approved drug was manufactured by the Company. These
annual reports further stated that the Company had to "expend time, money and
effort in the areas of production and quality control to ensure full technical
compliance." These annual reports failed to disclose that the Company was not
manufacturing drugs in accordance with CGMP, but was using unapproved formulas
and procedures, and the Company's employees, at former management's direction,
were concealing product adulteration from the FDA. These annual reports also
failed to disclose that
16
since the Company was not manufacturing generic drugs in accordance with CGMP,
FDA approval for any or all of the Company's new products could be adversely
affected. Based on the foregoing, the Commission found that the Company
committed violations of Sections 10(b) and 13(a) of the Exchange Act and Rules
10b-5, 12b-20 and 13a-1 thereunder, by filing with the Commission Annual Reports
on Form 10-K for the years ended December 31, 1990 and 1991 that omitted to
state material facts necessary to make the statements made, in the light of the
circumstances under which they were made, not misleading. The Order also
requires the Company to "cease and desist from committing or causing any
violation and any future violation" of Sections 10-(b) and 13(a) of the Exchange
Act and Rules 10b-5, 12b-20 and 13a-1 thereunder.
By letter dated October 23, 1995, the Company was notified by the New York State
Education Department (the "Department") that the Professional Conduct Officer of
the Office of Professional Discipline had determined that there was sufficient
evidence of professional misconduct on the Company's part to warrant a
disciplinary proceeding pursuant to New York law. Upon contacting the Deputy
Director of the Office of Professional Discipline, counsel for the Company was
advised that the alleged misconduct related to the same activities that were the
subject of the DOJ investigation. The Company submitted a written response on
November 16, 1995. The Company and the Department have agreed to the entry of a
Consent Order concluding any disciplinary proceedings. The Company will pay
$175,000 in fines over five years. In addition, the Company's registration as a
manufacturer of drugs in New York State is revoked, but such revocation is
stayed and the Company has been placed on probation for a maximum of five years.
The Company has the right to apply for removal from probation after two years.
On November 9, 1995, the Company received two Notices of Charge of
Discrimination from the United States Equal Employment Opportunity Commission
relating to two claimed violations of Title VII of the Civil Rights Act of 1964.
The first charge of employment discrimination was filed on October 31, 1995 by a
female employee of the Company and alleges sexual discrimination and harassment.
A second separate charge of discrimination was also filed on October 31, 1995,
by another female employee alleging sexual harassment against the same
individual. On November 20, 1995, the EEOC terminated its process with respect
to the charges and issued Notices of Right to Sue to the claimants. In February
1996 two lawsuits were filed in the Eastern District of New York captioned
Golovatskaya v. Halsey Drug Co., 96 CIV 0662 and Petrakova v. Halsey Drug Co.,
96 CIV 0660 in connection with the above charges. The lawsuits seek unspecified
damages. At this early stage of the proceedings, the Company is unable to
predict with reasonable certainty the likely outcome of these claims.
CENCI PROCEEDING
The Company had been a defendant in a lawsuit currently pending in the United
States District Court for the Eastern District of California entitled Cenci v.
Halsey Drug Co. The claims in this lawsuit relate to a 1991 Stock Purchase
Agreement whereby the Company agreed to purchase 51% of the stock of Cenci.
17
The plaintiff, both individually and as a shareholder of Cenci and Cenci Powder,
had sued the Company, one of the current officers and two former officers of the
Company. The complaint alleged that the Company had breached a number of
representations made during the course of the negotiations leading to the stock
purchase, including the representation that the Company would provide financial
assistance to both Cenci and Cenci Powder. The Complaint also alleged
misrepresentations relating to the scope of FDA's investigation of the Company.
The Complaint, which included several causes of action, sought unspecified
compensatory damages, as well as punitive damages, rescission, specific
performance, reformation and a declaration as to what amount, if any, was owed
to plaintiff. The Counterclaims of the Company sought unspecified compensatory
and punitive damages.
On March 10, 1997, a Settlement Agreement and Mutual Release was executed by all
parties to the lawsuit, terminating the action. The terms of the Settlement
provide for repayment of certain outstanding loans, made by the plaintiff to
Cenci Labs and Cenci Powders, as well as payment of settlement funds. These
payments will total $600,000, with no interest, paid in equal monthly
installments from March, 1997 to June, 1998. The Settlement Agreement further
provided for the balance of Cenci Labs and Cenci Powder stock to be turned over
to the Company, making the Company owner of 100% of Cenci Powder stock and
substantially all of Cenci Labs stock. Twenty-five thousand shares of
unregistered Common Stock of the Company was tendered to the Plaintiff.
OTHER PENDING LEGAL PROCEEDINGS
The Company was named as a defendant in an action commenced on August 19, 1995
by the Company's former product liability insurer ("Lexington") captioned
Lexington Insurance Company v. Halsey Drug Co., Inc., 95 Civ. 3403, pending in
the United States District Court for the Eastern District of New York. The
Complaint seeks the recovery of sums paid by Lexington to settle a lawsuit
brought by Linda K. Walton relating to the ingestion of quinidine gluconate
allegedly manufactured by the Company. The Complaint requests not less than
$75,000 in damages and payment by the Company of a $25,000 deductible, and a
declaration that the Walton claim, and other similar claims are not covered
under their policy. The Company and Lexington have agreed to a settlement
pursuant to which the Company is required to pay an aggregate amount of $50,000,
of which $10,000 has been paid, with the balance due on April 4, 1997. Lexington
will dismiss the declaratory portion of the Complaint without prejudice.
The Company was named as a defendant in an action captioned Allied Welfare Fund,
Vacation Fringe Benefit Fund and Union Mutual Fund v. Halsey Drug Co., 96 Civ
3655, brought in the United States District Court for the Eastern District of
New York. The Complaint seeks sums allegedly owed to three of the Company's
labor union funds under the Company's collective bargaining agreement.
Plaintiffs seek approximately $265,000. On or about February 28, 1997, the
Company and the plaintiffs agreed to settle the action. The settlement obligates
the Company to remain current on its obligations and to pay portions of the
alleged arrearages in installments. The Company has paid the alleged arrearages
under the stipulation, but is not current on its obligations as of the date of
this filing.
18
On March 4, 1992, an action was commenced against the Company and numerous other
pharmaceutical manufacturers in the Pennsylvania Court of Common Pleas,
Philadelphia Division, entitled captioned Ciavarelli and Ciavarelli v. Abbott
Laboratories, Inc., et al. The Complaint contains seven causes of action,
including negligence, strict liability and breach of warranty, among others, in
connection with the alleged exposure of Debra Ciavarelli in utero to
diethylstilbestrol ("DES"). The plaintiff was unable to determine which of the
defendants produced the DES used by Ms. Ciavarelli. The Complaint seeks in
excess of $25,000 in compensatory and punitive damages. This matter has been
referred to the Company's insurance carrier for defense, which has been assumed.
Twenty additional actions have been commenced and are still pending against the
Company along with numerous other pharmaceutical manufacturers in the
Pennsylvania Court of Common Pleas, Philadelphia Division, during 1992 and 1993.
Each of these actions alleges injury in connection with exposure to the drug
diethylstilbestrol (DES) and each seeks in excess of $25,000 in compensatory and
punitive damages. In each suit, the plaintiff was unable to determine which of
the defendants produced the DES that was used. Thirty-four similar actions have
already been settled and dismissed.
Two DES claims referred to the Company's insurance carriers are pending in other
jurisdictions.
Each of the following matters have been referred to the Company's insurance
carrier for defense. The Company does not believe any of the actions will have a
material impact on the Company's financial condition.
The Company has been named as a defendant in three additional actions which have
been referred to the Company's insurance carrier and have been accepted for
defense. The first action, Alonzo v. Halsey Drug Co., Inc. and K-Mart Corp., No.
64DOT-95111-CT-2736 (Indiana Superior Court, Porter County), was commenced on
November 7, 1995 and involves a claim for unspecified damages relating to the
alleged ingestion of "Doxycycline 100". The second action, Files v. Halsey Drug
Co., Index No. 198787/93 (New York Supreme Court, Suffolk County), commenced on
September 16, 1993, seeks $10,000,000 in damages for wrongful death allegedly
caused by the ingestion of Isoniazid. The action is currently in discovery. The
third action, Hunt v. Halsey Drug Co., Inc. Index No. 33723/93 (New York Supreme
Court, Kings County), was commenced on October 21, 1993, and seeks the recovery
of $8,000,000 for alleged personal injuries suffered by a Wells Fargo security
guard who had responded to a triggered alarm and was shot by a perpetrator. The
action is currently in discovery.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders during the fourth
quarter of 1996.
19
PART II
Item 5. Market for the Registrant's Common Equity and Related Security Holder
Matters.
(a) Market and Market Prices of Common Stock
The Company's common stock is listed on the American Stock Exchange (the
"Exchange") under the symbol "HDG". Set forth below for the periods indicated
are the high and low sales prices for the common stock as reported on the
Exchange.
American Stock Exchange High Low
- ----------------------- ---- ---
1997 Fiscal Year
First Quarter (through
March 27, 1997) 6 4 1/2
1996 Fiscal Year
First Quarter 7 3/4 3
Second Quarter 7 1/4 4
Third Quarter 5 7/8 4
Fourth Quarter 6 3/8 4
1995 Fiscal Year
First Quarter 2 1/2 1 7/8
Second Quarter 3 1/16 1 1/4
Third Quarter 4 1/4 1 3/4
Fourth quarter 4 1/4 3 5/16
1994 Fiscal Year
First Quarter 5 3/8 3 1/8
Second Quarter 4 1/2 2 11/16
Third Quarter 4 2 1/8
Fourth Quarter 3 13/16 1 9/16
There were 956 holders of record of the Company's common stock on March 19,
1997. This number, however, does not reflect the ultimate number of beneficial
holders of the Company's common stock.
(b) Dividend Policy
The payment of cash dividends from current earnings is subject to the discretion
of the Board of Directors and is dependent upon many factors, including the
Company's earnings, its capital needs and its general financial condition.
The Company does not intend to pay any cash dividends in the foreseeable future.
20
Item 6. Selected Financial Data.
The selected consolidated financial data presented on the following pages for
the years ended December 31, 1996, 1995, 1994, 1993 and 1992 are derived from
the Company's audited Consolidated Financial Statements. The Consolidated
Financial Statements as of December 31, 1996 and December 31, 1995, and for each
of the years in the three year period ended December 31, 1995, and the report
thereon, are included elsewhere herein. The selected financial information as of
and for the years ended December 31, 1993 and 1992 are derived from the audited
Consolidated Financial Statements of the Company not presented herein.
The information set forth below is qualified by reference to, and should be read
in conjunction with, the consolidated financial statements and related notes
thereto included elsewhere in this Report and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," (Item 7).
Years ended December 31,
-----------------------------------------------------------------
Operating Data: 1996 1995 1994 1993 1992
------ ------ ------ ------ -----
Net sales $ 12,379 $ 20,225 $ 24,182 $ 36,024 $ 49,868
Costs and expenses
Cost of sales 16,826 18,097 21,584 28,848 35,769
Research and development 1,854 818 502 2,140 1,090
Selling, general and
administrative 7,486 6,098 7,128 8,976 8,616
Provision for regulatory
settlement -- -- -- 5,935 2,000
Interest expense 1,708 1,307 735 631 372
Gain on sale of assets (1,000) (2,288) -- -- --
Provision for stockholders'
litigation settlement -- -- -- 3,000 --
----------- ----------- ----------- ----------- ----------
Income (loss) before provision
for income taxes, minority
interest and cumulative effect
of accounting change (14,495) (3,807) (5,767) (13,326) 2,019
Provision (benefit) for income
taxes -- 296 -- (2,540) 1,128
Minority interest in net loss
(benefit) of subsidiaries -- -- -- 150 37
Cumulative effect of accounting
change -- -- -- (267) --
----------- ----------- ----------- ----------- ----------
Net income (loss) $ (14,495) $ 4,103 $ (5,767) $ (10,903) $ 928
=========== =========== =========== =========== ==========
Net income (loss) per shares $ (1.49) $ (.52) $ (.80) $ (1.57) $ .13
=========== =========== =========== =========== ==========
Weighted average common and
common shares equivalents
outstanding 9,724,106 7,886,101 7,173,908 6,954,713 7,157,871
=========== =========== =========== =========== ==========
21
December 31,
------------------------------------------
Balance Sheet Data: 1996 1995 (1) 1994 1993 1992
------ --------- ------ ------ -----
Working capital (deficiency) $(12,201) $ (7,393) $ (4,451) $ (2,801) $ 3,461
Total assets 11,982 18,862 19,276 24,674 33,385
Total liabilities 19,603 20,402 19,924 20,755 19,347
Retained earnings (accumulated
deficit) (29,484) 14,989 (10,886) (5,118) 5,785
Stockholders' equity (deficit) (7,081 (1,540) (468) 3,920 14,038
(1) After giving effect to charges to operations aggregating $5,935,000
arising from, among other things, the Company's consent decree and plea
agreement with the DOJ and a $3,000,000 provision in connection with the
settlement of shareholder and derivative litigations.
