10-K/A 1 c69238a1e10-ka.txt AMENDMENT TO ANNUAL REPORT -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ------------------------------------ FORM 10-K/A [X] AMENDMENT 1 TO THE ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 2001 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number: 0-13976 AKORN, INC. (Name of registrant as specified in its charter) LOUISIANA 72-0717400 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization)
2500 MILLBROOK DRIVE, BUFFALO GROVE, ILLINOIS 60089 (Address of principal executive offices and zip code) REGISTRANT'S TELEPHONE NUMBER: (847) 279-6100 SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT: None SECURITIES REGISTERED UNDER SECTION 12(g) OF THE EXCHANGE ACT: Common Stock, No Par Value (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 in response to Item 405 of Regulation S-K is not contained in this form, 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. [ ] The financial statements included in this Form 10-K are unaudited. See the "Statement in Lieu of Independent Auditors' Report" included in Item 8. The aggregate market value of the voting stock held by non-affiliates (affiliates being, for these purposes only, directors, executive officers and holders of more than 5% of the Issuer's common stock) of the Issuer as of March 7, 2002 was approximately $47,229,000. The number of shares of the Issuer's common stock, no par value per share, outstanding as of March 7, 2002 was 19,555,514. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- FORWARD-LOOKING STATEMENTS Certain statements in this Form 10-K constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act. When used in this document, the words "anticipate," "believe," "estimate" and "expect" and similar expressions are generally intended to identify forward-looking statements. Any forward-looking statements, including statements regarding the intent, belief or expectations of the Company or its management are not guarantees of future performance. These statements involve risks and uncertainties and actual results may differ materially from those in the forward-looking statements as a result of various factors, including but not limited to: - the effects of federal, state and other governmental regulation of the Company's business; - the Company's success in developing, manufacturing and acquiring new products; - the Company's ability to bring new products to market and the effects of sales of such products on the Company's financial results; - the Company's working capital requirements; - the Company's ability to comply with debt covenants; - the effects of competition from generic pharmaceuticals and from other pharmaceutical companies; and - other factors referred to in this Form 10-K and the Company's other SEC filings. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors That May Affect Future Results". The Company does not intend to update these forward-looking statements. 1 We are filing this Annual Report on Form 10-K/A as Amendment No. 1 to our Form 10-K, filed on April 16, 2002 for the purposes of providing the information required by Items 10, 11, 12 and 13 of Part III. For the convenience of the reader, we have restated the Form 10-K in its entirety. The disclosure contained herein speaks as of the date of filing of the Form 10-K. FORM 10-K TABLE OF CONTENTS
PAGE ---- PART I Item 1. Description of Business..................................... 3 Item 2. Description of Properties................................... 6 Item 3. Legal Proceedings........................................... 7 Item 4. Submission of Matters to a Vote of Security Holders......... 8 PART II Item 5. Market for Common Equity and Related Stockholder Matters.... 9 Item 6. Selected Consolidated Financial Data........................ 10 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................... 10 Item 7A Quantitative and Qualitative Disclosures about Market Risk........................................................ 24 Item 8. Financial Statements and Supplementary Data................. 24 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................... 45 PART III Item 10. Directors and Executive Officers of the Registrant.......... 45 Item 11. Executive Compensation...................................... 46 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................. 50 Item 13. Certain Relationships and Related Transactions.............. 51 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................................... 52 Schedule II................................................. 54 Signatures.................................................. 55
2 PART I ITEM 1. DESCRIPTION OF BUSINESS Akorn, Inc. ("Akorn" or the "Company") manufactures and markets diagnostic and therapeutic pharmaceuticals in specialty areas such as ophthalmology, rheumatology, anesthesia and antidotes, among others. The Company also markets ophthalmic surgical instruments and related products. Customers include physicians, optometrists, wholesalers, group purchasing organizations and other pharmaceutical companies. Akorn is a Louisiana corporation founded in 1971 in Abita Springs, Louisiana. In 1997, the Company relocated its headquarters and certain operations to Illinois. Previous to 2001, the Company evaluated its business as two segments, ophthalmic and injectable. The Company now classifies its operations into three identifiable business segments, ophthalmic, injectable and contract services. These three segments are discussed in greater detail below. For information regarding revenues and gross profit for each of the Company's segments, see Note M to the consolidated financial statements included in Item 8 of this report. Ophthalmic Segment. The Company markets an extensive line of diagnostic and therapeutic ophthalmic pharmaceutical products as well surgical instruments and related supplies. Diagnostic products, primarily used in the office setting, include mydriatics and cycloplegics, anesthetics, topical stains, gonioscopic solutions, angiography dyes and others. Therapeutic products, sold primarily to wholesalers and other national account customers, include antibiotics, anti-infectives, steroids, steroid combinations, glaucoma medications, decongestants/antihistamines and anti-edema medications. Surgical products include surgical knives and other surgical instruments, balanced salt solution, post-operative kits, surgical tapes, eye shields, anti-ultraviolet goggles, facial drape supports and other supplies. Non-pharmaceutical products include various artificial tear solutions, preservative-free lubricating ointments, lid cleansers, vitamin supplements and contact lens accessories. Injectable Segment. The Company markets a line of specialty injectable pharmaceutical products, including anesthesia and products used in the treatment of rheumatoid arthritis and pain management. These products are marketed to wholesalers and other national account customers as well as directly to medical specialists. Contract Services Segment. The Company provides contract-manufacturing services as well as product research and development services to pharmaceutical and biotechnology companies. Manufacturing. The Company has two manufacturing facilities located in Decatur, Illinois and Somerset, New Jersey. See "Item 2. Description of Property." The Company manufactures a diverse group of sterile pharmaceutical products, including solutions, ointments and suspensions for its ophthalmic and injectable segments. The Decatur facilities manufacture product for all three of the Company's segments. The Somerset facility manufactures product for the ophthalmic segment. The Company is also in the process of adding freeze-dried (lyophilized) manufacturing capabilities at its Decatur facility. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors That May Affect Future Results -- Dependence on Development of Pharmaceutical Products and Manufacturing Capabilities." Sales and Marketing. While the Company is working to expand its proprietary product base through internal development and, to a lesser extent, acquisitions, the majority of current products are non-proprietary. The Company relies on its efforts in marketing, distribution, development and low cost manufacturing to maintain and increase market share. The ophthalmic segment uses a three-tiered sales effort. Outside sales representatives sell directly to physicians and group practices. In-house sales (telemarketing) and customer service (catalog sales) sell to optometrists and other customers. A national accounts group sells to wholesalers, retail chains and other group purchasing organizations. This national accounts group also markets the Company's injectable pharmaceutical products, which the Company also sells through telemarketing and direct mail activities to individual specialty physicians and hospitals. The contract services segment markets its contract manufacturing services through direct mail, trade shows and direct industry contacts. 3 The Company records an allowance for estimated product returns. This allowance is reflected as a reduction of account receivable balances. The Company evaluates the allowance balance against actual returns processed. Actual returns processed can vary materially from period to period. Based on the wholesaler's inventory information, the Company increased its allowance for potential product returns to $2,232,000 at March 31, 2001 from $232,000 at December 31, 2000. The provision for the three months ended March 31, 2001 was $2,559,000. The allowance for potential product returns was $548,000 at December 31, 2001. Research and Development. As of December 31, 2001, the Company had 17 Abbreviated New Drug Applications ("ANDAs") for generic pharmaceuticals in various stages of development. The Company filed 7 of these ANDAs and received approval for 1 ANDA in 2001. See "Government Regulation." The Company expects to continue to file ANDAs on a regular basis as pharmaceutical products come off patent allowing the Company to compete by marketing generic equivalents. The Food and Drug Administration ("FDA") approved the New Drug Application ("NDA") for Paremyd, on December 5, 2001. This product is to be launched during the first quarter of 2002. The Company is developing two new indications for ophthalmic products for which it currently anticipates filing NDAs in the future. See Note C to the consolidated financial statements included in Item 8 of this report. One is an indication for Indocyanine Green ("ICG") to treat age related macular degeneration ("AMD"). If the Company's developmental efforts are successful, the Company currently anticipates filing this NDA within the next four years and estimates the market size for this product to be $350 million annually. The Company also anticipates filing an NDA supplement within the next three years for an indication for ICG for intra-ocular staining. The Company estimates the market for this product to be $10 million annually. Pre-clinical and clinical trials required in connection with the development of pharmaceutical products are performed by contract research organizations under the direction of Company personnel. No assurance can be given as to whether the Company will file these NDAs, or any ANDAs, when anticipated, whether the Company will develop marketable products based on these filings or as to the actual size of the market for any such products. See "Government Regulation" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors That May Affect Future Results -- Dependence on Development of Pharmaceutical Products and Manufacturing Capabilities". The Company also maintains a business development program that identifies potential product acquisition or product licensing candidates. The Company has focused its business development efforts on niche products that complement its existing product lines and that have few or no competitors in the market. In 2000, the Company entered into an exclusive cross marketing agreement with Novadaq Technologies, Inc., for cardiac angiography procedures employing ICG. Under the terms of the agreement, as amended on January 25, 2002, Novadaq will assume all further costs associated with development of the technology. The Company, in consideration of foregoing any share of future net profits, will obtain an equity ownership interest in Novadaq and the right to be the exclusive supplier of ICG for use in Novadaq's diagnostic procedures. At December 31, 2001, 14 full-time employees of the Company were involved in research and development and product licensing. Research and development costs are expensed as incurred. Such costs amounted to $2,598,000, $4,132,000 and $2,744,000 for the years ended December 31, 2001, 2000 and 1999, respectively. Patents and Proprietary Rights. The Company considers the protection of discoveries in connection with its development activities important to its business. The Company intends to seek patent protection in the United States and selected foreign countries where deemed appropriate. As of December 31, 2001, the Company had received four U.S. patents and had four additional U.S. patent applications and one international patent application pending. In February of 2002, the Company was notified by the U.S. Patent and trademark Office that U.S. patent number 6,351,663 titled Methods for diagnosing and treating abnormal vasculature using fluorescent dye angiography and dye enhanced photocoagulation had been issued to the Company. This was one of the four U.S. patents on file as of December 31, 2001. The Company has also 4 licensed two U.S. patents from the Johns Hopkins University, Applied Physics Laboratory ("JHU/APL") for the development and commercialization of AMD diagnosis and treatment using ICG, which licenses require the Company to conduct clinical trials, which trials are at the Phase I stage and are ongoing. There can be no assurances that these clinical trials will be successful. In addition, a dispute has arisen between the Company and JHU/APL regarding the two patents licensed for AMD and the Company's performance under the terms of the applicable License Agreement. See "Legal Proceedings". The patents held by the Company cover ophthalmic products and processes except for four patents which are methods patents relating to a currently marketed injectable product. These four patents are not currently supporting any product or product indication currently marketed by the Company. There can be no assurance that the Company will obtain U.S. or foreign patents or, if obtained that they will provide substantial protection or be of commercial benefit. The Company also relies upon trademarks, trade secrets, unpatented proprietary know-how and continuing technological innovation to maintain and develop its competitive position. The Company enters into confidentiality agreements with certain of its employees pursuant to which such employees agree to assign to the Company any inventions relating to the Company's business made by them while in the Company's employ. However, there can be no assurance that others may not acquire or independently develop similar technology or, if patents are not issued with respect to products arising from research, that the Company will be able to maintain information pertinent to such research as proprietary technology or trade secrets. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors That May Affect Future Results -- Patents and Proprietary Rights". Employee Relations. At December 31, 2001, the Company had 310 full-time employees, of whom 292 were employed by Akorn and 18 by its wholly owned subsidiary, Akorn (New Jersey), Inc. The Company enjoys good relations with its employees, none of whom are represented by a collective bargaining agent. Competition. The marketing and manufacturing of pharmaceutical products is highly competitive, with many established manufacturers, suppliers and distributors actively engaged in all phases of the business. Most of the Company's competitors have substantially greater financial and other resources, including greater sales volume, larger sales forces and greater manufacturing capacity. See "Item 7. Management's Discussion and Analysis of Operations -- Factors That May Affect Future Results -- Competition; Uncertainty of Technological Change." The companies that compete with the ophthalmic segment include Alcon Laboratories, Inc., Allergan Pharmaceuticals, Inc., Ciba Vision and Bausch & Lomb, Inc. ("B&L"). The ophthalmic segment competes primarily on the basis of price and service. The ophthalmic segment purchases some ophthalmic products from B&L, who is in direct competition with the Company in several markets. The companies that compete with the injectable segment include both generic and name brand companies such as Abbott Labs, Gensia, American Pharmaceutical Products, Elkin Sinn and American Regent. The injectable segment competes primarily on the basis of price. Competitors in the contract services segment include Cook Imaging, Chesapeake Biological Laboratories, Ben Venue and Oread Laboratories. The manufacturing of sterile products must be performed under government mandated Good Manufacturing Practices. Suppliers and Customers. No supplier of products accounted for more than 10% of the Company's purchases in 2001, 2000 or 1999. The Company requires a supply of quality raw materials and components to manufacture and package pharmaceutical products for itself and for third parties with which it has contracted. The principal components of the Company's products are active and inactive pharmaceutical ingredients and certain packaging materials. Many of these components are available from only a single source and, in the case of many of the Company's ANDAs and NDAs, only one supplier of raw materials has been identified. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors That May Affect Future Results -- Dependence on Supply of Raw Materials and Components". No single customer accounted for more than 10% of the Company's revenues during 2001 or 1999. During 2000, the Company realized approximately 12% of its revenues from one customer. This customer is a distributor of the Company's products as well as a distributor of a broad range of health care products for 5 many companies in the health care sector. This customer is not the end user of the Company's products. If sales to this customer were to diminish or cease, the Company believes that the end users of its products would find no difficulty obtaining the Company's products either directly from the Company or from another distributor. The accounts receivable balance for this customer was approximately 22% of gross trade receivables at December 31, 2000. Government Regulation. Pharmaceutical manufacturers and distributors are subject to extensive regulation by government agencies, including the FDA, the Drug Enforcement Agency ("DEA"), the Federal Trade Commission ("FTC") and other federal, state and local agencies. The federal Food, Drug and Cosmetic Act (the "FDA Act"), the Controlled Substance Act and other federal statutes and regulations govern or influence the development, testing, manufacture, labeling, storage and promotion of products. The FDA inspects drug manufacturers and storage facilities to determine compliance with its Good Manufacturing Practice regulations, non-compliance with which can result in fines, recall and seizure of products, total or partial suspension of production, refusal to approve new drug applications and criminal prosecution. The FDA also has the authority to revoke approval of drug products. With certain exceptions, FDA approval is required before any drug can be manufactured and marketed. New drugs require the filing of an NDA, including clinical studies demonstrating the safety and efficacy of the drug. Generic drugs, which are equivalents of existing brand name drugs, require the filing of an ANDA, which waives the requirement of conducting clinical studies of safety and efficacy. Ordinarily, the filing of an ANDA for generic drugs that contain the same ingredients as drugs already approved for use in the United States requires data showing that the generic formulation is equivalent to the brand name drug and that the product is stable in its formulation. The Company has no control over the time required for the FDA to approve NDA or ANDA filings. During 2000, the Company received a warning letter as a result of a routine inspection of its Decatur manufacturing facilities. This letter focused on general documentation and cleaning validation issues. The Company was re-inspected in late 2001 and the FDA issued a Form 483 documenting its findings. The Company responded to these findings on January 4, 2002 and is awaiting a response from the FDA. The warning letter prevents the FDA from issuing any approval for new products manufactured at the Decatur facility. The warning letter does not inhibit the Company's ability to continue manufacturing products that are currently approved. The warning letter does not impact the operations at the Somerset facility. The Company also manufactures and distributes several controlled-drug substances, the distribution and handling of which are regulated by the DEA. Failure to comply with DEA regulations can result in fines or seizure of product. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors That May Affect Future Results -- Government Regulation". On March 6, 2002, the Company received a letter from the United States Attorney's Office, Central District of Illinois, Springfield, Illinois, advising the Company that the United States Drug Enforcement Administration had referred a matter to that office for a possible civil legal action for alleged violations of the Comprehensive Drug Abuse Prevention Control Act of 1970, 21 U.S.C. sec. 801, et. seq. and regulations promulgated under the Act. The Company is cooperating fully with the government and anticipates that any action under this matter will not have a material impact on its financial statements. See "Legal Proceedings". The Company does not anticipate any material adverse effect from compliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment. ITEM 2. DESCRIPTION OF PROPERTIES Since August 1998, the Company's headquarters and certain administrative offices, as well as a finished goods warehouse, have been located in leased space at 2500 Millbrook Drive, Buffalo Grove, Illinois. The Company leased approximately 24,000 square feet until June 2000 at which time it expanded to the current occupied space of approximately 48,000 square feet. From May 1997 to August 1998, the Company's headquarters and ophthalmic division offices were located in approximately 11,000 square feet of leased space 6 in Lincolnshire, Illinois. The Company sub-lets portions of the Lincolnshire space. The Company's former headquarters, consisting of approximately 30,000 square feet located on ten acres of land in Abita Springs, Louisiana, was sold in February 1999. The Company owns a 76,000 square foot facility located on 15 acres of land in Decatur, Illinois. This facility is currently used for packaging, distribution, warehousing and office space. In addition, the Company owns a 55,000 square-foot manufacturing facility in Decatur, Illinois. The Decatur facilities support all three of the Company's segments. The Company leases approximately 7,000 square feet of office and warehousing space in San Clemente, California, formerly used as a sales office to support the Injectable segment. The Company successfully sublet this space through the term of the lease when the San Clemente operations were closed and relocated to Buffalo Grove. The Company's Akorn (New Jersey) subsidiary also leases approximately 40,000 square feet of space in Somerset, New Jersey. This space is used for manufacturing, research and development and administrative activities related to the ophthalmic segment. The combined space is considered adequate to accommodate growth for the foreseeable future. ITEM 3. LEGAL PROCEEDINGS After