(2) Earnings before income taxes and minority interest, net earnings and
earnings per share were adversely affected by the establishment of a
reserve in the amount of $2,000,000 to cover estimated inventory
write-offs, product recalls and additional legal expenses.
22
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Certain statements set forth under this caption constitute "forward-looking
statements" within the meaning of the Reform Act. See "Special Note Regarding
Forward-Looking Statements" on page 1 of this Report for additional factors
relating to such Statements.
General
Sales for the year ended December 31, 1996 were approximately $12,379,000, as
compared to sales of approximately $20,225,000 for 1995. The net loss for the
year ended December 31, 1996 was $14,495,000, or $1.49 per share, as compared
with the net loss of $4,103,000 or $ .52 per share for 1995.
On December 19, 1996 the Company was released from the FDA Application Integrity
Program (the "AIP"), allowing the Company to submit ANDA applications for FDA
review for new products, as well as Supplements, for the first time since
October, 1991. At or about the time of such release, the Company submitted five
new ANDA's to the FDA for it review. In addition, the Company had previously
submitted a new ANDA with respect to the capsules, which the Company anticipates
will be reviewed in the near future. However, there can be no assurance any of
its new ANDA's, including the new capsule ANDA will be approved by the FDA. The
Company will not be able to market these products unless and until the FDA
approves the underlying ANDA's. Failure to obtain FDA approval for the new
ANDA's, or a significant delay in obtaining such approval, would materially
adversely affect the Company's business operations and financial condition. The
Company's release from the AIP, on December 19, 1996, related to the October,
1991 suspension, by the FDA, of review of all of Halsey's (but not Halsey's
subsidiaries applications for new drug approvals.
The reduction in sales for the year ended December 31, 1996 was primarily
attributable to the removal of four products with sales of $3,300,000 and
$8,400,000 in 1996 and 1995, respectively, from the marketplace and four ANDA's,
as a result of the FDA's requirement that withdrawal of the four ANDA's was
necessary for the release of the Company from the AIP.
Depreciation and amortization was approximately $1,906,000 in 1996, as compared
to $1,956,000 in 1995.
For the year ended December 31, 1995, the reduction in sales was primarily
attributable to the reduction of shipments of tablet products due to the sale at
the end of the First Quarter by the Company of the Tablets ANDA to Mallinckrodt,
which was partially offset by manufacturing revenue that the Company received as
part of its agreement with Mallinckrodt.
23
See "Item 3. Legal Proceedings. Government Consent Decrees" for additional
information regarding the plea agreements with the DOJ and consent decree on
behalf of the FDA.
Outlook
During 1997, the Company intends to focus its research and development program
on the reintroduction of certain previously discontinued products as well as the
development of new generic pharmaceuticals. See "Item 1. Business Research and
Development". As a result of its release from the AIP, the Company is now able
to resume the filing of ANDA applications for review with the FDA. As of March
12, 1997 the Company has received FDA approval on a Supplemental Application for
two products and has ANDA applications for five products currently under FDA
review.
During the year ended December 31, 1996, the Company continued to service the
outstanding debt owed to the Bank Group. On January 9, 1997, the Bank Group
received payment of $1,000,000, towards principal reduction interest payments
and legal expenses, resulting from a Mallinckrodt payment pursuant to the
Company's release from the AIP on December 19, 1996, as a condition of the sale
by the Company to Mallinckrodt of the Tablet ANDA. The $1,000,000 payment from
Mallinckrodt is recorded as income to the Company in 1996. This payment further
reduced the outstanding principal amount owed to the Bank Group to approximately
$2,500,000. The Bank Group has extended the Maturity Date of the loan to June
30, 1997.
24
Results of Operations
The following chart reflects expenses, earnings, income, losses and profits
expressed as a percentage of net sales for the years 1996, 1995 and 1994.
Percentage Change
Year-to-Year
Percentage of Net Sales Increase (Decrease)
--------------------------------- -----------------------------
Years ended
Year ended December December 31,
--------------------------------- -----------------------------
1996 1995 1994 1995 to 1996 1994 to 1995
---- ---- ---- ------------ ------------
Net sales 100.0% 100.0% 100.0% (38.8) (16.4)%
Cost of Goods 135.9 89.5 89.2 (7.0) (16.2)
----- ----- -----
Gross Profit -35.9 10.5 10.8 (309.0) (18.1)
Research & Development 15.0 4.0 2.0 126.7 62.9
Selling, general and
administrative expense 60.5 30.0 29.6 22.8 (14.5)
Provision for regulatory
settlement
----- ----- -----
(Loss) earnings from
operations (111.4) (23.7) (20.8) 187.9 (4.8)
Provision for stockholders
litigation settlement 100.0
Interest expense 13.9 6.5 3.0 30.6 (77.8)
----- ----- -----
(Loss) earnings before income
taxes, minority interest (117.1) (18.9) (23.8) 280.7 (34.0)
(Benefit) provision for income
taxes 0.0 1.5 (100)
----- -----
(Loss) earnings before
minority interest (117.1) (20.4) (23.8) 253.3 (28.9)
Minority interest in net
earnings (loss) of 0.0 0.0 0.0 0.0 0.0
----- ----- ----- ----- -----
subsidiaries
Net (loss) earnings (117.1)% (20.4)% (23.8)% 253.3% (28.9)%
===== ===== ===== ===== =====
Net Sales
The Company's net sales for the fiscal year ended December 31, 1996 of
$12,379,000 represents a decrease by $7,846,000 as compared to net sales for the
fiscal year ended December 31, 1995. In 1995, the Company's net sales decreased
by $3,957,000 as compared to 1994. The decrease in 1996 is primarily
attributable to the removal from the marketplace of four products and the
withdrawal of four ANDA's by the Company, pursuant to a requirement by the FDA,
as a pre-condition to release of the Company from the AIP. The decrease in 1995
was primarily attributable to the sale of the Tablets ANDA to Mallinckrodt.
25
Cost of Goods Sold
For 1996, cost of goods sold decreased by approximately $1,271,000 as compared
to 1995 This decrease is attributable to the reduction in shipments of products.
For 1995, cost of goods sold decreased by approximately $3,487,000 as compared
to 1994. The decrease for 1995 is primarily attributable to the reduction in
shipments of tablet products due to the sale by the Company of the Tablets ANDA
combined with significant reductions in manufacturing costs of personnel and
other expenses. The Company's gross margin as a percentage of sales for the
fiscal years ended December 31,1996, 1995 and 1994 was (35.9%), 10.54% and
10.0%, respectively. Sales reductions, withdrawal of the ANDA of the Capsule
product, unabsorbed manufacturing costs and inventory write-off had a direct
impact upon gross margin during 1996.
Research & Development expenses
For 1996, research & developments expenses amounted to $1,854,000 as compared to
$818,000 in 1995. This increase is attributable to the Company's effort to
actively introduce new products, and to reintroduce products previously
discontinued.
26
Selling, General and Administrative Expenses
Selling, general and administrative expenses as a percentage of sales for the
fiscal years 1996, 1995 and 1994 were 60.5%, 30.0% and 29.6%, respectively.
These expenses increased by approximately $1,388,000, or 22.8%, in fiscal year
1996, as compared to 1995. This increase is attributable to additional legal
expenses and litigation settlements during the year, as well as consulting
expenses for FDA related matters. These expenses decreased by approximately
$1,030,000 or 14.5% in fiscal year 1995 as compared to 1994. The decrease in
both years was attributable to cost saving measures effected by management
during each year, combined with a decrease in net sales.
Interest Expense
Interest expense for 1996 increased by $401,000 as compared to 1995 as a result
of a higher level of borrowings due to the issuance of convertible subordinated
debentures, as well as fees payable to the Company's banks (see "Liquidity and
Capital Resources" below). Interest expense for 1995 increased by $572,000 as
compared to 1994 due to the issuance of the convertible subordinated debentures.
Provision for Income Taxes
The Company had no tax (benefit) provision for 1996, 1995 and 1994 since the
available loss carryback to prior years was utilized by the net operating loss
for 1993 carryback to the prior three years.
Net Loss
For 1996 the Company had a net loss of $14,495,000 as compared to a net loss of
$ 4,103,000 for 1995. This net loss is attributable to the reduction in sales
not offset by a comparable reduction in cost of goods sold, increased legal
expenses, litigation settlements during the year and increased research &
development expenses.
Liquidity and Capital Resources
At December 31, 1996, the Company had cash and cash equivalents of $118,000 as
compared to $353,000 at December 31, 1995. The Company had a working capital
deficit at December 31, 1996 of $11,001,000.
The Company consummated a private offering (the "August Private Offering") of
250 units ("Units") of securities on August 6, 1996 for an aggregate purchase
price of $2,500,000. Each Unit consisted of (i) a convertible subordinated
debenture ("August Debentures") in the principal amount of $10,000 issued at par
and (ii) 461 redeemable common stock purchase warrants ("August Redeemable
Warrants"). The consummation of this private offering during the third quarter
of 1996 resulted in net proceeds of approximately $ 2,160,000. The company was
required to use $391,000 of such net proceeds to repay a portion of its bank
debt, accrued interest and legal fees. The Company used the balance of the net
proceeds of the Offering for: working capital; registration of the underlying
shares under the Securities Act; purchase of equipment; and for research and
development expenses.
27
The August Debentures will become due and payable as to principal five years
from the date of issuance. Interest, at the rate of 10% per annum, is payable on
a quarterly basis. The August Debentures are convertible at any time after
issuance into Underlying Shares at a conversion price (the "Conversion Price")
of $3.25 per share, subject to adjustment.
Each August Redeemable Warrant entitles the holder to purchase one Underlying
Share for $3.25 during the five year period commencing on the date of issuance.
The August Redeemable Warrants are redeemable by the Company at a price of $.01
per Warrant at any time commencing one year after issuance, upon not less than
30 days prior written notice, if the last sale price of the Common Stock on the
Exchange following such one year anniversary equals or exceeds $3.25 per share
(the "Threshold") for the 20 consecutive trading days ending on the third day
prior to the notice of redemption to holders.
On August 18, 1996 and on December 29, 1996, the Company converted July
Debentures of $4,080,000 and the November Debentures of $3,660,000 into
2,040,000 and 1,464,000 shares of Common Stock, respectively.
In addition, a total of 589,540 warrants of the convertible debentures
consisting of 306,000 warrants of the July debentures, 219,000 warrants of the
November debentures and 64,540 warrants of August 1996 debentures were exercised
for stock, from which the Company derived gross proceeds of $1,369,256. The
Company utilized these proceeds for working capital.
As a result of the decline in shipments of solid dosage products from the
Company's Brooklyn plant following the entry of the consent decree, and as a
result of the lack of available borrowings under the Company's credit agreement,
the Company's liquidity position has been materially adversely affected since
June 30, 1993 and the Company's capital resources have been severely limited.
The Company has actively sought to reduce its operating costs at the Brooklyn
plant, where it has made significant reductions in personnel. In addition, the
Company's liquidity position has been affected during the second half of 1994 by
the discontinuance of shipments of liquid products from its Cenci subsidiary as
a result of review completed by the Company of this liquid operation. In an
effort to reduce the loss from lower revenues at this subsidiary, the Company
has reduced its operating costs at Cenci through significant reductions of
personnel and other expenses.
Under the terms of the plea agreement with the DOJ, the Company has agreed to
pay a $2,500,000 fine, payable in quarterly installments of $125,000 over five
years. Two installments have been paid to date. Only additional partial payments
have been paid in the amount of $100,000. The agreement with the DOJ stipulates
if any payments are not made in a timely fashion, the entire amount of the fine
shall become due and payable immediately. As a result, the entire amount of the
settlement has been classified as current as of December 31, 1996. As of the
current date, no action has been initiated to require immediate payment of the
entire amount.
In March 1995, the Company and its banks restructured the Company's amended
credit agreement to include an extension of the due date to August 31, 1995,
modification of the financial covenants, reduction of the exercise prices of all
warrants granted to the banks in excess of $2.375 per share to $2.375 per share
and extension of the expiration date of the warrants to December 1999. As
28
consideration for these modifications, the banks received $1,500,000 of the
proceeds received from the transaction with Mallinckrodt. Funds have been
applied to reduce outstanding principal by approximately $1,113,000 to
approximately $3,777,000, to pay accrued interest (approximately $154,000) and
fees (approximately $233,000). In addition, if the outstanding borrowings were
not repaid by August 31, 1995, the Company has been required to pay an
additional 3%($ 102,000) of the then outstanding principal due to the banks.
Such amount has been accrued.