the close of business on March 27, 2002, the Company received a letter informing it that the staff of the Securities and Exchange Commission's regional office in Denver, Colorado, plans to recommend to the Commission that it bring an enforcement action for injunctive relief against the Company. Based on the letter, the Company believes the recommended action would concern the Company's alleged misstatement, in quarterly and annual Securities and Exchange Commission filing and earnings press releases, of its income for fiscal year 2000 by allegedly failing to reserve for doubtful accounts receivable and overstating its accounts receivable balance. The Company has also learned that certain of its former officers, as well as a current employee have received similar notifications. The Company disagrees with the staff's proposed recommendation and allegations; it has been invited to submit its views as to why an enforcement action should not be brought, and intends to do so. Because the proposed enforcement action relates to matters in a prior fiscal year, it is not anticipated that these proceedings will have any material impact on the Company's Consolidated Balance Sheet as of December 31, 2001 or on the Company's 2002 or future operating results. The Company is party to a License Agreement with The Johns Hopkins University, Applied Physics Laboratory ("JHU/APL") effective April 26, 2000, and amended effective July 15, 2001 (See Note C). Pursuant to the License Agreement, the Company licensed two patents from JHU/APL for the development and commercialization of a diagnosis and treatment for age-related macular degeneration ("AMD") using Indocyanine Green ("ICG"). A dispute has arisen between the Company and JHU/APL concerning the License Agreement. Specifically, JHU/APL has challenged the Company's performance under the License Agreement and alleged that the Company is in breach of the License Agreement. The Company's has denied JHU/APL's allegations and contends that it has performed in accordance with the terms of the License Agreement. As a result of the dispute, on March 29, 2002, the Company commenced a lawsuit in the U.S. District Court for the Northern District of Illinois, seeking declaratory and other relief against JHU/APL. On Monday, April 1, 2002, the Company and JHU/APL agreed, through counsel, to attempt to negotiate a resolution to the present dispute. If negotiations prove unsuccessful, the Company and JHU/APL will seek to mediate the dispute. Failing that, the litigation would proceed forward. The Company has an intangible asset valued at $2,084,500 recorded as a result of the License Agreement, as amended. Unsuccessful resolution of the dispute could result in a revaluation of this intangible asset. On March 6, 2002, the Company received a letter from the United States Attorney's Office, Central District of Illinois, Springfield, Illinois, advising the Company that the United States Drug Enforcement Administration had referred a matter to that office for a possible civil legal action for alleged violations of the Comprehensive Drug Abuse Prevention Control Act of 1970, 21 U.S.C. sec. 801, et. seq. and regulations promulgated under the Act. The Company is cooperating fully with the government and anticipates that any action under this matter will not have a material impact on its financial statements. On August 9, 2001, the Company was served with a Complaint which had been filed on August 8, 2001 in the United States District Court for The Northern District of Illinois, Eastern Division. The suit named the 7 Company as well as Mr. Floyd Benjamin, the former president and chief executive officer of the Company, and Dr. John N. Kapoor, the Company's current chairman of the board and then interim chief executive officer as defendants. The suit, which was filed by Michelle Golumbski, individually, and on behalf of all others similarly situated, alleged various violations of the federal securities laws in connection with the Company's public statements and filings with the Securities and Exchange Commission during the period from February 20, 2001 through May 22, 2001. The plaintiff subsequently voluntarily dismissed her claims against Akorn, Inc., Mr. Floyd Benjamin and Dr. John N. Kapoor, and, in exchange for the Company's consent to this voluntary dismissal, also provided, through counsel, a written statement that the plaintiff would not reassert her claims against any of the defendants in any subsequent actions. The Company did not provide the plaintiff with any compensation in consideration for this voluntary dismissal. On April 4, 2001, the International Court of Arbitration (the "ICA") of the International Chamber of Commerce notified the Company that Novadaq Technologies, Inc. ("Novadaq") had filed a Request for Arbitration with the ICA on April 2, 2001. Akorn and Novadaq had previously entered into an Exclusive Cross-Marketing Agreement dated July 12, 2000 (the "Agreement"), providing for their joint development and marketing of certain devices and procedures for use in fluorescene angiography (the "Products"). Akorn's drug indocyanine green ("ICG") would be used as part of the angiographic procedure. The United States Food and Drug Administration ("FDA") had requested that the parties undertake clinical studies prior to obtaining FDA approval. In its Request for Arbitration, Novadaq asserted that under the terms of the Agreement, Akorn should be responsible for the costs of performing the requested clinical trials, which were estimated to cost approximately $4,400,000. Alternatively, Novadaq sought a declaration that the Agreement should be terminated as a result of Akorn's alleged breach. Finally, in either event, Novadaq sought unspecified damages as a result of the alleged failure or delay on Akorn's part in performing its obligations under the Agreement. In its response, Akorn denied Novadaq's allegations and alleged that Novadaq had breached the agreement. On January 25, 2002, the Company and Novadaq reached a settlement of the dispute. Under terms of a revised agreement entered into as part of the settlement, Novadaq will assume all further costs associated with development of the technology. The Company, in consideration of foregoing any share of future net profits, obtained an equity ownership interest in Novadaq and the right to be the exclusive supplier of ICG for use in Novadaq's diagnostic procedures. In addition, Antonio R. Pera, Akorn's President and Chief Operating Officer, was named to Novadaq's Board of Directors. In conjunction with the revised agreement, Novadaq and the Company each withdrew their respective arbitration proceedings. The Company is a party in legal proceedings and potential claims arising in the ordinary course of its business. The amount, if any, of ultimate liability with respect to such matters cannot be determined. Despite the inherent uncertainties of litigation, management of the Company at this time does not believe that such proceedings will have a material adverse impact on the financial condition, results of operations, or cash flows of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the quarter ended December 31, 2001. 8 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded on the NASDAQ National Market under the symbol AKRN. On March 7, 2002, there were approximately 615 holders of record of the Company's Common Stock. This number does not include shareholders for which shares are held in a 'nominee' or 'street' name. The closing price of the Company's Common Stock on March 7, 2002 was $3.94 per share. High and low bid prices per NASDAQ for the periods indicated were:
HIGH LOW ------ ----- Year Ended December 31, 2001: 1st Quarter............................................... $ 6.25 $1.97 2nd Quarter............................................... 3.25 1.03 3rd Quarter............................................... 4.23 2.79 4th Quarter............................................... 4.74 2.76 Year Ended December 31, 2000: 1st Quarter............................................... $13.56 $4.00 2nd Quarter............................................... 9.88 5.50 3rd Quarter............................................... 12.63 5.00 4th Quarter............................................... 11.00 2.16
The Company did not pay cash dividends in 2001, 2000 or 1999 and does not expect to pay dividends on our common stock in the foreseeable future. Moreover, the Company is currently prohibited by its credit agreement with The Northern Trust Company from making any dividend payment. 9 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth selected consolidated financial information for the Company for the years ended December 31, 2001, 2000, 1999, 1998 and 1997. The results for 2001 and 2000 are unaudited. See "Item 8, Statement in Lieu of Independent Auditors' Report."
YEARS ENDED DECEMBER 31, -------------------------------------------------- 2001 2000 1999 1998 1997 -------- -------- ------- -------- ------- PER SHARE Equity........................................ $ 1.16 $ 2.02 $ 1.85 $ 1.40 $ 1.20 Net income: Basic....................................... $ (1.01) $ 0.11 $ 0.37 $ 0.26 $ 0.11 Diluted..................................... $ (1.01) $ 0.11 $ 0.36 $ 0.25 $ 0.11 Price: High................................... $ 6.44 $ 13.63 $ 5.56 $ 9.19 $ 4.50 Low.................................... $ 1.03 $ 3.50 $ 3.50 $ 2.54 $ 1.84 P/E: High................................... NM 124x 15x 35x 41x Low.................................... NM 32x 10x 10x 17x INCOME DATA (000's) Revenues...................................... $ 42,248 $ 66,927 $64,632 $ 56,667 $42,323 Gross profit.................................. 7,101 28,837 33,477 29,060 18,776 Operating income (loss)....................... (28,516) 5,789 12,122 9,444 3,165 Interest expense.............................. (3,547) (2,400) (1,921) (1,451) (497) Pretax income (loss).......................... (32,225) 3,506 10,639 7,686 2,844 Income taxes.................................. (12,614) 1,319 3,969 3,039 1,052 Net income (loss)............................. (19,611) 2,187 6,670 4,647 1,792 Weighted average shares outstanding: Basic....................................... 19,337 19,030 18,269 17,891 16,614 Diluted..................................... 19,337 19,721 18,573 18,766 16,925 BALANCE SHEET (000's) Current assets................................ $ 28,580 $ 42,123 $35,851 $ 24,948 $19,633 Net fixed assets.............................. 33,518 34,031 20,812 15,860 12,395 Total assets.................................. 84,461 96,518 76,098 61,416 38,715 Current liabilities........................... 52,937 15,768 9,693 13,908 8,612 Long-term obligations......................... 9,066 40,918 32,015 21,228 9,852 Shareholders' equity.......................... 22,458 39,832 34,390 26,280 20,251 CASH FLOW DATA (000's) From operations............................... $ (654) $ 362 $ 131 $ 1,093 $ 64 Dividends paid................................ -- -- -- -- -- From investing................................ (4,126) (17,688) (6,233) (13,668) (6,387) From financing................................ 9,328 18,108 5,391 10,898 7,356 Change in cash and equivalents................ 4,548 782 (711) (1,677) 1,033
--------------- NM -- Not meaningful ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's discussion and analysis of financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements. The results for 2001 and 2000 are unaudited. See "Item 8, Statement in Lieu of Independent Auditors' Report." 10 RESULTS OF OPERATIONS The Company's revenues are derived from sales of diagnostic and therapeutic pharmaceuticals and surgical instruments by the ophthalmic segment, from sales of diagnostic and therapeutic pharmaceuticals by the injectable segment and from contract services revenue. The following table sets forth the percentage relationships that certain items from the Company's Consolidated Statements of Income bear to revenues for the years ended December 31, 2001, 2000 and 1999.
YEARS ENDED DECEMBER 31, ------------------------------ 2001 2000 1999 ---- ---- ---- Revenues Ophthalmic................................................ 41% 42% 50% Injectable................................................ 23 38 35 Contract Services......................................... 36 20 15 --- --- --- Total revenues.............................................. 100% 100% 100% Gross profit................................................ 17% 43% 52% Selling, general and administrative expenses................ 75 26 26 Amortization of intangibles................................. 4 2 3 Research and development expenses........................... 6 6 4 --- --- --- Operating income (loss)..................................... (68) 9 19 Net income (loss)........................................... (46)% 3% 10%
SIGNIFICANT ACCOUNTING POLICIES The Company accrues an estimate of the difference between the gross sales price of certain products sold to wholesalers and the expected resale prices of such products under contractual arrangements with third parties such as hospitals and group purchasing organizations at the time of sale to the wholesaler. Similarly, the Company records an allowance for rebates related to contracts and other programs with wholesalers. These allowances are reflected as a reduction of account receivable balances. The Company evaluates the allowance balances against actual chargebacks and rebates processed by wholesalers. Actual chargebacks and rebates processed can vary materially from period to period. The Company has an increasing number of contracts and other programs with wholesalers, each incorporating various numbers and types of chargebacks and rebates. The recorded allowance amount reflects the Company's current estimate of the chargeback and rebate amounts wholesalers have earned under these various contracts and programs. In May 2001, the Company completed an analysis of its March 31, 2001 allowance for chargebacks and rebates and determined that an increase from the allowance of $3,296,000 at December 31, 2000 was necessary. In performing such analysis, the Company utilized recently obtained reports of wholesaler's inventory information, which had not been previously obtained or utilized. Based on the wholesaler's March 31, 2001 inventories and historical chargeback and rebate activity, the Company recorded an allowance of $6,961,000, which resulted in an expense of $12,000,000 for the three months ended March 31, 2001. During the quarter ended June 30, 2001, the Company further refined its estimates of the chargeback and rebate liability determining that an additional $2,250,000 provision needed to be recorded. This additional increase to the allowance was necessary to reflect the continuing shift of sales to customers who purchase their products through group purchasing organizations and buying groups. The Company had previously seen a much greater level of list price business than is occurring in the current business environment. The Company records an allowance for estimated product returns. This allowance is reflected as a reduction of account receivable balances. The Company evaluates the allowance balance against actual returns processed. Actual returns processed can vary materially from period to period. Based on the wholesaler's inventory information, the Company increased its allowance for potential product returns to $2,232,000 at March 31, 2001 from $232,000 at December 31, 2000. The provision for the 11 three months ended March 31, 2001 was $2,559,000. The allowance for potential product returns was $548,000 at December 31, 2001. The Company records an allowance for doubtful accounts, which reflects trade receivable balances owed to the Company that are believed to be uncollectible. This allowance is reflected as a reduction of account receivable balances. The expense related to doubtful accounts is reflected in SG&A expenses. Based upon its recent unsuccessful efforts to collect past due balances, the Company updated its analysis of potentially uncollectible trade receivable balances and recorded a total bad debt provision for the year of $12,000,000. The Company recorded $7,520,000 and $4,610,00 in the first and second quarter of 2001, respectively and reduced the allowance $130,000 in the fourth quarter of 2001. As a result, and after the effect of balances written off, the allowance for doubtful accounts increased to $3,706,000 at December 31, 2001 from $801,000 at December 31, 2000. The Company records an allowance for discounts and allowances, which reflects discounts and allowances available to certain customers based on agreed upon terms of sale. This allowance is reflected as a reduction of account receivable balances. The Company evaluates the allowance balance against actual discounts taken. The Company records an estimate for slow-moving and obsolete inventory based upon recent historical sales by unit. The Company evaluates the potential sales of its products over their remaining lives and estimates the amount that may expire before being sold. In the fourth quarter of 2000, the Company increased this reserve by $2,700,000 to account for slow moving and obsolete inventory primarily related to products purchased from third parties in 1998 and 1999 for which the original sales forecast overestimated actual demand. In the first quarter of 2001, based on sales trends and forecasted sales activity by product, the Company increased its allowance for inventory obsolescence to $4,583,000. The provision for the three months ended March 31, 2001 was $1,500,000. The allowance for inventory obsolescence was $1,845,000 at December 31, 2001. All other increases to the allowances for chargebacks and rebates, returns, doubtful accounts, discounts and allowances and inventory obsolescence occurred as part of the normal recording of product sales. COMPARISON OF TWELVE MONTHS ENDED DECEMBER 31, 2001 AND 2000 Revenues decreased 36.9% for the year ended December 31, 2001 compared to the prior year. Ophthalmic segment revenues decreased 38.2%, primarily reflecting the decline in sales in the antibiotic, glaucoma and artificial tear product lines. The remaining decline in ophthalmic revenues reflects the effect of increases to the allowance for chargebacks and rebates discussed in Note K to the Consolidated Financial Statements. The allowances for chargebacks and rebates and returns are recorded as reductions to gross sales in computing net sales. Ophthalmic net sales were also negatively impacted by price competition for some of the Company's higher volume product lines. The reduction in sales was due to both declines in unit price as well as volume. Injectable segment revenues decreased 60.9%, primarily due to the increases in the allowances for chargebacks and rebates and returns, discussed in Note K to the Consolidated Financial Statements and a sharp reduction in anesthesia and antidote product sales. The sharp reduction is attributable to excessive wholesaler inventories that were reduced during the year without compensating purchases made by the wholesalers. Contract services revenues increased 10.6% compared to the same period in 2000, primarily due to price increases necessary to cover increasing production costs. Consolidated gross profit decreased 75.4% for the year, with gross margins decreasing from 43.1% to 16.8%. This reflects the effects of the aforementioned decline in net sales, as well as an increase in the reserve for slow-moving, unsaleable and obsolete inventory items (See Note K). In addition, the Company incurred unfavorable manufacturing variances at both the Somerset, NJ facility and its Decatur, IL facility, which eroded the gross margin percentage. These variances were the result of reduced activity in the plant, primarily caused by the previously discussed reduction in sales that resulted from the wholesaler inventories being reduced without compensating purchases. Management anticipates that manufacturing variances will decrease 12 in the future as a result of the restructuring program (See Note S) implemented during 2001. The Company is actively looking into increasing its manufacturing activity at its Somerset facility either through additional product approvals or increasing its third-party manufacturing business. Selling, general and administrative expenses ("SG&A") increased 81.2% for the year as compared to 2000. The increase primarily reflects a provision for bad debts of $12,000,000. The provision for bad debts in 2000 was $607,000. SG&A expenses also increased due to asset impairment charges of $2,132,000 and restructuring-related charges of $1,117,000 primarily severance and lease costs. Without these charges, SG&A would have decreased 6.4%, reflecting the results of the cost cutting and restructuring efforts employed during the year. Amortization of intangibles decreased 1.6% for the year, reflecting the exhaustion of certain product intangibles. Research and Development expenses ("R&D") decreased 37.1%, primarily reflecting a scaling back of research and development activities. The Company is focusing on strategic product niches in which it believes it will be able to add value, primarily in the areas of controlled substances and ophthalmics. Interest expense increased 47.8% compared to 2000, reflecting higher interest rates on higher average outstanding debt balances (See Note G) partially offset by capitalized interest related to the lyophilized pharmaceuticals manufacturing line expansion. Net loss for 2001 was $19,611,000, or $1.01 per share, compared to net income of $2,187,000, or $0.11 per share, for the prior year. COMPARISON OF TWELVE MONTHS ENDED DECEMBER 31, 2000 AND 1999 Revenues increased 3.6% for the year ended December 31, 2000 compared to the prior year. Ophthalmic segment revenues decreased 13.1%, primarily due to sharply reduced sales in generic therapeutic pharmaceuticals for glaucoma and allergies. The reduction in sales was due to both declines in unit price as well as volume. Injectable segment revenues increased 20.3%, primarily due to sales of acquired anesthesia products. Injectable segment sales also benefited from favorable unit prices due to a continuing shortage of certain distributed products and increased contract-manufacturing activity. In both segments, wholesaler-discounting programs unfavorably impacted unit prices. These discounts take the form of chargebacks and rebates. Chargebacks and rebates are discussed further in Note K to the Consolidated Financial Statements. This charge is reflected as a reduction in net sales, primarily ophthalmic. Consolidated gross profit decreased 13.9% for the year, with gross margins decreasing from 51.8% to 43.1%. Pricing pressure on ophthalmic generic pharmaceuticals as well as the disproportionate increase in contract manufacturing revenues caused the decrease in gross margins. Contract manufacturing activity commands significantly lower margins than sales of the Company's other product lines. Margins in 2000 were also reduced by a $4.0 million ($2.7 million in the fourth quarter) increase in the reserve for slow-moving and obsolete inventory. This increase was primarily related to products purchased from third parties in 1998 and 1999 for which the original sales forecast overestimated demand. Selling, general and administrative expenses ("SG&A") increased 4.0%, reflecting routine escalations in rental and other contracts, routine compensation increases, and the increase in leased space in the Buffalo Grove facility. Amortization of intangibles decreased 19.1% for the year, reflecting a patent expiration in the 2nd quarter of 1999. Research and Development expenses ("R&D") increased 50.6%, primarily reflecting costs associated with Piroxicam clinical trials and beginning stage development of the Company's age-related macular degeneration product. Interest expense increased 24.9%, reflecting higher interest rates on higher average outstanding debt balances partially offset by capitalized interest related to major capital projects in 2000. 