In July 1995, the Company and its banks (the "Banks") amended the credit
agreement as a result of the consummation of the July Private Offering. As
consideration for waiving any breach or default under the Credit Agreement as a
result of the July Private Offering, the Banks received $500,000 of the proceeds
as payment for interest, fees and principal and an extension of the warrant
exercise period to July 17, 2000. As a result of the Zatpack transaction, the
July Private Offering, and the issuance of 824,742 shares in settlement of the
class action litigation, the anti-dilution clauses in the Banks' warrants were
triggered, increasing the number of the Banks' warrants and decreasing the
corresponding exercise prices. As a result, the Banks now hold warrants to
purchase 700,000 shares of the Company's common stock at a price of $2.05.
The credit agreement with the Bank Group has been extended to June 30, 1997.
On March 21, 1995, the Company sold its Tablets ANDA for 5mg Oxycodone HCl/325mg
Acetaminophen tablets and certain pieces of equipment utilized in connection
with the production activities under the Tablets ANDA for up to $5.4 million to
Mallinckrodt. Mallinckrodt paid the Company $2 million of the purchase price on
the closing date, having previously paid $500,000 in July 1994. Mallinckrodt
paid on January 9, 1997 $1 million when the Company received on December 19,
1996 general clearance from the FDA for unrestricted operations at it facility
in Brooklyn, New York and written notice from the FDA that it is in compliance
with certain provisions of the consent order dated July 9, 1993. Mallinckrodt
will pay the Company $1.9 million balance of the Deferred Purchase Price when
Mallinckrodt receives certain authorizations from the FDA, but in no event later
than March 21, 1998. See "Item 1. Business. Dispositions" for additional
information regarding this transaction.
On March 30, 1995, the Company signed the Zatpack Agreement with Zatpack which
provides for the purchase of 500,000 shares of common stock of the Company by
Zatpack in consideration of $1,000,000. The Zatpack Note has been converted into
642,407 shares of Common Stock (the "Note Shares"), in March, 1997, at an
adjusted conversion price of $2.39 per share, thereby canceling the
indebtedness. See "Item 1. Business. Other Transactions - Agreements with
Zatpack, Inc." for additional information regarding the Zatpack Agreement.
From late December 1996 through March 31, 1997, the Company borrowed an
aggregate of approximately $1,100,000 from certain of the holders of the
Company's convertible subordinated debentures. These borrowings, which are
evidenced by unsecured promissory notes, are due and payable as to principal on
demand. Interest, at the rate of 10% per annum, is payable on a quarterly basis.
The Company utilized the proceeds of these borrowings for working capital.
29
As previously indicated, the Company has continued to actively pursue financing.
At the current time, the Company is discussing with several parties obtaining
financing which will replace the Company's banks and provide additional working
capital. There can be no assurance that the Company will be able to obtain any
such financing on commercially acceptable terms.
The Company has insufficient resources to meet both its current obligations at
December 31, 1996 and its long-term obligations. To meet such obligations and to
pursue the development of new generic drug products, the Company must find
alternative sources funding. As previously indicated, the Company has continued
to actively pursue financing. At the current time, the Company is discussing
with several parties obtaining financing which will replace the Company's banks
and provide additional working capital. There can be no assurance that the
Company will be able to obtain any such financing on commercially acceptable
terms. In addition, the report of the Company's independent certified public
accountants contains an explanatory paragraph as to the Company's ability to
continue as a going concern. Among the factors cited by the accountants as
raising substantial doubt as to the Company's ability to continue as a going
concern are: the loss incurred by the Company of approximately $14,495,000
during the year ended December 31, 1996; the Company's working capital
deficiency of approximately $12,201,000 at that date; the expiration of the
Credit Agreement on December 31, 1996 (which subsequently was extended to June
30, 1997, as described above); and the Company not being in compliance with the
terms of its banking agreement and convertible subordinated debentures. See Note
A of Note to Consolidated Financial Statements.
The Company is delinquent in its payment of payroll taxes to the extent of
approximately $1,500,000. Although the Company anticipates receiving a Federal
income tax refund that will offset this liability to a substantial extent, the
Company does not currently have the funds available to retire this delinquency.
If the Company is unable to pay its payroll taxes, whether due to a denial of
the tax refund or otherwise, the Company could be materially adversely affected.
Capital Expenditures
The Company's capital expenditures during 1996, 1995 and 1994 were $208,000,
$536,000 and $216,000, respectively. The decrease in capital expenditures in
1996 as compared to prior years is attributable to the Company's cash
conservation measures implemented in 1995.
Item 8. Financial Statements and Supplementary Data.
See Index to Financial Statements after signature page.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not Applicable.
30
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required by Item 10 will be included in the Company's Proxy
Statement for the 1997 Annual Meeting of Shareholders, which will be filed
within 120 days after the close of the Company's fiscal year ended December 31,
1996, and is hereby incorporated herein by reference to such Proxy Statement.
Item 11. Executive Compensation.
The information required by Item 11 will be included in the Company's Proxy
Statement for the 1997 Annual Meeting of Shareholders, which will be filed
within 120 days after the close of the Company's fiscal year ended December 31,
1996, and is hereby incorporated herein by reference to such Proxy Statement.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by Item 12 will be included in the Company's Proxy
Statement for the 1997 Annual Meeting of Shareholders, which will be mailed
within 120 days after the close of the Company's fiscal year ended December 31,
1996, and is hereby incorporated herein by reference to such Proxy Statement.
Item 13. Certain Relationships and Related Transactions.
The information required by Item 13 will be included in the Company's Proxy
Statement for the 1997 Annual Meeting of Shareholders, which will be mailed
within 120 days after the close of the Company's fiscal year ended December 31,
1996, and is hereby incorporated herein by reference to such Proxy Statement.
31
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
A. Financial Statements - See Index to Financial Statements.
B. Financial Statement Schedules
Not Applicable.
C. Reports on Form 8-K
None.
D. Exhibits
Exhibit
Number
- ------
3.1 Certificate of Incorporation and amendments (incorporated by reference
to Exhibit 3.1 to Amendment No. 2 to the Registrant's Registration
Statement on Form S-18, File No. 33-2471-NY).
3.2 Restated Bylaws (incorporated by reference to Exhibit 3.1 to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 1993).
10.1 Credit Agreement, dated as of December 22, 1992, among the Registrant
and The Chase Manhattan Bank, N.A. (incorporated by reference to
Exhibit 10.1 to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1992 (the "1992 Form 10-K")).
10.2 Amendment Two, dated as of January 12, 1994, to Credit Agreement among
the Registrant and The Chase Manhattan Bank, N.A. , together with
forms of Stock Warrant and Registration Rights Agreement (incorporated
by reference to Exhibit 10.1.1 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1993 (the "1993 Form
10-K")).
10.3 Amendment Three, dated as of May 31, 1994, to Credit Agreement among
the Registrant and The Chase Manhattan Bank, N.A. (incorporated by
reference to Exhibit 6(a) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1994).
10.4 Amendment Four, dated as of July 1994, to Credit Agreement among the
Registrant and The Chase Manhattan Bank, N.A. (incorporated by
reference to Exhibit 6(a) to the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1994)).
32
10.5 Amendment Five, dated as of March 21, 1995, to Credit Agreement among
the Registrant and The Chase Manhattan Bank, N.A. (incorporated by
reference to Exhibit 10.7 to the Registrant's Current Report on Form
8-K dated March 21, 1995 (the "March 8-K")).
10.5(1) Form of Warrants issued to The Bank of New York, The Chase Manhattan
Bank, N.A. and the Israel Discount Bank (incorporated by reference to
Exhibit 10.5(i) to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1995 (the "1995 Form 10-K")).
10.5(2) Letter Agreement, dated July 10, 1995, among Halsey Drug Co.,Inc., The
Chase Manhattan Bank, N.A., The Bank of New York and Israel Discount
Bank of New York (incorporated by reference to Exhibit 6(a) to the
Registrant's Quarterly Report on Form 10-Q for the quarter ended June
30, 1995 (the "June 10-Q")).
10.5(3) Letter Agreement, dated November 16, 1995, among Halsey Drug Co.,Inc.,
The Chase Manhattan Bank, N.A., The Bank of New York and Israel
Discount Bank of New York (incorporated by reference to Exhibit
10.25(iv) to the 1995 10-K).
10.5(4) Amendment 6, dated as of August 6, 1996, to Credit Agreement among
Halsey Drug Co.,Inc., The Chase Manhattan Bank, N.A., The Bank of New
York and Israel Discount Bank of New York (incorporated by reference
to Exhibit 10.1 to Amendment No. 1 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1996 (the "June
1996 10-Q)).
*10.5(5) Letter Agreement, dated March 25, 1997 among Halsey Drug Co., Inc.,
the Chase Manhattan Bank, as successor in interest to The Chase
Manhattan Bank (National Association), The Bank of New York and Israel
Discount Bank.
10.6 Agreement Regarding Release of Security Interests dated as of March
21, 1995 by and among the Company, Mallinckrodt Chemical Acquisition,
Inc. and The Chase Manhattan Bank, N.A.(incorporated by reference to
Exhibit 10.9 of the March 8-K).
10.7 Consulting Agreement dated as of September, 1993 between the
Registrant and Joseph F. Limongelli (incorporated by reference to
Exhibit 10.6 to the 1993 Form 10-K).
10.8 Employment Agreement, dated as of January 1, 1993, between the
Registrant and Rosendo Ferran (incorporated by reference to Exhibit
10.2 to the 1992 Form 10-K).
10.9 Employment Agreement, dated as of July 1, 1994, between the Registrant
and Leonard H. Weiss (incorporated by reference to Exhibit 10.9 to the
1994 Form 10-K).
10.10(1) Halsey Drug Co., Inc. 1984 Stock Option Plan, as amended (incorporated
by reference to Exhibit 10.3 to the 1992 Form 10-K).
33
10.10(2) Halsey Drug Co., Inc. 1995 Stock Option and Restricted Stock Purchase
Plan (incorporated by reference to Exhibit 4.1 to the Registrant's
Registration Statement on Form S-8, File No. 33-98396).
*10.10(3) Halsey Drug Co., Inc. Non-Employee Director Stock Option Plan.
10.11 Leases, effective February 13, 1989 and January 1, 1990, respectively,
among the Registrant and Milton J. Ackerman, Sue Ackerman, Lee
Hinderstein, Thelma Hinderstein and Marilyn Weiss (incorporated by
reference to Exhibits 10.6 and 10.7, respectively, to the Registrant's
Annual Report on Form 10-K for the year ended December 31, 1989).
10.12 Lease, effective as of April 15, 1988, among the Registrant and Milton
J. Ackerman, Sue Ackerman, Lee Hinderstein, Thelma Hinderstein and
Marilyn Weiss, and Rider thereto (incorporated by reference to Exhibit
10.12 to the Registrant's Annual Report on Form 10-K for the year
ended December 31, 1987).
10.12(1) Lease, as of October 31, 1994, among Registrant and Milton J.
Ackerman, Sue Ackerman, Lee Hinderstein, Thelma Hinderstein and
Marilyn Weiss, together with Modification, Consolidation and Extension
Agreement (incorporated by reference to Exhibit 10.12(i) to the
Registrant's Annual Report on Form 10-K for the year ended December
31, 1995). 10.13 Asset Purchase Agreement dated as of March 21, 1995
among Mallinckrodt Chemical Acquisition, Inc. ("Acquisition"),
Mallinckrodt Chemical, Inc., as guarantor and the Registrant
(incorporated by reference to Exhibit 10.1 to the March 8-K).
10.13 Asset Purchase Agreement dated as of March 21, 1995 among Mallinckrodt
Chemical Acquisition, Inc. ("Acquisition"), Mallinckrodt Chemical,
Inc., as guarantor and the Registrant (incorporated by reference to
Exhibit 10.1 to the March 8-K).
10.14 Toll Manufacturing Agreement for APAP/Oxycodone Tablets dated as of
March 21, 1995 between Acquisition and the Registrant (incorporated by
reference to Exhibit 10.2 to the March 8-K).
10.15 Capsule ANDA Option Agreement dated as of March 21, 1995 between
Acquisition and the Registrant (incorporated by reference to Exhibit
10.3 to the March 8-K).
10.16 Tablet ANDA Noncompetition Agreement dated as of March 21, 1995
between the Registrant and Acquisition (incorporated by reference to
Exhibit 10.4 to the March 8-K).
10.17 Subordinated Non-Negotiable Promissory Term Note in the amount of
$1,200,00 dated March 21, 1995 issued by the Registrant to Acquisition
(incorporated by reference to Exhibit 10.5 to the March 8-K).
10.18 Term Note Security Agreement dated as of March 21, 1995 among the
Company, Houba, Inc. and Acquisition (incorporated by reference to
Exhibit 10.6 to the March 8-K).