13 Net income for 2000 was $2,187,000, or $0.11 per diluted share, compared to $6,670,000, or $0.36 per diluted share, for the prior year. The decrease in earnings resulted from the above mentioned items. FINANCIAL CONDITION AND LIQUIDITY As of December 31, 2001, the Company had cash and cash equivalents of $5,355,000. The net working capital balance at December 31, 2001 was $(24,357,000) versus $26,355,000 at December 31, 2000 resulting primarily from decreases in receivables and inventory and reclassification of the Company's senior debt obligation as a current liability. During the year ended December 31, 2001, the Company used $654,000 in cash for operations. Investing activities, which include the purchase of product-related intangible assets as well as equipment required $4,126,000 in cash. Fixed asset purchases related to the lyophilized (freeze-dried) pharmaceuticals manufacturing line expansion accounted for $2,566,000 of the $4,126,000 cash used in investing activities and the Company expects to spend an additional $2,500,000 for such expansion during 2002. Financing activities provided $9,328,000 in cash primarily through the issuance of $5,000,000 subordinated convertible debentures and a $3,250,000 promissory note. In 1997 the Company entered into a $15 million revolving credit arrangement, increased to $25 million in 1998, and subsequently increased to $45 million in 1999, subject to certain financial covenants and certain liens on the Company's fixed assets. The credit agreement, as amended effective January 1, 2002, requires the Company to maintain certain financial covenants. These covenants include minimum levels of cash receipts, limitations on capital expenditures, a $750,000 per quarter limitation on product returns and required amortization of the loan principal. The agreement also prohibits the Company from declaring any cash dividends on its common stock and identifies certain conditions in which the principal and interest on the credit agreement would become immediately due and payable. These conditions include: (a) an action by the FDA which results in a partial or total suspension of production or shipment of products, (b) failure to invite the FDA in for re-inspection of the Decatur manufacturing facilities by June 1, 2002, (c) failure to make a written response, within 10 days, to the FDA, with a copy to the lender, to any written communication received from the FDA after January 1, 2002 that raises any deficiencies, (d) imposition of fines against the Company in an aggregate amount greater than $250,000, (e) a cessation in public trading of Akorn stock other than a cessation of trading generally in the United States securities market, (f) restatement of or adjustment to the operating results of the Company in an amount greater than $27,000,000, (g) failure to enter into an engagement letter with an investment banker for the underwriting of an offering of equity securities by June 15, 2002, (h) failure to not be party to an engagement letter at any time after June 15, 2002 or (i) experience any material adverse action taken by the FDA, the SEC, the DEA or any other Governmental Authority based on an alleged failure to comply with laws or regulations. Management believes it will be able to comply with the covenants during 2002. In the event that the Company is not in compliance with the covenants during 2002 and does not negotiate amended covenants and/or obtain a waiver thereto, then the debt holder, at its option, may demand immediate payment of all outstanding amounts due it. The amended credit agreement requires a minimum payment of $5.6 million, which relates to an estimated federal tax refund, with the balance of $39.2 million due June 30, 2002. The estimated $5.6 million tax refund must be remitted within three days of receipt from the Internal Revenue Service. The Company is also obligated to remit any additional federal tax refunds received above the estimated $5.6 million. The current credit facility matures on June 30, 2002 at which point the Company will need to re-negotiate or obtain new financing. Management believes that additional long-term financing will be needed to finance product development or acquisitions. There are no guarantees that such financing will be available or available at an acceptable cost. See Note G to Consolidated Financial Statement for a description of this indebtedness and other indebtedness of the Company. On July 12, 2001 the Company entered into a $5,000,000 subordinated debt transaction with the John N. Kapoor Trust dtd. 9/20/89 (the "Trust"), the sole trustee and sole beneficiary of which is Dr. John N. Kapoor, the Company's current CEO and Chairman of the Board of Directors. The transaction is evidenced by a Convertible Bridge Loan and Warrant Agreement (the "Trust Agreement") in which the Trust agreed to provide two separate tranches of funding in the amounts of $3,000,000 ("Tranche A" which was received on 14 July 13) and $2,000,000 ("Tranche B" which was received on August 16). As part of the consideration provided to the Trust for the subordinated debt, the Company issued the Trust two warrants which allow the Trust to purchase 1,000,000 shares of common stock at a price of $2.85 per share and another 667,000 shares of common stock at a price of $2.25 per share. The exercise price for each warrant represented a 25% premium over the share price at the time of the Trust's commitment to provide the subordinated debt. Under the terms of the Trust Agreement, the subordinated debt will bear interest at prime plus 3%, which is the same rate the Company pays on its senior debt. Interest will not be paid to the Trust, but will instead accrue as required by the terms of a subordination agreement which was entered into between the Trust and the Company's senior lenders. The convertible feature of the Trust Agreement, as amended, allows for conversion of the subordinated debt plus interest into common stock of the Company, at a price of $2.28 per share of common stock for Tranche A and $1.80 per share of common stock for Tranche B. The Company, in accordance with Accounting Principles Board ("APB") Opinion No. 14, recorded the subordinated debt transaction such that the convertible debt and warrants have been assigned independent values. The fair value of the warrants was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yield of 0%, (ii) expected volatility of 79%, (iii) risk free rate of 4.75%, and (iv) expected life of 5 years. As a result, the Company assigned a value of $1,516,000 to the warrants and recorded this amount as additional paid in capital. The remaining $3,484,000 was recorded as long-term debt. The resultant bond discount, equivalent to the value assigned to the warrants, will be amortized and charged to interest expense over the life of the subordinated debt. In December 2001, the Company entered into a $3,250,000 five-year loan with NeoPharm, Inc. ("NeoPharm") to fund Akorn's efforts to complete its lyophilization facility located in Decatur, Illinois. Under the terms of the Promissory Note, dated December 20, 2001, interest will accrue at the initial rate of 3.6% and will be reset quarterly based upon NeoPharm's average return on its cash and readily tradable long and short-term securities during the previous calendar quarter. The principal and accrued interest is due and payable on or before maturity on December 20, 2006. The note provides that Akorn will use the proceeds of the loan solely to validate and complete the lyophilization facility located in Decatur, Illinois and to address the issues set forth in the Form 483 and warning letter received from the FDA. The Promissory Note is subordinated to Akorn's senior debt owed to The Northern Trust Company but is senior to Akorn's subordinated debt owed to the Trust. The note was executed in conjunction with a Processing Agreement that provides NeoPharm, Inc. with the option of securing at least 15% of the capacity of Akorn's lyophilization facility each year. Dr. John N. Kapoor, the Company's chairman and chief executive officer is also chairman of NeoPharm and holds a substantial stock position in that company as well as in the Company. Commensurate with the completion of the Promissory Note between the Company and NeoPharm, the Company entered into an agreement with the Trust, which amended the Trust Agreement. The amendment extended the Trust Agreement to terminate concurrently with the Promissory Note on December 20, 2006. The amendment also made it possible for the Trust to convert the interest accrued on the $3,000,000 tranche into common stock of the Company. Previously, the Trust could only convert the interest accrued on the $2,000,000 tranche. The change related to the convertibility of the interest accrued on the $3,000,000 tranche requires that shareholder approval be received by August 31, 2002. 15 SELECTED QUARTERLY DATA In Thousands, Except Per Share Amounts (Unaudited)
NET INCOME (LOSS) ---------------------------------- GROSS PER SHARE PER SHARE REVENUES PROFIT (LOSS) AMOUNT BASIC DILUTED -------- ------------- ------ --------- --------- Year Ended December 31, 2001: 1st Quarter.............................. $ 6,076 $(5,783) $(12,977) $(0.67) $(0.67) 2nd Quarter.............................. 10,637 2,509 (6,275) (0.33) (0.33) 3rd Quarter.............................. 12,842 5,013 (479) (0.02) (0.02) 4th Quarter.............................. 12,693 5,362 120 0.01 0.01 ------- ------- -------- ------ ------ $42,248 $ 7,101 $(19,611) $(1.01) $(1.01) ======= ======= ======== ====== ====== Year Ended December 31, 2000: 1st Quarter.............................. $16,644 $ 8,413 $ 1,794 $ 0.10 $ 0.09 2nd Quarter.............................. 18,320 9,786 2,184 0.11 0.11 3rd Quarter.............................. 16,878 7,096 415 0.02 0.02 4th Quarter.............................. 15,085 3,542 (2,206) (0.11) (0.11) ------- ------- -------- ------ ------ $66,927 $28,837 $ 2,187 $ 0.11 $ 0.11 ======= ======= ======== ====== ======
FACTORS THAT MAY AFFECT FUTURE RESULTS Financial Risk Factors A small number of wholesale drug distributors accounts for a large portion of the Company's revenues. In 2001, sales to five wholesale drug distributors accounted for 42% of total gross sales and approximately 47% of gross trade receivables as of December 31, 2001. The loss of one or more of these customers, a change in purchasing patterns, an increase in returns of the Company's products, delays in purchasing products and delays in payment for products by one or more distributors could have a material negative impact on the Company's revenue and results of operations and may lead to a violation of debt covenants. At December 31, 2001, the Company had total outstanding indebtedness of $53,933,000, or 71% of total capitalization. This significant debt load could limit the Company's operating flexibility as a result of restrictive covenants placed on the Company by its lenders. Further, the current debt levels could require usage of a large portion of the cash flow from operations for debt payments that would reduce the availability of cash flow to fund operations, product acquisitions, expansion of the Company's sales force, facilities improvements and research and development activities. On several past occasions, the Company has been out of compliance with a number of the financial and other covenants contained in the documents, which govern its debt. To date, the Company has been able to either renegotiate the terms of such covenants or obtain waivers of such non-compliance. See "Financial Condition and Liquidity". No assurance can be given, however, that, if the Company was to fail to comply in the future with its existing covenants that the Company's lenders would be willing to either further negotiate the terms of such covenants or waive the Company's compliance with the covenants. Under the terms of the Company's loan documents, the Company's lenders would have the right to declare a default under the loan documents and to thereupon pursue any and all of the remedies available to them under the loan documents, including, but not limited to, foreclosure on substantially all of the Company's assets. While the Company believes that it will be able to fully satisfy all of the terms and conditions set forth in its loan documents, future events could make such performance more difficult or impossible. The Company may need additional funds to operate and grow its business. The Company may seek additional funds through public and private financing, including equity and debt offerings. Adequate funds through the financial markets or from other sources, may not be available when needed or on terms favorable to the Company or its stockholders. Insufficient funds could cause the Company to delay, scale back, or 16 abandon some or all of its product acquisition, licensing opportunities, marketing, product development, research and development and manufacturing opportunities. The Company is party to a License Agreement with The Johns Hopkins University, Applied Physics Laboratory ("JHU/APL") effective April 26, 2000, and amended effective July 15, 2001 (See Note C). A dispute (see "Legal Proceedings") has arisen between the Company and JHU/APL concerning the License Agreement. The Company has an intangible asset valued at $2,084,500 recorded as a result of the License Agreement, as amended. Unsuccessful resolution of the dispute could result in a revaluation of this intangible asset. Government Regulation Federal and state statutes and government agencies regulate virtually all aspects of the Company's business. The development, testing, manufacturing, processing, quality, safety, efficacy, packaging, labeling, record-keeping, distribution, storage and advertising of the Company's products, and disposal of waste products arising from such activities, are subject to regulation by one or more federal agencies. These agencies