34
10.19 Amendment dated March 21, 1995 to Subordination Agreement dated as of
July 21, 1994 between Mallinckrodt Chemical, Inc., Mallinckrodt
Chemical Acquisition, Inc., the Registrant, The Chase Manhattan Bank
(National Association), Israel Discount Bank of New York, The Bank of
New York, and The Chase Manhattan Bank (National Association)
(incorporated by reference to Exhibit 10.8 to the March 8-K).
10.20 Agreement dated as of March 30, 1995 between the Registrant and
Zatpack, Inc. (incorporated by reference to Exhibit 10.10 to the March
8-K).
10.21 Waiver and Termination Agreement dated as of March 30, 1995 between
Zuellig Group, W.A., Inc. and Indiana Fine Chemicals Corporation
(incorporated by reference to Exhibit 10.11 to the March 8-K).
10.22 Convertible Subordinated Note of the Registrant dated December 1, 1994
issued to Zatpack, Inc. (incorporated by reference to Exhibit 10.12 to
the March 8-K).
10.23 Agreement dated as of March 30, 1995 among the Registrant, Indiana
Fine Chemicals Corporation, Zuellig Group, N.A., Inc., Houba Inc.,
Zetapharm, Inc. and Zuellig Botanicals, Inc. (incorporated by
reference to Exhibit 10.13 to the March 8-K).
10.24 Supply Agreement dated as of March 30, 1995 between Houba, Inc. and
Zetapharm, Inc. (incorporated by reference to Exhibit 10.14 to the
March 8-K).
10.25 Form of 10% Convertible Subordinated Debenture (incorporated by
reference to Exhibit 6(a) to the June 10-Q).
10.26 Form of Redeemable Common Stock Purchase Warrant (incorporated by
reference to Exhibit 6(a) to the June 10-Q).
10.27 Form of 10% Convertible Subordinated Debenture (incorporated by
reference to Exhibit 4.1 to the Registrant's Current Report on Form
8-K dated December 4, 1995 (the "December 8-K")).
10.28 Form of Redeemable Common Stock Purchase Warrant (incorporated by
reference to Exhibit 4.2 to the December 8-K).
10.29 Form of 10% Convertible Subordinated Debenture (incorporated by
reference to Exhibit 99 to the June 1996 10-Q).
10.30 Form of Redeemable Common Stock Purchase Warrant (incorporated by
reference to Exhibit 4.1 to Amendment No. 1 to the June 1996 10-Q).
35
21 Subsidiaries of the Registrant (incorporated by reference to Exhibit
22 to the 1993 Form 10-K).
*23.1 Consent of Grant Thornton LLP, independent certified public
accountants.
*27 Financial Data Schedule, which is submitted electronically to the
Securities and Exchange Commission for informational purposes only and
not filed.
* Filed herewith.
36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Company has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
HALSEY DRUG CO., INC.
(Registrant)
By: /s/ Rosendo Ferran
------------------------------------
Rosendo Ferran, President
Date: March , 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
/s/William G. Skelly Chairman and Director March 31 , 1997
- -------------------------
William G. Skelly
/s/Rosendo Ferran President, Chief Executive Officer March 31, 1997
- ------------------------- and Director (Principal Executive
Rosendo Ferran Officer)
/s/Robert J. Mellage Controller (Principal Accounting March 31, 1997
- ------------------------- Officer)
Robert J. Mellage
/s/R.H. Francis Director March 31, 1997
- -------------------------
R.H. Francis
/s/Alan J. Smith Director March 31, 1997
- -------------------------
Alan J. Smith
37
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Independent Certified Public Accountants F-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-5
Consolidated Statement of Stockholders' Equity F-6
Consolidated Statements of Cash Flows F-8
Notes to Consolidated Financial Statements F-9 - F-35
REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS
Board of Directors
Halsey Drug Co., Inc.
We have audited the accompanying consolidated balance sheets of Halsey Drug Co.,
Inc. and Subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Halsey Drug Co.,
Inc. and Subsidiaries as of December 31, 1996 and 1995, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
As more fully discussed in Note A, the accompanying financial statements have
been prepared assuming that the Company will continue as a going concern. The
Company has incurred a loss of approximately $14,495,000 during the year ended
December 31, 1996, has a deficiency in working capital of approximately
$12,201,000 and an accumulated deficit of approximately $29,484,000 and owes
approximately $1,500,000 in delinquent payroll taxes. In addition, the Company's
current banking agreement expires on June 30, 1997 and the Company is currently
not in compliance with the financial covenants of its banking agreement and its
convertible subordinated debentures agreement. These matters, among others,
raise substantial doubt about the Company's ability to continue as a going
concern. Management's plans in regard to these conditions are described in Note
A. The financial statements do not include any adjustments that may result from
the outcome of this uncertainty.
GRANT THORNTON LLP
New York, New York
March 28, 1997
F-2
Halsey Drug Co., Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31,
(in thousands)
1996 1995
------- -------
CURRENT ASSETS
Cash $ 118 $ 353
Accounts receivable - trade, net of allowances
for doubtful accounts of $424 and $280
in 1996 and 1995, respectively 226 1,689
Other receivable 1,000
Inventories 3,758 7,716
Prepaid insurance and other current assets 252 656
------- -------
Total current assets 5,354 10,414
PROPERTY, PLANT AND EQUIPMENT, NET 6,222 7,394
OTHER ASSETS 406 1,054
------- -------
$11,982 $18,862
======= =======
The accompanying notes are an integral part of these statements.
F-3
Halsey Drug Co., Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS (continued)
December 31,
(in thousands)
1996 1995
-------- --------
CURRENT LIABILITIES
Bank overdraft $ 286 $ 213
Due to banks 3,195 3,395
Notes payable 1,625 200
Convertible subordinated debentures 2,173 7,347
Department of Justice settlement 2,168 2,000
Accounts payable 4,533 2,579
Accrued expenses 3,575 1,867
Advances from minority stockholders 206
-------- --------
Total current liabilities 17,555 17,807
LONG-TERM DEBT 1,508 2,595
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock - $.01 par value; authorized,
20,000,000 shares; issued and outstanding,
13,175,708 shares and 8,973,459 shares in
1996 and 1995, respectively 131 90
Additional paid-in capital 23,316 14,459
Accumulated deficit (29,484) (14,989)
-------- --------
(6,037) (440)
Less treasury stock - at cost (474,603 shares and
500,000 shares in 1996 and 1995, respectively) (1,044) (1,100)
-------- --------
(7,081) (1,540)
-------- --------
$ 11,982 $ 18,862
======== ========
The accompanying notes are an integral part of these statements.
F-4
Halsey Drug Co., Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
(in thousands, except per share data)
1996 1995 1994
--------- --------- ---------
Net sales $ 12,379 $ 20,225 $ 24,182
Cost of goods sold 16,826 18,097 21,584
--------- --------- ---------
Gross profit (4,447) 2,128 2,598
Research and development 1,854 818 502
Selling, general and administrative expenses 7,486 6,098 7,128
--------- --------- ---------
Loss from operations (13,787) (4,788) (5,032)
Interest expense 1,708 1,307 735
Gain on sale of assets (1,000) (2,288)
--------- --------- ---------
Loss before income taxes (14,495) (3,807) (5,767)
Provision for income taxes 296
--------- --------- ---------
NET LOSS $ (14,495) $ (4,103) $ (5,767)
========= ========= =========
Loss per common share $ (1.49) $ (.52) $ (.80)
========= ========= =========
Average number of outstanding shares 9,724,106 7,886,101 7,173,908
========= ========= =========
The accompanying notes are an integral part of these statements.
F-5
Halsey Drug Co., Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Years ended December 31, 1996, 1995 and 1994
(in thousands)
Common stock, Treasury stock,
$.01 par value Additional at cost
------------------- paid-in Accumulated ----------------
Shares Amount capital deficit Shares Amount Total
------ ------ ---------- ----------- ------ ------ -----
Balance at January 1, 1994 7,109,537 $71 $ 8,967 $ (5,119) $ 3,919
Issuance of common stock 500,000 5 995 1,000
Issuance of warrants to banks 200 200
Net loss (5,767) (5,767)
--------- --- ------- -------- -------- ------- -------
Balance at December 31, 1994 7,609,537 76 10,162 (10,886) (648)
Issuance of common stock 500,000 5 791 796
Issuance of common stock in connection
with litigation settlement 824,742 8 2,992 3,000
Repurchase of common stock (500,000) $(1,100) (1,100)
Issuance of warrants with convertible
subordinated debentures 416 416
Exercise of stock options 39,180 1 98 99
Net loss (4,103) (4,103)
--------- --- ------- -------- -------- ------- -------
Balance at December 31, 1995
(brought forward) 8,973,459 90 14,459 (14,989) (500,000) (1,100) (1,540)
F-6
Halsey Drug Co., Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (continued)
Years ended December 31, 1996, 1995 and 1994
(in thousands)
Common stock, Treasury stock,
$.01 par value Additional at cost
------------------- paid-in Accumulated ----------------
Shares Amount capital deficit Shares Amount Total
------ ------ ---------- ----------- ------ ------ -----
Balance at December 31, 1995
(brought forward) 8,973,459 $ 90 $14,459 $(14,989) (500,000) $(1,100) $ (1,540)
Net loss for the year ended
December 31, 1996 (14,495) (14,495)
Issuance of common stock -
conversion of debentures 3,504,000 35 6,724 6,759
Issuance of shares as settlement 59,550 262 25,397 56 318
Issuance of warrants with convertible
subordinated debentures 355 355
Exercise of warrants of convertible
debentures 589,540 6 1,363 1,369
Stock options exercised 49,159 153 153
---------- ---- ------- -------- --------- ------- --------
Balance at December 31, 1996 13,175,708 $131 $23,316 $(29,484) $(474,603) $(1,044) $ (7,081)
========== ==== ======= ======== ========= ======= ========
The accompanying notes are an integral part of this statement.
F-7
Halsey Drug Co., Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31,
(in thousands)
1996 1995 1994
-------- -------- --------
Cash flows from operating activities
Net loss $(14,495) $ (4,103) $ (5,767)
-------- -------- --------
Adjustments to reconcile net loss to net
cash used in operating activities
Depreciation and amortization 1,906 1,956 2,350
Provision for losses on accounts receivable 144 271
Provision for loss on investment 500
Provision for inventory losses 1,095
Gain on sale of assets (1,000) (2,288) (92)
Accrued interest 280 77 100
Deferred income taxes 296
Changes in assets and liabilities
Accounts receivable 1,319 637 2
Inventories 2,863 (881) 2,389
Income taxes receivable 660
Prepaid insurance and other current assets (96) (160) 134
Accounts payable 1,029 (2,031) (995)
Accrued expenses 2,633 44 528
-------- -------- --------
Total adjustments 10,673 (2,350) 5,347
-------- -------- --------
Net cash used in operating activities (3,822) (6,453) (420)
-------- -------- --------
Cash flows from investing activities
Capital expenditures (390) (536) (216)
(Increase) decrease in other assets 116 (169)
Net proceeds from sale of assets 1,889 125
Deferred income 500
-------- -------- --------
Net cash provided by (used in) investing
activities (390) 1,469 240
-------- -------- --------
F-8
Halsey Drug Co., Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Year ended December 31,
(in thousands)
1996 1995 1994
------- ------- -------
Cash flows from financing activities
(Decrease) increase in notes payable $ 25 $(1,192) $ (489)
Proceeds from issuance of common stock 318 796 1,000
Payments to Department of Justice (90) (86)
Bank overdraft 73 (5) (224)
Repurchase of common stock (1,100)
Payments to minority stockholders (206) (212) (25)
Proceeds from issuance of convertible subordinated
debentures 2,500 7,740
Proceeds from exercise of stock options 153 99
Proceeds from exercise of warrants 1,369
Increase in other assets (255) (727)
------- ------- -------
Net cash provided by financing activities 3,977 5,309 176
------- ------- -------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS (235) 325 (4)
Cash and cash equivalents at beginning of year 353 28 32
------- ------- -------
Cash and cash equivalents at end of year $ 118 $ 353 $ 28
======= ======= =======
Supplemental disclosures of noncash activities:
1. The issuance of 3,504,000 shares of the Company's common stock upon
conversion of $6,759,000 of convertible subordinated debentures is included
in common stock and additional paid-in capital.
2. The valuation of the warrants issued in 1996 and 1995, of $355,000 and
$416,000, respectively, with convertible subordinated debentures is
included in additional paid-in capital.
3. The issuance in 1996 and 1995 of 59,550 and 824,742 shares of the Company's
common stock is valued at $318,000 and $3,000,000, respectively, in
connection with litigation settlements.
4. The valuation of the warrants issued in 1994 , $200,000, to its banks, is
included in additional paid-in capital.
The accompanying notes are an integral part of these statements.
F-9
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1996, 1995 and 1994
NOTE A - SUMMARY OF ACCOUNTING POLICIES
The Company, a New York based corporation established in 1935, and its
subsidiaries, are engaged in the manufacture, sale and distribution of
generic drugs. The Company sells its generic drug products under its Halsey
label and under private-label arrangements with drug store chains and drug
wholesalers throughout the United States.
A summary of the significant accounting policies consistently applied in
the preparation of the accompanying consolidated financial statements
follows.
1. Principles of Consolidation and Basis of Presentation
The consolidated financial statements include 100% of the accounts of
the Company and its wholly-owned subsidiaries, Blue Cross Products
Co., Inc., Houba, Inc., Halsey Pharmaceuticals, Inc., and Indiana Fine
Chemicals Corporation, The Medi-Gum Corporation, H.R. Cenci
Laboratories, Inc. (97% owned) and Cenci Powder Products, Inc. (100%
owned). The Medi-Gum Corporation and Halsey Pharmaceuticals have not
commenced operations. All material intercompany accounts and
transactions have been eliminated.
As of December 31, 1996, the Company has a working capital deficiency
of approximately $12,201,000, has an accumulated deficit of
approximately $29,484,000, has incurred a loss of approximately
$14,495,000 during the year ended December 31, 1996, and is not in
compliance with its financial covenants pursuant to its banking
agreement and its convertible subordinated debenture agreement. In
addition, the Company is delinquent in the payment of its payroll
taxes (approximately $1,500,000) (Note H) and the Company's credit
agreement with its banks expires June 30, 1997. These factors and
other matters as discussed in Note M, raise substantial doubt about
the Company's ability to continue as a going concern. The financial
statements do not include any adjustments relative to the
recoverability and classification of recorded asset amounts or amounts
and classification of liabilities that might be necessary should the
Company be unable to continue in existence. Management's plans with
respect to those conditions include seeking alternative sources of
financing. In this regard, the Company (a) is reviewing several
unsolicited expressions of interest from prospective joint venture
partners and investors, (b) plans to refinance or extend the maturity
date of the Company's bank debt, (c) has sold the rights to one of its
products to a major vendor and has received a commitment for future
production of such product (Note I) and (d) submitted Abbreviated New
Drug Applications ("ANDA") for approval by the Food and Drug
Administration ("FDA") (Note M). There can be no assurance that
management can obtain alternative sources of financing or obtain
approvals for the ANDA's.
F-10
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE A (continued)
2. Inventories
Inventories are stated at the lower of cost or market; cost is
determined using the first-in, first-out method.
3. Property, Plant and Equipment
Property, plant and equipment are stated at cost less accumulated
depreciation and amortization. Depreciation and amortization are
provided for in amounts sufficient to relate the cost of depreciable
assets to operations over their estimated service lives, principally
on a straight-line basis. The estimated lives used in determining
depreciation and amortization are:
Buildings 25 years
Machinery and equipment 5-10 years
Leasehold improvements 5-10 years
Leasehold improvements are amortized over the lives of the respective
leases or the service lives of the improvements, whichever is shorter.
4. Income Taxes
The Company adopted Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes" ("SFAS No. 109"), as of January 1,
1993. The standards for SFAS No. 109 require that the Company utilize
an asset and liability approach for financial accounting and reporting
for income taxes. The primary objectives of accounting for income
taxes under SFAS No. 109 are to (a) recognize the amount of tax
payable for the current year and (b) recognize the amount of deferred
tax liability or asset based on management's assessment of the tax
consequences of events that have been reflected in the Company's
financial statements or tax returns.
F-11
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE A (continued)
5. Loss Per Share
The computation of loss per share of common stock is based upon the
weighted average number of common shares outstanding during the
period, plus (in periods in which they have a dilutive effect) the
effect of common shares contingently issuable upon exercise of stock
options and warrants. Fully diluted earnings per share is considered
equal to primary earnings per share for all years presented as the
effect of other potentially dilutive securities would be antidilutive.
6. Statements of Cash Flows
For purposes of the statements of cash flows, the Company considers
all highly liquid debt instruments purchased with an original maturity
of three months or less to be cash equivalents. The Company paid
income taxes for the years ended December 31, 1995 and 1994 of
$201,000 and $39,000, respectively. In addition, the Company interest
of approximately $1,173,000, $786,000 and $504,000, respectively, for
the years ended December 31, 1996, 1995 and 1994. The Company did not
pay any income taxes during the year ended December 31, 1996.
7. Use of Estimates in Consolidated Financial Statements
In preparing consolidated financial statements in conformity with
generally accepted accounting principles, management makes estimates
and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the
date of the consolidated financial statements, as well as the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
8. Reclassifications
Certain reclassifications have been made to the 1995 and 1994
presentation to conform to the 1996 presentation.
F-12
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE A (continued)
9. Impairment of Long Lived Assets
The Company adopted Statement of Financial Accounting Standards No.
121 ("SFAS No. 121"), "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," during the year
ended December 31, 1996. The statement requires that the Company
recognize and measure impairment losses of long-lived assets and
certain identifiable intangibles and value long-lived assets to be
disposed of.
The Company reviews long-lived assets and certain identifiable
intangibles held and used for possible impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. The Company has determined that no provision
is necessary for the impairment of long-lived assets at December 31,
1996.
10. Research and Development Costs
All research and development costs, including payments related to
licensing agreements on products under development and research
consulting agreements are expensed when incurred.
NOTE B - FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 ("SFAS No. 107"), "Fair
Value of Financial Instruments," requires disclosure of the estimated fair
value of an entity's financial instrument assets and liabilities. For the
Company, financial instruments consist principally of subordinated
promissory notes and long-term and short-term debt.
F-13
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE B (continued)
The following methods and assumptions are used to estimate the fair value
of each class of financial instrument for which it is practicable to
estimate that value:
Long-term and Short-term Debt and Convertible Subordinated Debentures
The fair value of the Company's long-term and short-term debt and
convertible subordinated debentures is estimated based upon the quoted
market prices for the same or similar issues or on the current rates
offered to the Company for debt of the same remaining maturities.
The carrying amount and fair value of the above financial instruments are
as follows:
December 31,
----------------------------------------------
1996 1995
---------------------- ----------------------
Carrying Fair value Carrying Fair value
amount amount amount amount
-------- ---------- -------- ----------
(in thousands)
Long-term and short-term
debt $6,328 $6,328 $6,190 $6,190
Convertible subordinated
debentures 2,173 2,173 7,347 7,347
F-14
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE C - INVENTORIES
Inventories consist of the following:
December 31,
-------------------------
1996 1995
------ ------
(in thousands)
Finished goods $2,121 $2,491
Work-in-process 1,018 1,398
Raw materials 619 3,827
------ ------
$3,758 $7,716
====== ======
NOTE D - PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment are summarized as follows:
December 31,
-------------------------
1996 1995
------ ------
(in thousands)
Machinery and equipment $11,641 $11,247
Leasehold improvements 5,708 5,756
Building 1,263 1,203
Land 265 265
------ -------
18,877 18,471
Less accumulated depreciation and amortization 12,655 11,077
------ -------
$ 6,222 $ 7,394
====== =======
Depreciation expense for the years ended December 31, 1996, 1995 and 1994
was approximately $1,562,000, $1,576,000 and $1,930,000, respectively.
F-15
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE E - DEBT
a. Line of Credit
In December 1992, the Company entered into a credit agreement
providing for borrowings of up to $7,000,000 at the prime rate plus an
initial margin of 1/2%, originally maturing in December 1994. Upon
certain conditions, as defined in the agreement, the margin rate
increases by 2%. Borrowings under the line were available for working
capital purposes based upon a percentage of the parent company's
eligible accounts receivable and are collateralized by such accounts
receivable. The agreement contains certain financial covenants,
including minimum interest coverage and working capital ratios,
tangible net worth, limitations on capital expenditures, and maximum
debt-to-equity ratios. As of December 31, 1996, the Company was not in
compliance with the above covenants.
In 1994, the Company and its banks amended the credit agreement to
include the stock of certain subsidiaries, the accounts receivable of
Houba, Inc., and the parent company's inventory and equipment as
additional collateral, to increase the initial margin rate to 2% (
10.25 % at December 31, 1996), to restrict certain payments made by
the Company, to require payment to be made by the Company to the banks
of any income tax refunds received by the Company, to extend the
maturity date to August 31, 1995, and to agree in principal to modify
the financial covenants at a later date. In addition, if the
outstanding borrowings were not repaid by August 30, 1995, the Company
was required to pay $102,000, which represented 3% of the then
outstanding principal due to the banks. Such amount was accrued in
1995 and fully paid in 1996.
As consideration for the above amendments and the Company's continued
borrowings in excess of the borrowing formula, the Company has issued
stock warrants to the banks, expiring December 31, 1999, to purchase
up to 635,663 shares of the Company's common stock at exercise prices
ranging from $2.35 to $2.375 per share (subject to the antidilution
provisions of the credit agreement, as amended). The fair value of the
warrants, $200,000, as determined by the Company's Board of Directors,
was recorded by the Company in 1994 as additional paid-in capital and
a discount to bank debt which was fully amortized through the maturity
date, August 31, 1995.
F-16
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE E (continued)
In addition, the Company and its banks amended the credit agreement as
a result of the Company having consummated private offerings of its
securities on July 18, 1995 and November 29, 1995. As consideration
for waiving any breach or default under the credit agreement as a
result of these private offerings, the bank group received $950,000 of
the proceeds as payment for interest, fees and principal and an
extension of the warrant exercise period to July 17, 2000. In
addition, the exercise prices of all warrants for 699,696 shares of
the Company's common stock have been adjusted for antidilution to
prices ranging from $1.98 to $2.07. On March 25, 1997, the bank group
extended the maturity date of the credit agreement to June 30, 1997.
b. Convertible Subordinated Promissory Note
Pursuant to the Zatpack, Inc. ("Zatpack") agreement (Note N), the
Company issued a convertible subordinated promissory note dated
December 1, 1994, to Zatpack, for the cancellation of trade payables
and advances by Zuellig Group N.A., Inc. ("Zuellig") to the Company's
subsidiaries, in the amount of $1,292,000, bearing interest at 8% per
annum, compounded annually, due December 1, 1997. The outstanding
principal, plus all accrued and unpaid interest, $1,508,000 at
December 31, 1996, was convertible, at the option of Zatpack, into the
Company's common stock at the rate of one share of common stock for
every $2.50 of principal and interest being converted (the $2.50 is
subject to the antidilution provisions of the promissory note). In
March 1997, the principal amount, with accrued interest of $243,110
was converted into 642,407 shares of Common Stock at an adjusted
conversion price of $2.39 per share, thereby cancelling the
indebtedness.
c. Subordinated Promissory Notes
On March 21, 1995, (see Note I) the Company satisfied certain accounts
payable by issuing a subordinated promissory note to Mallinckrodt
Chemical Acquisition, Inc. ("Mallinckrodt") for $1,200,000, bearing
interest at 8% per annum, with interest and principal payable at the
earlier of: (i) receipt by Mallinckrodt of all necessary
authorizations from the FDA or (ii) September 21, 1997. The note is
collateralized by substantially all of the assets of the Company and
is subordinated to future bank indebtedness of up to $8,000,000. The
$1,200,000 note represents the deferral of payment by the Company of a
portion of its trade accounts payable due to an affiliate of
Mallinckrodt.
F-17
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE E (continued)
On July 14, 1995, the Company borrowed from and issued a $200,000
subordinated promissory note to Mallinckrodt, bearing interest at 8% per
annum, with principal and interest payable June 30, 1996. The principal and
interest is payable, at the option of Mallinckrodt, in the form of cash or
a credit to the Company's accounts receivable due from Mallinckrodt on June
30, 1996.
Borrowings under long-term debt are as follows:
December 31,
-------------------------
1996 1995
------ ------
(in thousands)
Convertible subordinated promissory note $1,508 $1,395
Subordinated promissory notes 1,400 1,400
Other 225
------ ------
3,133 2,795
Less: current maturities of long-term debt (1,625) (200)
------ ------
$1,508 $2,595
====== ======
NOTE F - CONVERTIBLE SUBORDINATED DEBENTURES
On July 18, 1995, the Company issued 408 units, at $10,000 per unit, in a
private placement of its securities ("July Private Placement"). Each unit
consists of: (i) a 10% convertible subordinated debenture due July 18, 2000
in the principal amount of $10,000, interest payable quarterly, and
convertible into shares of the Company's common stock at a conversion price
of $2.00 per share, subject to dilution, and (ii) 750 redeemable common
stock purchase warrants ("warrants"). Each warrant entitles the holder to
purchase one share of common stock for $2.00, subject to adjustment during
the five-year period commencing July 18, 1995. The warrants were redeemable
by the Company at a price of $.01 per warrant at any time commencing July
18, 1996, provided that at July 18, 1996, the fair market value of the
Company's common stock equals or exceeds $2.00 per share for the 20
consecutive trading days ending on the third day prior to the notice of
redemption to the holders of the warrant. The debentures were converted
into 2,040,000 shares of common stock in August 1996.