include the Food and Drug Administration ("FDA"), the Drug Enforcement Agency ("DEA"), the Federal Trade Commission ("FTC"), the Consumer Product Safety Commission, the Occupational Safety and Health Administration ("OSHA") and the U.S. Environmental Protection Agency ("EPA"). Similar state and local agencies also regulate these activities. Failure to comply with applicable statutes and government regulations could have a material adverse effect on the Company's business, financial condition and results of operations. All pharmaceutical manufacturers, including the Company, are subject to regulation by the FDA under the authority of the Federal Food, Drug, and Cosmetic Act ("FDC Act"). Under the FDC Act, the federal government has extensive administrative and judicial enforcement powers over the activities of pharmaceutical manufacturers to ensure compliance with FDA regulations. Those powers include, but are not limited to, the authority to initiate court action to seize unapproved or non-complying products, to enjoin non-complying activities, to halt manufacturing operations that are not in compliance with current good manufacturing practices ("cGMP"), to recall products which present a health risk, and to seek civil monetary and criminal penalties. Other enforcement activities include refusal to approve product applications or the withdrawal of previously approved applications. Any such enforcement activities, including the restriction or prohibition on sales of products marketed by the Company or the halting of manufacturing operations of the Company, could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, product recalls may be issued at the discretion of the Company, the FDA or other government agencies having regulatory authority for pharmaceutical product sales. Recalls may occur due to disputed labeling claims, manufacturing issues, quality defects or other reasons. No assurance can be given that recalls of the Company's pharmaceutical products will not occur in the future. Any product recall could have a material adverse effect on the Company's business, financial condition and results of operations. Further, product recalls, in certain circumstances, could constitute an event of default under the provision of the Company's senior debt. All "new drugs" must be the subject of an FDA-approved new drug application ("NDA") before they may be marketed in the United States. Certain prescription drugs are not currently required to be the subject of an approved NDA but, rather, may be marketed pursuant to an FDA regulatory enforcement policy permitting continued marketing of those drugs until the FDA determines whether they are safe and effective. All generic equivalents to previously approved drugs or new dosage forms of existing drugs must be the subject of an FDA-approved abbreviated new drug application ("ANDA") before they may be marketed in the United States. The FDA has the authority to withdraw existing NDA and ANDA approvals and to review the regulatory status of products marketed under the enforcement policy. The FDA may require an approved NDA or ANDA for any drug product marketed under the enforcement policy if new information reveals questions about the drug's safety or efficacy. All drugs must be manufactured in conformity with cGMP and drugs subject to an approved NDA or ANDA must be manufactured, processed, packaged, held, and labeled in accordance with information contained in the NDA or ANDA. 17 The Company and its third-party manufacturers are subject to periodic inspection by the FDA to assure such compliance. The FDA imposes additional stringent requirements on the manufacture of sterile pharmaceutical products to ensure the sterilization processes and related control procedures consistently produce a sterile product. Additional sterile manufacturing requirements include the submission for expert review of detailed documentation for sterilization process validation in drug applications beyond those required for general manufacturing process validation. Various sterilization process requirements are the subject of detailed FDA guidelines, including requirements for the maintenance of microbiological control and quality stability. Pharmaceutical products must be distributed, sampled and promoted in accordance with FDA requirements. The FDA also regulates drug labeling and the advertising of prescription drugs. A finding by a governmental agency or court that the Company is not in compliance could have a material adverse effect on the Company's business, financial condition and results of operations. During 2000, the Company received a warning letter as a result of a routine inspection of its Decatur manufacturing facilities. This letter focused on general documentation and cleaning validation issues. The Company was re-inspected in late 2001 and the FDA issued a Form 483 documenting their findings. The Company responded to these findings on January 4, 2002 and is awaiting a response from the FDA. The warning letter prevents the FDA from issuing any approval for new products manufactured at the Decatur facility. The warning letter does not inhibit the Company's ability to continue manufacturing products that are currently approved. The warning letter does not impact the operations at the Somerset facility. While the Company believes that all of its current pharmaceuticals are lawfully marketed in the United States under current FDA enforcement policies or have received the requisite agency approvals for manufacture and sale, such marketing authority is subject to withdrawal by the FDA. In addition, modifications or enhancements of approved products are in many circumstances subject to additional FDA approvals which may or may not be granted and which may be subject to a lengthy application process. Any change in the FDA's enforcement policy or any decision by the FDA to require an approved NDA or ANDA for a Company product not currently subject to the approved NDA or ANDA requirements or any delay in the FDA approving an NDA or ANDA for a Company product could have a material adverse effect on the Company's business, financial condition and results of operations. A number of products marketed by the Company are "grandfathered" drugs that are permitted to be manufactured and marketed without FDA-issued ANDAs or NDAs on the basis of their having been marketed prior to enactment of relevant sections of the FDC Act. The regulatory status of these products is subject to change and/or challenge by the FDA, which could establish new standards and limitations for manufacturing and marketing such products, or challenge the evidence of prior manufacturing and marketing upon which grandfathering status is based. The Company is not aware of any current efforts by the FDA to change the status of any of its "grandfathered" products, but there can be no assurance that such initiatives will not occur in the future. Any such change in the status of the Company's "grandfathered" products could have a material adverse effect on the Company's business, financial condition and results of operations. The Company also manufactures and sells drugs which are "controlled substances" as defined in the federal Controlled Substances Act and similar state laws, which establishes, among other things, certain licensing, security and record keeping requirements administered by the DEA and similar state agencies, as well as quotas for the manufacture, purchase and sale of controlled substances. The DEA could limit or reduce the amount of controlled substances which the Company is permitted to manufacture and market. The Company has not experienced sanctions or fines for non-compliance with the foregoing regulations, but no assurance can be given that any such sanctions or fines would not have a material adverse effect on the Company's business, financial condition and results of operations. On March 6, 2002, the Company received a letter from the United States Attorney's Office, Central District of Illinois, Springfield, Illinois, advising the Company that the United States Drug Enforcement Administration had referred a matter to that office for a possible civil legal action for alleged violations of the Comprehensive Drug Abuse Prevention Control Act of 1970, 21 U.S.C. sec. 801, et. seq. and regulations promulgated under the Act. The Company is cooperating fully with the government and anticipates that any action under this matter will not have a material impact on its financial statements. 18 The Company cannot determine what effect changes in regulations or statutes or legal interpretation, when and if promulgated or enacted, may have on its business in the future. Changes could, among other things, require changes to manufacturing methods, expanded or different labeling, the recall, replacement or discontinuation of certain products, additional record keeping and expanded documentation of the properties of certain products and scientific substantiation. Such changes or new legislation could have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Development of Pharmaceutical Products and Manufacturing Capabilities The Company's strategy for growth is dependent upon its ability to develop products that can be promoted through current marketing and distributions channels and, when appropriate, the enhancement of such marketing and distribution channels. The Company currently has 17 ANDAs in various stages of development and anticipates filing two NDAs at some point in the future. See "Item 1. Description of Business -- Research and Development." The Company may not meet its anticipated time schedule for the filing of ANDAs and NDAs or may decide not to pursue ANDAs or NDAs that it has submitted or anticipates submitting. The internal development of new pharmaceutical products by the Company is dependent upon the research and development capabilities of the Company's personnel and its infrastructure. There can be no assurance that the Company will successfully develop new pharmaceutical products or, if developed, successfully integrate new products into its existing product lines. In addition, there can be no assurance that the Company will receive all necessary approvals from the FDA or that such approvals will not involve delays, which adversely affect the marketing and sale of the Company's products. Until such time as the Company receives clearance from the Form 483 and warning letter received from the FDA, the Company will not receive approval from the FDA to manufacture any new NDA products at its Decatur facility. The Company's failure to develop new products or receive FDA approval of ANDAs or NDAs, or address the issues raised in the Form 483 and warning letter received from the FDA, could have a material adverse effect on the Company's business, financial condition and results of operations. Another part of the Company's growth strategy is to develop the capability to manufacture lyophilized (freeze-dried) pharmaceutical products. While the Company has devoted resources to developing these capabilities, it may not be successful in developing these capabilities, or the Company may not realize the anticipated benefits from developing these capabilities. Generic Substitution The Company's branded pharmaceutical products are subject to competition from generic equivalents and alternative therapies. Generic pharmaceuticals are the chemical and therapeutic equivalents of brand-name pharmaceuticals and represent an increasing proportion of pharmaceuticals dispensed in the United States. There is no proprietary protection for most of the branded pharmaceutical products sold by the Company and generic and other substitutes for most of its branded pharmaceutical products are sold by other pharmaceutical companies. In addition, governmental and cost-containment pressures regarding the dispensing of generic equivalents will likely result in generic substitution and competition generally for the Company's branded pharmaceutical products. Although the Company attempts to mitigate the effect of this substitution through, among other things, creation of strong brand-name recognition and product-line extensions for its branded pharmaceutical products, there can be no assurance that the Company will be successful in these efforts. Increased competition in the sale of generic pharmaceutical products could have a material adverse effect on the Company's business, financial condition and results of operations. Generic substitution is regulated by the federal and state governments, as is reimbursement for generic drug dispensing. There can be no assurance that substitution will be permitted for newly approved generic drugs or that such products will be subject to government reimbursement. Dependence on Generic and Off-Patent Pharmaceutical Products The success of the Company depends, in part, on its ability to anticipate which branded pharmaceuticals are about to come off patent and thus permit the Company to develop, manufacture and