F-18
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE F (continued)
On November 29, 1995, the Company issued 366 units, at $10,000 per unit, in
a private placement of its securities ("November Private Placement"). Each
unit consists of (i) a 10% convertible subordinated debenture due November
29, 2000 in the principal amount of $10,000, interest payable quarterly,
and convertible into shares of the common stock, at a conversion price of
$2.50 per share, subject to dilution, and (ii) 600 redeemable common stock
purchase warrants. The terms and conditions of the warrants issued in
connection with the November Private Placement are similar to those issued
in the July Private Placement, except that the exercise price of the
warrant pursuant to the November Private Placement is $2.50 per share.
These debentures were converted into 1,464,000 shares of common stock in
December 1996.
The Company received net proceeds from the July and November Private
Placements of $7,013,000, net of issuance costs of $727,000, and allocated
the market value of the warrants, as determined by the Company's Board of
Directors, $416,000, to additional paid-in capital with a corresponding
adjustment to debt discount. The net proceeds from such issuances have been
used for the following purposes: repurchase of 500,000 shares of the
Company's common stock, registration of the underlying shares pursuant to
the Private Placements, the purchase of equipment, research and development
costs and for working capital. In addition, the Company was required to use
$950,000 of the net proceeds to repay a portion of its bank debt. .
On August 6, 1996, the Company issued 250 units, at $10,000 per unit, in a
private placement of its securities ("August Private Placement"). Each unit
consists of: (i) a 10% convertible subordinated debenture due August 6,
2001 in the principal amount of $10,000, interest payable quarterly, and
convertible into shares of the Company's common stock at a conversion price
of $3.25 per share, subject to dilution, and (ii) 750 redeemable common
stock purchase warrants ("warrants"). Each warrant entitles the holder to
purchase one share of common stock for $3.25, subject to adjustment during
the five-year period commencing August 6, 1996. Pursuant to the agreement,
the Company was required to establish an escrow account to repay interest
in the outstanding convertible debentures. The balance held in escrow at
December 31, 1996, was approximately $112,000.
The Company received net proceeds from the private offering of
approximately $2,160,000. The Company was required to use $391,000 of said
net proceeds to repay a portion of its bank debt, accrued interest and
legal fees. The Company used the balance of the net proceeds of the
Offering for: working capital; registration of the underlying shares under
the Securities Act; purchase of equipment; and for research and development
expenses.
F-19
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE G - ACCRUED EXPENSES
Accrued expenses are summarized as follows:
December 31,
-------------------------
1996 1995
------ ------
(in thousands)
Payroll taxes payable (Note H) $1,554 $ 390
Accrued payroll 441 460
Professional fees 227 120
Interest 539 337
Other 814 560
------ ------
$3,575 $1,867
====== ======
NOTE H - INCOME TAXES
The actual income tax expense varies from the Federal statutory rate
applied to consolidated operations as follows:
Year ended December 31,
-------------------------------------------------------
1996 1995 1994
--------------- --------------- ---------------
Amount % Amount % Amount %
------- ---- ------- ---- ------- ----
(in thousands)
Federal statutory rate $(4,928) (34.0)% $ (749) (34.0)% $(1,961) (34.0)%
Loss of which no tax benefit
was provided 4,233 29.1 280 12.7 1,223 21.2
Losses of subsidiaries with
no tax benefit 424 3.0 240 10.9 479 8.3
Amortization of Warrants 32 .2
Goodwill amortization 73 .5 77 3.5 77 1.3
Department of Justice
settlement 57 .4
Other 109 .8 152 6.9 182 3.2
------- ---- ------- ---- ------- ----
Actual tax expense $ -- -- $ -- -- $ -- --
======= ==== ======= ==== ======= ====
F-20
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE H (continued)
The Company has net operating loss carryforwards aggregating approximately
$16,877,000, expiring during the years 2009 through 2011. In addition,
certain of the Company's subsidiaries file separate Federal income tax
returns and have separate net operating loss carryforwards aggregating
approximately $5,297,000, expiring during the years 1998 through 2011.
The tax loss carryforwards of the Company and its subsidiaries are subject
to limitation by Section 382 of the Internal Revenue Code with respect to
the amount utilizable each year. This limitation reduces the Company's
ability to utilize net operating loss carryforwards included above each
year. The amount of the limitation has not been quantified by the Company.
The components of the Company's deferred tax assets (liabilities), pursuant
to SFAS No. 109, are summarized as follows:
December 31,
-------------------------
1996 1995
------ ------
(in thousands)
Deferred tax assets
Net operating loss carryforward $ 12,824 $ 4,792
Allowance for doubtful accounts 178 117
Research and development tax credit 212 212
Reserve for inventory 605 65
Litigation settlement 284
Rent 96
Capital loss carryforwards 210
Other 97 36
-------- --------
Gross deferred tax assets 14,506 5,222
-------- --------
Deferred tax liabilities
Depreciation (663) (771)
Installment sale gain (1,218)
Other (165) (165)
-------- --------
(2,046) (936)
-------- --------
Net deferred tax assets before
valuation allowance 12,460 4,286
Valuation allowance (12,460) (4,286)
-------- --------
Net deferred tax assets $ -- $ --
======== ========
F-21
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE H (continued)
SFAS No. 109, requires a valuation allowance against deferred tax assets
if, based on the weight of available evidence, it is more likely than not
that some or all of the deferred tax assets may not be realized. The
valuation allowance at December 31, 1996 primarily pertains to
uncertainties with respect to future utilization of net operating loss
carryforwards.
The payroll taxes payable at December 31, 1996 include approximately
$1,500,000 of delinquent payroll taxes, substantially all of which
liability was incurred in 1996. The Company has accrued interest and
penalties on this amount. The Company expects that this liability will be
satisfied by income tax refund claims which were filed. To date the IRS has
not taken action with respect to these refund claims pending the completion
of an IRS audit for the year 1993. This audit was recently completed by the
IRS auditor with no changes proposed. However completion is pending review
within the IRS, therefore the Company has not recorded tax refund claims.
NOTE I - SALE OF ASSETS
(a) On March 21, 1995, the Company sold its Abbreviated New Drug
Application ("ANDA") for 5mg Oxycodone HCL/325mg Acetaminophen Tablets
("Tablets") and certain equipment used in the production of the
Tablets for up to $5.4 million to Mallinckrodt. The Company received
$500,000 of the proceeds in July 1994, which was recorded as deferred
income on the Company's 1994 consolidated balance sheet. Mallinckrodt
also paid the Company $2,000,000 on March 21, 1995 and the remainder
was to be payable as follows: (i) $1,000,000 upon the Company
receiving general clearance from the FDA for unrestricted operations
at its Brooklyn facility and written notice from the FDA that it is in
compliance with certain provisions of the consent degree dated June
29, 1993 and (ii) $1,900,000 at the earlier of (a) Mallinckrodt
receiving certain authorizations from the FDA or (b) September 21,
1997. Mallinckrodt also agreed to defer $1,200,000 of the Company's
trade debt due to an affiliate of Mallinckrodt (Note E). Pursuant to
the release of the Company from the AIP by the FDA on December 19,
1996, the Company recorded a gain of $1,000,000. On January 9, 1997,
Mallinckrodt tendered this amount to the Bank Group.
F-22
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE I (continued)
In connection with the agreement, the Company agreed to manufacture
Tablets for Mallinckrodt for a period of three years and Mallinckrodt
agreed to order a minimum number of Tablets from the Company for two
years ending March 21, 1997. The Company and Mallinckrodt entered into
a noncompetition agreement pursuant to which the Company agreed not to
compete with Mallinckrodt and its affiliates with respect to the
Tablets ANDA until March 21, 2000.
In addition, the Company issued to Mallinckrodt an option to purchase
the ANDA for acetaminophen/oxycodone capsules at an exercise price
equal to 3/4 of annual net capsule revenue, as defined. Upon exercise
of the option, the Company and Mallinckrodt would enter into
agreements pursuant to which the Company would (i) manufacture
acetaminophen/ oxycodone capsules for Mallinckrodt for a period of
time and (ii) be prohibited from competing with Mallinckrodt and its
affiliates with respect to the production of such capsules.
NOTE J - PENSION EXPENSE
The Company maintains the following two pension plans:
1. Management Pension Plan
The Company maintains a defined benefit pension plan covering
substantially all nonunion employees.
Historically, the Company's funding policy for the management pension
plan (the "Plan"), had been to contribute amounts equal to its
liability as determined under the Employee Retirement Income Security
Act of 1974 ("ERISA"). Under this funding policy, contributions would
be sufficient to maintain plan assets in excess of the projected
benefit obligation. As of December 31, 1996, the Company has not
funded its 1995 ERISA obligation of approximately $92,000 and the
remaining balance of its 1993 and 1992 ERISA obligations of
approximately $191,000. Failure to timely fund these obligations may
result in the termination of the Plan and/or other monetary penalties.
F-23
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE J (continued)
Planned Company contributions over the next several years are expected
to improve the funded status of the plan. The plan's assets are
diversified in stocks, bonds, mutual funds and short-term and other
investments.
Net pension cost for the Company-sponsored pension plan consists of
the following:
December 31,
-------------------------------
1996 1995 1994
-------- -------- ------
(in thousands)
Normal service cost $ 24 $ 49 $ 50
Interest cost 32 25 27
Actual return on plan assets (23) (19) (18)
Net amortization and deferral (8) (9) (10)
---- ---- ----
Net pension cost $ 25 $ 46 $ 49
==== ==== ====
F-24
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE J (continued)
The reconciliation of the funded status of the plan to the amount reported
in the Company's balance sheet is as follows:
Year ended December 31,
-----------------------
1996 1995
---- ----
(in thousands)
Actuarial present value of benefit obligations
at November 30, 1996 and 1995
Estimated present value of vested benefits $ 440 $ 405
Estimated present value of nonvested benefits 52 44
----- -----
Accumulated benefit obligation 492 449
Value of future pay increases 12 22
----- -----
Projected benefit obligation 504 471
Estimated market value of plan assets
at November 30, 1996 and 1995 569 456
----- -----
Excess (deficiency) of plan assets
over projected benefit obligation 65 (15)
Unrecognized net gain (loss) (72) 33
Unrecognized net asset at December 1,
1987 being amortized over 24 years (8) (9)
----- -----
$ (15) $ 9
===== =====
The assumptions used as of November 30, 1996 and 1995 in determining
pension expense and funded status shown above were as follows:
1996 1995
------ ------
Discount rate 7.00% 7.00%
Rate of salary progression 4.00 4.00
Long-term rate of return on assets 7.00 7.00
F-25
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE J (continued)
2. Employees' Pension Plan
The Company contributed approximately $492,000, $450,000 and $462,000
in 1996, 1995 and 1994, respectively, to a multiemployer pension plan
for employees covered by collective bargaining agreements. This plan
is not administered by the Company and contributions are determined in
accordance with provisions of negotiated labor contracts. Information
with respect to the Company's proportionate share of the excess, if
any, of the actuarially computed value of vested benefits over the
total of the pension plan's net assets is not available from the
plan's administrator.
The Multiemployer Pension Plan Amendments Act of 1980 (the "Act")
significantly increased the pension responsibilities of participating
employers. Under the provision of the Act, if the plans terminate or
the Company withdraws, the Company could be subject to a "withdrawal
liability."
NOTE K - STOCK OPTION PLAN
In September 1995, the stockholders of the Company approved the adoption of
a stock option and restricted stock purchase plan (the "1995 Option Plan").
The 1995 Option Plan replaces its existing stock option plan which expired
in January 1994. The 1995 Option Plan provides for the granting of (i)
nonqualified options to purchase the Company's common stock at not less
than the fair market value on the date of the option grant, (ii) incentive
stock options to purchase the Company's common stock at not less than the
fair market value on the date of the option grant and (iii) rights to
purchase the Company's common stock on a "Restricted Stock" basis, as
defined, at not less than the fair market value on the date the right is
granted. The total number of shares which may be sold pursuant to options
and rights granted under the 1995 Option Plan is 1,000,000. No option can
be granted under the 1995 Option Plan after May 2005 and no option can be
outstanding for more than ten years after its grant.
In October 1996, the Board of Directors of Company adopted a non-employee
director stock option plan which provides for the granting of nonqualified
stock options not to exceed 100,000 shares in total and at an exercise
price per share equal to the fair market value of a share or the respective
grant dates. No option can be granted under the plan or after October 16,
2006 and no option can be outstanding for more than ten years after its
grant. No option have been granted under this plan to date.
F-26
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE K (continued)
The Company has adopted the disclosure provisions of Financial
Accounting Standards No. 123. "Accounting for Stock-Based
Compensation"(SFAS No. 123). It applies APB Opinion No. 25.
"Accounting for Stock Issued to Employees" and related
interpretations in accounting for its plans and does not
recognize compensation expense for its stock-based compensation
plans other than for restricted stock. If the Company had elected
to recognize compensation expense based upon the fair value at
the grant date for awards under these plans consistent with the
methodology prescribed by SFAS No. 123, the Company's net income
and earnings per share would be reduced to the proforma amounts
indicated below:
Thousands, Year ended Year ended
except per share amounts December 31, 1996 December 31, 1995
------------------------ ----------------- -----------------
Net loss
As reported $(14,495) $(4,103)
Pro forma (14,902) (4,459)
Loss per share
As reported (1.49) (.52)
Pro forma (1.52) (.56)
These pro forma amounts may not be representative of future disclosures
because they do not take into effect pro forma compensation expenses
related to grants made before 1995. The fair value of these options was
estimated at the date of grant using the Black-Scholes option-pricing model
with the following weighted average assumptions for the year ended December
31, 1996 and 1995, respectively; expected volatility of 82 and 71 percent;
risk-free interest rates of 6.6 and 5.8 percent; and expected life of 4.6
years and 8.8 years. The weighted-average fair value of options granted
during the year ended December 31, 1996 and 1995 for which the exercise
price equals the market price on the grant date was $2.68 and $2.27,
respectively, and the weighted average exercise prices were $4.19 and
$3.16, respectively.
F-27
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE K (continued)
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions including the
expected stock price volatility. Because the Company's employee stock
options have characteristics significantly different from those of traded
options, and because changes in the subjective input assumptions can
materially affect the fair market estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the
fair value of its employee stock options.
Transactions involving stock options are summarized as follows:
Stock options Weighted-average
outstanding exercise price
------------- ----------------
Balance January 1, 1994 413,881 $3.88
Granted 10,000 2.00
Cancelled (201,731) 3.67
--------
Balance at December 31, 1994 222,150 3.98
Granted 471,600 3.16
Exercised (39,180) 2.50
Cancelled (54,070) 3.36
--------
Balance at December 31, 1995 600,500 3.49
Granted 20,000 4.19
Exercised (49,159) 3.12
Cancelled (21,334) 4.39
--------
Balance at December 31, 1996 550,007 3.53
========
F-28
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE K (continued)
The following table summarizes information concerning currently outstanding
and exercisable stock options:
Options outstanding Options exercisable
----------------------------------------------------- ---------------------------------
Number Weighted Number
outstanding at average Weighted exercisable at Weighted
Range of December 31, remaining average December 31, average
exercise prices 1996 contractual life exercise price 1996 exercise price
- --------------- --------------- ---------------- -------------- --------------- --------------
$1.94 - 4.00 464,440 8.41 years $3.15 331,063 $3.19
4.25 - 6.25 85,567 1.48 years 5.67 75,567 5.84
NOTE L - COMMITMENTS
The Company occupies plant and office facilities under noncancellable
operating leases which expired in December 1995. On October 31, 1994, the
Company entered into a new operating lease for the plant and office
facilities covering the period from January 1, 1996 to December 31, 2005.
These new operating leases provide for scheduled base rent increases over
the term of the lease, however, the total amount of the base rent payments
will be charged to operations using the straight-line method over the term
of the lease. The leases provide for payment of real estate taxes based
upon a percentage of the annual increase. The Company's subsidiaries, H.R.
Cenci Laboratories, Inc. and Cenci Powder Products, Inc., lease plant and
office facilities on a month-to-month basis from a former officer of the
subsidiaries. Rent expense relating to these leases amounted to
approximately $90,000, $86,000 and $99,000 in 1996, 1995 and 1994,
respectively. In addition, the Company rents certain equipment under
operating leases, generally for terms of four years. Total rent expense for
the years ended December 31, 1996, 1995 and 1994 was approximately
$884,000, $659,000 and $582,000, respectively.
F-29
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE L (continued)
The approximate minimum rental commitments under these operating leases are
as follows:
Twelve months ending December 31, (in thousands)
1997 $ 928
1998 975
1999 1,023
2000 1,075
2001 1,128
2002 and thereafter 5,106
-------
Total minimum payments required $10,235
=======
On January 1, 1993, the Company entered into an employment agreement with
an officer having an initial term of five years. This employment agreement
contains change in control provisions that would entitle the officer to
receive certain severance benefits if there is a change in control in the
Company, as defined, and a termination of employment. The maximum
contingent liability as of December 31, 1996 under this agreement is
approximately $878,000.
NOTE M - CONTINGENCIES
The Company currently is a defendant in several lawsuits involving product
liability and other claims. The Company's insurance carriers have assumed
the defense for all product liability and other actions involving the
Company. None of the lawsuits is brought as a class action. The ultimate
outcome of these lawsuits cannot be determined at this time, and
accordingly, no adjustment has been made to the consolidated financial
statements.
On October 23, 1996, the Company withdrew four of its ANDAs including its
ANDA (the "Capsule ANDA") for acetaminophen/oxycodone capsules, and halted
sales of the affected products. Net sales pursuant to the withdrawn Capsule
ANDA were approximately $3 million and $8 million for the years ended
December 31, 1996 and 1995, respectively, and accounted for approximately
24% and 50% of the Company's total net sales during such twelve month
periods (Note P). The Company instituted the withdrawal at the suggestion
of the FDA and in anticipation of its release from the FDA's Application
Integrity Policy list and its restrictions (collectively, the "AIP"). The
FDA has placed the Company on the AIP, in October 1991, in connection with
its investigation of the Company's
F-30
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE M (continued)
operations which culminated in the 1993 consent decree. Under the AIP, the
FDA suspended all of the parent company's (i.e., Halsey Drug Co.'s)
applications for new drug approvals, including ANDAs and supplements to
ANDAs. At the FDA's suggestion, the Company retained outside consultants to
perform validity assessments of its drug applications. Thereafter, in
October 1996, the FDA recommended that several applications, including the
Capsule ANDA, be withdrawn. As a basis for its decision, the FDA cited
questionable and incomplete data submitted in connection with the
applications. The FDA indicated that withdrawal of the four ANDAs was
necessary for the release of the Company from the AIP. The FDA further
required submission by the Company of a Corrective Action Plan. Said Plan
was prepared and submitted by the Company and accepted by the FDA.
On December 19, 1996, the FDA released the Company from the AIP. Release
from the AIP permits the Company to submit ANDA applications to the FDA for
review, for the first time since October 1991. At or about the time of such
release, the Company submitted five new ANDAs to the FDA for its review. In
addition, the Company had previously submitted a new ANDA with respect to
the Capsules, which the Company anticipates will be reviewed in the near
future. However, there can be no assurance any of its new ANDAs, including
the new Capsule ANDA, will be approved by the FDA. The Company will not be
able to market these new products unless and until the FDA approves the new
underlying ANDAs. Failure to obtain FDA approval for the new ANDAs, or a
significant delay in obtaining such approval, would materially adversely
affect the Company's business operations and financial condition.
On June 21, 1993, the Company entered into a plea agreement with the DOJ to
resolve the government's investigation. Under the terms of the plea
agreement, the Company agreed to plead guilty to five counts of
adulteration of a single drug product shipped in interstate commerce and
related recordkeeping violations. The plea agreement also requires the
Company to pay a fine of $2,500,000 over five years in quarterly
installments of $125,000 beginning September 15, 1993. Accordingly, the
Company recorded a provision of $2,060,000 (net of imputed interest). As of
December 31, 1996, the Company has only paid two quarterly installments and
additional partial
F-31
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE M (continued)
payments of $100,000. The plea agreement stipulates that if the Company
does not make timely payments, the entire fine becomes due and payable. As
a result, the entire DOJ settlement has been reclassified as a current
liability in the 1996 and 1995 consolidated balance sheets. At the present
time, no action has been initiated by the DOJ to require immediate payment
of the entire amount. Should the DOJ require immediate payment, it could
result in a material adverse impact on the financial condition of the
Company.
In connection with several shareholder lawsuits, the Company agreed to pay
to the plaintiffs $1,000,000 in cash, which has been paid by the Company's
insurance carrier in full. In November 1995, the Company satisfied the
remainder of its settlement obligation by issuing 824,742 shares of its
common stock valued at $3,000,000 or $3.6375 per share.
On January 29, 1997, the Commission simultaneously instituted and
settled an administrative proceeding against the Company,
pursuant to the Company's Offer of Settlement, dated September
13, 1996, as modified by letters dated October 11, 1996 and
January 10, 1997. The Order made the following findings, among
others, which the Company neither admitted nor denied. The
Company's December 31, 1990 and December 31, 1991 Annual Reports
on Form 10-K stated that the Company had to follow Current Good
Manufacturing Practices ("CGMP") regulations at all times during
which an FDA approved drug was manufactured by the Company. These
annual reports further stated that the Company had to "expend
time, money and effort in the areas of production and quality
control to ensure full technical compliance." These annual
reports failed to disclose that the Company was not manufacturing
drugs in accordance with CGMP, but was using unapproved formulas
and procedures, and the Company's employees, at former
management's direction, were concealing product adulteration from
the FDA. These annual reports also failed to disclose that since
the Company was not manufacturing generic drugs in accordance
with CGMP, FDA approval for any or all of the Company's new
products could be adversely affected. Based on the foregoing, the
Commission found that the Company committed violations of
Sections 10(b) and 13(a) of the Exchange Act and Rules 10b-5,
12b-20 and 13a-1 thereunder, by filing with the Commission Annual
Reports on Form 10-K for the years ended December 31, 1990 and
1991 that omitted to state material facts necessary to make the
statements made, in the light of the circumstances under which
they were made, not misleading. The Order also requires the
Company to "cease and desist from committing or causing any
violation and any future violation" of Sections 10-(b) and 13(a)
of the Exchange Act and Rules 10b-5, 12b-20 and 13a-1 thereunder.
In 1995, the SEC filed a complaint requiring the Company to cease and
desist from violating Section 17(a) of the Securities Act and Sections
10(b) and 13(a) of the Exchange Act and Rules 10b-5, 12b-20, 13a-1 and
13a-13 thereunder. The complaint alleged that the Company's December 31,
1990 and December 31, 1991 Annual Reports on Form 10-K and March 31, 1991,
June 30, 1991, September 30, 1991, March 31, 1992, June 30, 1992 and
September 30, 1992 quarterly reports on Form 10-Q were materially false and
misleading. The SEC complaint conforms in large part to a settlement
proposal previously submitted by the Company. The Company, without
admitting the allegations, entered into a Consent Decree not to violate the
law in the future.
By letter dated October 23, 1995, the Company was notified by the New York
State Education Department (the "Department") that the Professional Conduct
Officer of the Office of Professional
F-32
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE M (continued)
Discipline had determined that there was sufficient evidence of
professional misconduct on the Company's part to warrant a disciplinary
proceeding pursuant to New York law. Upon contacting the Deputy Director of
the Office of Professional Discipline, counsel for the Company was advised
that the alleged misconduct related to the same activities that were the
subject of the DOJ investigation, indictment and plea. The Company
submitted a written response on November 16, 1995. The Company and the
Department have agreed to the entry of a Consent Order concluding any
disciplinary proceedings. The Company will pay $175,000 in fines over five
years. In addition, the Company's registration as a manufacturer of drugs
in New York State is revoked, but such revocation is stayed and the Company
has been placed on probation for a maximum of five years. The Company has
the right to apply for removal from probation after two years.
A lawsuit was filed by the minority shareholders of H.R. Cenci
Laboratories, Inc. and Cenci Powder Products, Inc. against the Company and
several of the officers of the Company. The lawsuit alleged that the
Company has breached several representations made during the course of
negotiations leading to the Company's purchase of 51% of the stock of H.R.
Cenci Laboratories, Inc. This action sought unspecified compensatory
damages, as well as punitive damages, rescission, specific performance,
reformation and a declaration as to what amount, if any, was owed to
plaintiff. The Company filed a Counterclaim, seeking unspecified
compensatory and punitive damages. On March 10, 1997, a Settlement
Agreement and Mutual Release was executed by all parties to the lawsuit,
terminating the action. The terms of the Settlement provide for repayment
of certain outstanding loans, made by the plaintiff to Cenci Labs and Cenci
Powders, as well as payment of settlement funds. These payments total
$600,000, paid in equal monthly installments from March, 1997 to June,
1998. The Settlement Agreement further provided for the balance of Cenci
Labs and Cenci Powder stock to be turned over to the Company. Twenty-five
thousand share of unregistered Common Stock of the Company was tendered to
the plaintiff. At December 31, 1996, the Company recorded a charge of
$309,000 relating to the settlement.