market equivalent generic pharmaceutical products. Generic pharmaceuticals must meet the same quality standards as branded 19 pharmaceuticals, even though these equivalent pharmaceuticals are sold at prices that are significantly lower than that of branded pharmaceuticals. In addition, generic products that third parties develop may render the Company's generic products noncompetitive or obsolete. Although the Company has successfully brought generic pharmaceutical products to market in a timely manner in the past, there can be no assurance that the Company will be able to consistently bring these products to market quickly and efficiently in the future. An increase in competition in the sale of generic pharmaceutical products or the Company's failure to bring such products to market before its competitors could have a material adverse effect on the Company's business, financial condition and results of operations. Risks and Expense of Legal Proceedings The Company is currently involved in several pending or threatened legal actions with both private parties and certain government agencies. See "Legal Proceedings". While the Company believes that its positions in these various matters are meritorious, to the extent that the Company's personnel must spend time and the Company must expend resources to pursue or contest these various matters, or any additional matters that may be asserted from the time to time in the future, this represents time and money that is not available for other actions that the Company might otherwise pursue which could be beneficial to the Company's future. In addition, to the extent that the Company is unsuccessful in any legal proceedings, the consequences could have a negative impact on the Company or its operations. These consequences could include, but not be limited to, fines, penalties, injunctions, the loss of patent or other rights, the need to write down or off the value of assets (which could negatively impact the Company's earnings) and a wide variety of other potential remedies or actions that could be taken against the Company. While the Company will continue to vigorously pursue its rights in all such matters, no assurance can be given that the Company will be successful in any of these proceedings or, even if successful, that the Company would be able to recoup any of the moneys expended in pursuing such matters. Competition; Uncertainty of Technological Change The Company competes with other pharmaceutical companies, including major pharmaceutical companies with financial resources substantially greater than those of the Company, in developing, acquiring, manufacturing and marketing pharmaceutical products. The selling prices of pharmaceutical products typically decline as competition increases. Further, other products now in use, under development or acquired by other pharmaceutical companies, may be more effective or offered at lower prices than the Company's current or future products. The industry is characterized by rapid technological change that may render the Company's products obsolete, and competitors may develop their products more rapidly than the Company. Competitors may also be able to complete the regulatory process sooner, and therefore, may begin to market their products in advance of the Company's products. The Company believes that competition in sales of its products is based primarily on price, service, availability and product efficacy. There can be no assurance that: (i) the Company will be able to develop or acquire commercially attractive pharmaceutical products; (ii) additional competitors will not enter the market; or (iii) competition from other pharmaceutical companies will not have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Supply of Raw Materials and Components The Company requires a supply of quality raw materials and components to manufacture and package pharmaceutical products for itself and for third parties with which it has contracted. The principal components of the Company's products are active and inactive pharmaceutical ingredients and certain packaging materials. Many of these components are available from only a single source and, in the case of many of the Company's ANDAs and NDAs, only one supplier of raw materials has been identified. Because FDA approval of drugs requires manufacturers to specify their proposed suppliers of active ingredients and certain packaging materials in their applications, FDA approval of any new supplier would be required if active ingredients or such packaging materials were no longer available from the specified supplier. The qualification of a new supplier could delay the Company's development and marketing efforts. If for any reason the Company is unable to obtain sufficient quantities of any of the raw materials or components required to 20 produce and package its products, it may not be able to manufacture its products as planned, which could have a material adverse effect on the Company's business, financial condition and results of operations. Dependence on Third-Party Manufacturers The Company derives a significant portion of its revenues from the sale of products manufactured by third parties, including its competitors in some instances. There can be no assurance that the Company's dependence on third parties for the manufacture of such products will not adversely affect the Company's profit margins or its ability to develop and deliver its products on a timely and competitive basis. If for any reason the Company is unable to obtain or retain third-party manufacturers on commercially acceptable terms, it may not be able to distribute certain of its products as planned. No assurance can be made that the manufacturers utilized by the Company will be able to provide the Company with sufficient quantities of its products or that the products supplied to the Company will meet the Company's specifications. Any delays or difficulties with third-party manufacturers could adversely affect the marketing and distribution of certain of the Company's products, which could have a material adverse effect on the Company's business, financial condition and results of operations. Product Liability The Company faces exposure to product liability claims in the event that the use of its technologies or products or those it licenses from third parties is alleged to have resulted in adverse effects in users thereof. Receipt of regulatory approval for commercial sale of such products does not mitigate such product liability risks. While the Company has taken, and will continue to take, what it believes are appropriate precautions, there can be no assurance that it will avoid significant product liability exposure. In addition, future product labeling may include disclosure of additional adverse effects, precautions and contraindications, which may adversely impact sales of such products. The Company currently has product liability insurance in the amount of $10.0 million for aggregate annual claims with a $50,000 deductible per incident and a $250,000 aggregate annual deductible. However, there can be no assurance that such insurance coverage will be sufficient to fully cover potential claims. Additionally, there can be no assurance that adequate insurance coverage will be available in the future at acceptable costs, if at all, or that a product liability claim would not have a material adverse effect on the Company's business, financial condition and results of operations. Acquisition and Licensing of Pharmaceutical Products The Company may purchase or license pharmaceutical product lines of other pharmaceutical or biotechnology companies. Other companies, including those with substantially greater financial, marketing and other resources, compete with the Company for the right to acquire or license such products. Were the Company to elect to pursue this strategy, its success would depend, in part, on its ability to identify potential products that meet the Company's criteria, including possessing a recognizable brand name or being complementary to the Company's existing product lines. There can be no assurance that the Company would have success in identifying potential product acquisitions or licensing opportunities or that, if identified, it would complete such product acquisitions or obtain such licenses on acceptable terms or that it would obtain the necessary financing, or that it could successfully integrate any acquired or licensed products into its existing product lines. The inability to complete acquisitions of, or obtain licenses for, pharmaceutical products could have a material adverse effect on the Company's business, financial condition and results of operations. Furthermore, there can be no assurance that the Company, once it has obtained rights to a pharmaceutical product and committed to payment terms, will be able to generate sales sufficient to create a profit or otherwise avoid a loss. Any inability to generate such sufficient sales or any subsequent reduction of sales could have a material adverse effect on the Company's business, financial condition and result of operations. Patents and Proprietary Rights The patent position of competitors in the pharmaceutical industry generally is highly uncertain, involves complex legal and factual questions, and is the subject of much litigation. There can be no assurance that any patent applications relating to the Company's potential products or processes will result in patents being 21 issued, or that the resulting patents, if any, will provide protection against competitors who: (i) successfully challenge the Company's patents; (ii) obtain patents that may have an adverse effect on the Company's ability to conduct business; or (iii) are able to circumvent the Company's patent position. It is possible that other parties have conducted or are conducting research and could make discoveries of pharmaceutical formulations or processes that would precede any discoveries made by the Company, which could prevent the Company from obtaining patent protection for these discoveries or marketing products developed therefrom. Consequently, there can be no assurance that others will not independently develop pharmaceutical products similar to or obsoleting those that the Company is planning to develop, or duplicate any of the Company's products. The inability of the Company to obtain patents for its products and processes or the ability of competitors to circumvent or obsolete the Company's patents could have a material adverse effect on the Company's business, financial condition and results of operations. Exercise of Warrants, Conversion of Subordinated Debt, May have Dilutive Effect Under terms of a $5,000,000 subordinated debt transaction, which the Company entered into with the John N. Kapoor trust dtd. 9/20/89 (the "Trust"), the sole trustee and sole beneficiary of which is Dr. John N. Kapoor, the Company's current CEO and Chairman of the Board of Directors, the Trust agreed to provide the Company with $5,000,000 of subordinated debt in two separate tranches of $3,000,000 ("Tranche A") and $2,000,000 ("Tranche B"). In return for providing the subordinated debt, the Trust was granted Warrants to purchase 1,000,000 shares of common stock, at a purchase price of $2.85 per share for Tranche A and 667,000 shares of common stock, at a purchase price of $2.25 per share, for Tranche B. In addition, Tranche A, plus the interest on Tranche A, is convertible into common stock of the Company at a price of $2.28 per share, and Tranche B, plus the interest on Tranche B, is convertible into common stock of the Company at a price of $1.80 per share. If the price per share of the Company's common stock at the time of exercise of the Warrants or conversion of the subordinated debt is in excess of the various Warrant exercise or conversion prices, exercise of the Warrants and conversion of the subordinated debt would have a dilutive effect on the Company's common stock. The amount of such dilution, however, cannot currently be determined as it would depend on the amount disparity between the stock price and the price at which the warrants were exercised or the subordinated debt was converted at the time of exercise or conversion. Need to Attract and Retain Key Personnel in Highly Competitive Marketplace The Company's performance depends, to a large extent, on the continued service of its key research and development personnel, other technical employees, managers and sales personnel and its ability to continue to attract and retain such personnel. Competition for such personnel is intense, particularly for highly motivated and experienced research and development and other technical personnel. The Company is facing increasing competition from companies with greater financial resources for such personnel. There can be no assurance that the Company will be able to attract and retain sufficient numbers of highly-skilled personnel in the future, and the inability to do so