The Company was named as a defendant in an action captioned Allied Welfare Fund,
Vacation Fringe Benefit Fund and Union Mutual Fund v. Halsey Drug Co., 96 Civ
3655, brought in the United States District Court for the Eastern District of
New York. The complaint seeks sums allegedly owed to three of the Company's
labor union funds under the Company's collective bargaining agreement.
Plaintiffs seek approximately $265,000. On or about February 28, 1997, the
Company and the plaintiffs agreed to settle the action. The settlement obligates
the Company to remain current on its obligations and to pay portions of the
alleged arrearages in installments. The Company has paid the alleged arrearages
under the stipulation, but is not current on its obligations as
F-33
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE M (continued)
of the date of this filing. The Company's Collective Bargaining Agreement
expires in June 1997 for all union employees who represent 45% of the Company's
total labor force.
NOTE N - SALE OF COMMON STOCK
On March 30, 1995, the Company entered into an agreement with Zatpack which
provides for the purchase of 500,000 shares of common stock of the Company
by Zatpack, with registration rights, in consideration of $1,000,000. The
$1,000,000 consideration consists of the cancellation of indebtedness
(incurred by the Company's subsidiaries for the purchase of raw materials
delivered from affiliates of Zuellig) and shares of Indiana Fine Chemicals
Corporation. As a result of the above transaction, the Company owns 100% of
Indiana Fine Chemical Corporation (prior to the above transaction, the
Company owned 70% of Indiana Fine Chemical Corporation). In addition, the
Company issued a convertible promissory note to Zatpack, dated December 1,
1994 (Note E). Zatpack has acquired the above assets from Zuellig and its
subsidiaries.
On October 27, 1994, the Company sold 500,000 shares of its common stock in
exchange for $1,000,000 from Ranbaxy Pharmaceuticals, Inc. ("Ranbaxy"). In
connection with these shares, Ranbaxy had the right to have its shares of
the Company's common stock registered under the Securities Act of 1993. In
July 1995, the Company repurchased the 500,000 shares from Ranbaxy for
$1,100,000.
NOTE O - SIGNIFICANT CUSTOMERS AND SUPPLIERS
The Company sells its products to a large number of customers who are
primarily drug distributors, drug store chains and wholesalers and are not
concentrated in any specific region. The Company performs ongoing credit
evaluations of its customers and generally does not require collateral.
During 1996, the Company had net sales to one customer in excess of 10% of
total sales, aggregating 10% of total sales. During 1995, the Company had
net sales to two customers in excess of 10% of total sales, each
aggregating 25% and 11% of total sales, respectively. During 1994, the
Company had net sales to three customers in excess of 10% of total sales,
each aggregating 12% of total sales. Balances due from these customers were
approximately 10% and 25% of total accounts receivable at December 31, 1996
and 1995, respectively. The loss of any of these customers could have a
material adverse effect on the Company.
F-34
Halsey Drug Co., Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
December 31, 1996, 1995 and 1994
NOTE P - FOURTH QUARTER ADJUSTMENTS
During the fourth quarter, the Company recorded a provision to write down
approximately $1.1 million of inventory to its net realizable value.
F-35
Exhibit Page
Number Description Number
- ------ ----------- ------
3.1 Certificate of Incorporation and amendments(incorporated
by reference to Exhibit 3.1 to Amendment No. 2 to the
Registrant's Registration Statement on Form S-18, File No.
33-2471-NY).
3.2 Restated Bylaws (incorporated by reference to Exhibit 3.1
to the Registrant's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1993).
10.1 Credit Agreement, dated as of December 22, 1992, among the
Registrant and The Chase Manhattan Bank, N.A.
(incorporated by reference to Exhibit 10.1 to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1992 (the "1992 Form 10-K")).
10.2 Amendment Two, dated as of January 12, 1994, to Credit
Agreement among the Registrant and the Chase Manhattan
Bank, N.A. , together with forms of Stock Warrant and
Registration Rights Agreement (incorporated by reference
to Exhibit 10.1.1 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1993 (the "1993
Form 10-K")).
10.3 Amendment Three, dated as of May 31, 1994, to Credit
Agreement among the Registrant and The Chase Manhattan
Bank, N.A. (incorporated by reference to Exhibit 6(a) to
the Registrant's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1994).
10.4 Amendment Four, dated as of July 1994, to Credit Agreement
among the Registrant and The Chase Manhattan Bank, N.A.
(incorporated by reference to Exhibit 6(a) to the
Registrant's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1994)).
Exhibit Page
Number Description Number
- ------ ----------- ------
10.5 Amendment Five, dated as of March 21, 1995, to Credit
Agreement among the Registrant and The Chase Manhattan
Bank, N.A. (incorporated by reference to Exhibit 10.7 to
the Registrant's Current Report on Form 8-K dated March
21, 1995 (the "March 8-K")).
10.5(1) Form of Warrants issued to The Bank of New York, The Chase
Manhattan Bank, N.A. and the Israel Discount Bank
(incorporated by reference to Exhibit 10.5(i) to the
Registrant's Annual Report on Form 10-K for the year ended
December 31, 1995 (the "1995 Form 10-K)).
10.5(2) Letter Agreement, dated July 10, 1995, among Halsey Drug
Co., Inc., The Chase Manhattan Bank, N.A., The Bank of New
York and Israel Discount Bank of New York (incorporated by
reference to Exhibit 6(a) to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1995
(the "June 10-Q")).
10.5(3) Letter Agreement, dated November 16, 1995, among Halsey
Drug Co., Inc., The Chase Manhattan Bank, N.A., The Bank
of New York and Israel Discount Bank of New York
(incorporated by reference to Exhibit 10.25(iv) to the
1995 10-K).
10.5(4) Amendment 6, dated as of August 6, 1996, to Credit
Agreement among Halsey Drug Co., Inc., The Chase Manhattan
Bank, N.A., The Bank of New York and Israel Discount Bank
of New York (incorporated by reference to Exhibit 10.1 to
Amendment No. 1 to the Registrant's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1996 (the "June
1996 10-Q)).
*10.5(5) Letter Agreement, dated March 25, 1997 among Halsey Drug
Co., Inc., the Chase Manhattan Bank, as successor in
interest to The Chase Manhattan Bank (National
Association), The Bank of New York and Israel Discount
Bank.
Exhibit Page
Number Description Number
- ------ ----------- ------
10.6 Agreement Regarding Release of Security Interests dated as
of March 21, 1995 by and among the Company, Mallinckrodt
Chemical Acquisition, Inc. and The Chase Manhattan Bank,
N.A. (incorporated by reference to Exhibit 10.9 on the
March 8-K).
10.7 Consulting Agreement dated as of September, 1993 between
the Registrant and Joseph F. Limongelli (incorporated by
reference to Exhibit 10.6 to the 1993 Form 10-K)).
10.8 Employment Agreement, dated as of January 1, 1993, between
the Registrant and Rosendo Ferran (incorporated by
reference to Exhibit 10.2 to the 1992 Form 10-K).
10.9 Employment Agreement, dated as of July 1, 1994, between
the Registrant and Leonard H. Weiss (incorporated by
reference to Exhibit 10.9 to the 1994 Form 10-K).
10.10(1) Halsey Drug Co., Inc. 1984 Stock Option Plan, as amended
(incorporated by reference to Exhibit 10.3 to the 1992
Form 10-K).
10.10(2) Halsey Drug Co., Inc. 1995 Stock Option and Restricted
Stock Purchase Plan (incorporated by reference to Exhibit
4.1 to the Registrant's Registration Statement on Form
S-8, File No. 33-98396).
*10.10(3) Halsey Drug Co., Inc. Non-Employee director Stock Option
Plan
10.11 Leases, effective February 13, 1989 and January 1, 1990,
respectively, among the Registrant and Milton J. Ackerman,
Sue Ackerman, Lee Hinderstein, Thelma Hinderstein and
Marilyn Weiss (incorporated by reference to Exhibits 10.6
and 10.7, respectively, to the Registrant's Annual Report
on Form 10-K for the year ended December 31, 1989).
Exhibit Page
Number Description Number
- ------ ----------- ------
10.12 Lease, effective as of April 15, 1988, among the
Registrant and Milton J. Ackerman, Sue Ackerman, Lee
Hinderstein, Thelma Hinderstein and Marilyn Weiss, and
Rider thereto (incorporated by reference to Exhibit 10.12
to the Registrant's Annual Report on Form 10-K for the
year ended December 31, 1987).
10.12(1) Lease, as of October 31, 1994, among Registrant and Milton
J. Ackerman, Sue Ackerman, Lee Hinderstein, Thelma
Hinderstein and Marilyn Weiss, together with Modification,
Consolidation and Extension Agreement (incorporated by
reference to Exhibit 10.12 to the Registrant's Annual
Report on Form 10-K for the year ended December 31, 1995).
10.13 Asset Purchase Agreement dated as of March 21, 1995 among
Mallinckrodt Chemical Acquisition, Inc. ("Acquisition"),
Mallinckrodt Chemical, Inc., as guarantor and the
Registrant (incorporated by reference to Exhibit 10.1 to
the March 8-K).
10.14 Toll Manufacturing Agreement for APAP/Oxycodone Tablets
dated as of March 21, 1995 between Acquisition and the
Registrant (incorporated by reference to Exhibit 10.2 to
the March 8-K).
10.15 Capsule ANDA Option Agreement dated as of March 21, 1995
between Acquisition and the Registrant (incorporated by
reference to Exhibit 10.3 to the March 8-K).
10.16 Tablet ANDA Noncompetition Agreement dated as of March 21,
1995 between the Registrant and Acquisition (incorporated
by reference to Exhibit 10.4 to the March 8-K).
Exhibit Page
Number Description Number
- ------ ----------- ------
10.17 Subordinated Non-Negotiable Promissory Term Note in the
amount of $1,200,00 dated March 21, 1995 issued by the
Registrant to Acquisition (incorporated by reference to
Exhibit 10.5 to the March 8-K).
10.18 Term Note Security Agreement dated as of March 21, 1995
among the Company, Houba, Inc., and Acquisition
(incorporated by reference to Exhibit 10.6 to the March
8-K.
10.19 Amendment dated March 21, 1995 to Subordination Agreement
dated as of July 21, 1994 between Mallinckrodt Chemical,
Inc., Mallinckrodt Chemical Acquisition, Inc., the
Registrant, The Chase Manhattan Bank (National
Association), Israel Discount Bank of New York, The Bank
of New York, and The Chase Manhattan Bank (National
Association) (incorporated by reference to Exhibit 10.8 to
the March 8-K).
10.20 Agreement dated as of March 30, 1995 between the
Registrant and Zatpack, Inc. (incorporated by reference to
Exhibit 10.10 to the March 8-K).
10.21 Waiver and Termination Agreement dated as of March 30,
1995 between Zuellig Group, N.A., Inc. and Indiana Fine
Chemicals Corporation (incorporated by reference to
Exhibit 10.11 to the March 8-K).
10.22 Convertible Subordinated Note of the Registrant dated
December 1, 1994 issued to Zatpack, Inc. (incorporated by
reference to Exhibit 10.12 to the March 8-K).
Exhibit Page
Number Description Number
- ------ ----------- ------
10.23 Agreement dated as of March 30, 1995 among the Registrant,
Indiana Fine Chemicals Corporation, Zuellig Group, N.A.,
Inc., Houba Inc., Zetapharm, Inc. and Zuellig Botanicals,
Inc. (incorporated by reference to Exhibit 10.13 to the
March 8-K).
10.24 Supply Agreement dated as of March 30, 1995 between Houba,
Inc. and Zetapharm, Inc. (incorporated by reference to
Exhibit 10.14 to the March 8-K).
10.25 Form of 10% Convertible Subordinated Debenture
(incorporated by reference to Exhibit 6(a) to the June
10-Q).
10.26 Form of Redeemable Common Stock Purchase Warrant
(incorporated by reference to Exhibit 6(a) to the June
10-Q).
10.27 Form of 10% Convertible Subordinated Debenture
(incorporated by reference to Exhibit 4.1 to the
Registrant's Current Report on Form 8-K dated December 4,
1995 (the "December 8-K").
10.28 Form of Redeemable Common Stock Purchase Warrant
(incorporated by reference to Exhibit 4.2 to the December
8-K).
10.29 Form of 10% Convertible Subordinated Debenture
(incorporated by reference to Exhibit 99 to the June 1996
10-Q).
10.30 Form of Redeemable Common Stock Purchase Warrant
(incorporated by reference to Exhibit 4.1 to Amendment No.
1 to the June 1996 10-Q).
21 Subsidiaries of the Registrant (incorporated by reference
to Exhibit 22 to the 1993 10-K).
Exhibit Page
Number Description Number
- ------ ----------- ------
*23.1 Consent of Grant Thornton LLP, independent certified
public accountants.
*27 Financial Data Schedule, which is submitted electronically
to the Securities and Exchange Commission for
informational purposes only and not filed.
* Filed herewith.