could have a material adverse effect on the Company's business, operating results and financial condition and results of operations. Dependence on Key Executive Officers The Company's success will depend, in part, on its ability to attract and retain key executive officers. The inability to find or the loss of one or more of the Company's key executive officers could have a material adverse effect on the Company's business, financial condition and results of operations. Quarterly Fluctuation of Results; Possible Volatility of Stock Price The Company's results of operations may vary from quarter to quarter due to a variety of factors including the timing of the development and marketing of new pharmaceutical products, the failure to develop such products, delays in obtaining government approvals, including FDA approval of NDAs or ANDAs for Company products, expenditures to comply with governmental requirements for manufacturing facilities, expenditures incurred to acquire and promote pharmaceutical products, changes in the Company's customer base, a customer's termination of a substantial account, the availability and cost of raw materials, interruptions 22 in supply by third-party manufacturers, the introduction of new products or technological innovations by the Company's competitors, loss of key personnel, changes in the mix of products sold by the Company, changes in sales and marketing expenditures, competitive pricing pressures and the Company's ability to meet its financial covenants. There can be no assurance that the Company will be successful in maintaining or improving its profitability or avoiding losses in any future period. Such fluctuations may result in volatility in the price of the Company's Common Stock. Relationships with Other Entities; Conflicts of Interest Mr. John N. Kapoor, Ph.D., the Company's Chairman of the Board and Chief Executive Officer is affiliated with EJ Financial Enterprises, Inc., a health care consulting investment company ("EJ Financial"). EJ Financial is involved in the management of health care companies in various fields, and Dr. Kapoor is involved in various capacities with the management and operation of these companies. The John N. Kapoor Trust, the beneficiary and sole trustee of which is Dr. Kapoor, is a principal shareholder of each of these companies. As a result, Dr. Kapoor does not devote his full time to the business of the Company. Although such companies do not currently compete directly with the Company, certain companies with which EJ Financial is involved are in the pharmaceutical business. Discoveries made by one or more of these companies could render the Company's products less competitive or obsolete. In addition, one of these companies, NeoPharm, Inc. of which Dr. Kapoor is Chairman and a major stockholder, recently entered into a loan agreement with the Company. Further, Dr. Kapoor has loaned the Company $5,000,000 with the result that he has become a major creditor of the Company as well as a major stockholder. See "Financial Condition and Liquidity". Potential conflicts of interest could have a material adverse effect on the Company's business, financial condition and results of operations. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivatives Instruments and Hedging Activities." SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133, as amended by SFAS No. 137 and No. 138, was effective for the Company's fiscal 2001 financial statements and was adopted by the Company on January 1, 2001. Adoption of these standards did not have a material effect on the Company's financial position or results of operations. In July 2001, the FASB approved three statements, SFAS 141, "Business Combinations," SFAS 142, "Goodwill and Other Intangible Assets," and SFAS 143, "Accounting for Asset Retirement Obligations." SFAS 141 supercedes APB Opinion No. 16, "Business Combinations," and eliminates the pooling-of-interests method of accounting for business combinations, thus requiring all business combinations be accounted for using the purchase method. In addition, in applying the purchase method, SFAS 141 changes the criteria for recognizing intangible assets apart from goodwill. The following criteria is to be considered in determining the recognition of the intangible assets: (1) the intangible asset arises from contractual or other legal rights, or (2) the intangible asset is separable or dividable from the acquired entity and capable of being sold, transferred, licensed, rented, or exchanged. The requirements of SFAS 141 are effective for all business combinations completed after June 30, 2001. The adoption of this new standard did not have a material impact on the Company's financial statements. SFAS 142 supercedes APB Opinion No. 17, "Intangible Assets," and requires goodwill and other intangible assets that have an indefinite useful life to no longer be amortized; however, these assets must be reviewed at least annually for impairment. The Company has adopted SFAS 142 as of January 1, 2002. The Company is currently evaluating the impact of this new standard on the Company's financial statements. SFAS 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the 23 liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The Company has adopted SFAS 143 as of January 1, 2002. The adoption of this new standard did not have a material impact on the Company's financial statements. In August 2001, the FASB issued SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement also supercedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 is effective January 1, 2002. The adoption of this new standard did not have a material impact on the Company's financial statements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is subject to market risk associated with changes in interest rates. The Company's interest rate exposure involves three debt instruments. The credit agreement with The Northern Trust Company and the subordinated convertible debentures issued to the John N. Kapoor Trust bear the same interest rate, which fluctuates at Prime plus 300 basis points. The promissory note issued to NeoPharm, Inc. ("NeoPharm") bears interest at an initial rate of 3.6% and will be reset quarterly based upon NeoPharm's average return on its cash and readily tradable long and short-term securities during the previous calendar quarter. All of the Company's remaining long-term debt is at fixed interest rates. The Company believes that reasonably possible near-term changes in interest rates would not have a material effect on the Company's financial position, results of operations and cash flows. The Company's financial instruments consist mainly of cash, accounts receivable, accounts payable and debt. The carrying amounts of these instruments, except debt, approximate fair value due to their short-term nature. The estimated fair value of the Company's debt instruments is based upon rates currently available to the Company for debt with similar terms and remaining maturities. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following financial statements are included in Part II, Item 8 of this Form 10-K. Statement in Lieu of Independent Auditors' Report........... 25 Consolidated Balance Sheets as of December 31, 2001 and 2000...................................................... 26 Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999.......................... 27 Consolidated Statements of Shareholders' Equity for the years ended December 31, 2001, 2000 and 1999.............. 28 Consolidated Statements of Cash Flow for the years ended December 31, 2001, 2000 and 1999.......................... 29 Notes to Consolidated Financial Statements.................. 30
24 STATEMENT IN LIEU OF INDEPENDENT AUDITORS' REPORT The SEC has informed the Company of a proposed enforcement action (See "Item 3. Legal Proceedings"), which has alleged the Company's accounts receivable were overstated as of December 31, 2000. If the enforcement action is ultimately brought to bear, it is possible that the Company would have to restate its 2000 and 2001 financial statements. Because of this uncertainty, Deloitte & Touche LLP, the Company's auditors, are unwilling to give an opinion on the Company's consolidated financial statements and notes thereto for December 31, 2001 and 2000 and the years then ended until this matter is resolved, and as a result these financial statements and notes are unaudited. However, management believes that, subject to the resolution of the above-mentioned matter, the unaudited consolidated financial statements and notes to consolidated financial statements as of these dates and for these periods contain all the information and necessary adjustments for a fair presentation of these financial statements and footnotes. Because the proposed enforcement action relates to matters in a prior fiscal year, it is not anticipated that these proceedings will have any material impact on the Company's Consolidated Balance Sheet as of December 31, 2001 or on the Company's 2002 or future operating results. 25 AKORN, INC. CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT PAR VALUE DATA) (UNAUDITED)
DECEMBER 31, ------------------ 2001 2000 ------- ------- ASSETS CURRENT ASSETS Cash and cash equivalents................................. $ 5,355 $ 807 Trade accounts receivable (less allowance for uncollectibles of $3,706 and $801 at December 31, 2001 and 2000, respectively)................................ 5,902 24,144 Inventory................................................. 8,135 14,058 Deferred income taxes..................................... 2,069 2,016 Income taxes recoverable.................................. 6,540 -- Prepaid expenses and other assets......................... 579 1,098 ------- ------- TOTAL CURRENT ASSETS................................... 28,580 42,123 OTHER ASSETS Intangibles, net.......................................... 18,485 20,342 Deferred income taxes..................................... 3,765 -- Other..................................................... 113 22 ------- ------- TOTAL OTHER ASSETS..................................... 22,363 20,364 PROPERTY, PLANT AND EQUIPMENT, NET.......................... 33,518 34,031 ------- ------- TOTAL ASSETS........................................... $84,461 $96,518 ======= ======= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Current installments of long-term debt.................... $45,072 $ 7,753 Trade accounts payable.................................... 3,035 5,900 Income taxes payable...................................... -- 556 Accrued compensation...................................... 760 854 Accrued expenses and other liabilities.................... 4,070 705 ------- ------- TOTAL CURRENT LIABILITIES.............................. 52,937 15,768 Long-term debt.............................................. 8,861 39,089 Other long-term liabilities................................. 205 -- Deferred income taxes....................................... -- 1,829 ------- ------- TOTAL LIABILITIES...................................... 62,003 56,686 ======= ======= COMMITMENTS AND CONTINGENCIES (Notes C, H and N) SHAREHOLDERS' EQUITY Preferred stock, $1.00 par value -- authorized 5,000,000 shares; none issued Common stock, no par value -- authorized 40,000,000 shares; issued and outstanding 19,465,815 and 19,247,299 shares at December 31, 2001 and 2000, respectively............... 24,884 22,647 Retained (deficit) earnings............................... (2,426) 17,185 ------- ------- TOTAL SHAREHOLDERS' EQUITY............................. 22,458 39,832 ------- ------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.................. $84,461 $96,518 ======= =======
See notes to consolidated financial statements. 26 AKORN, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
YEARS ENDED DECEMBER 31, ------------------------------ 2001 2000 1999 -------- ------- ------- Revenues.................................................... $ 42,248 $66,927 $64,632 Cost of sales............................................... 35,147 38,090 31,155 -------- ------- ------- GROSS PROFIT.............................................. 7,101 28,837 33,477 Selling, general and administrative expenses................ 31,525 17,397 16,733 Amortization of intangibles................................. 1,494 1,519 1,878 Research and development expenses........................... 2,598 4,132 2,744 -------- ------- ------- 35,617 23,048 21,355 -------- ------- ------- OPERATING INCOME (LOSS)................................... (28,516) 5,789 12,122 Interest and other income (expense): Interest income........................................... -- -- 31 Interest expense.......................................... (3,547) (2,400) (1,921) (Loss) gain on sale of fixed assets....................... (78) -- 275 Other (expense) income, net............................... (84) 117 132 -------- ------- ------- (3,709) (2,283) (1,483) -------- ------- ------- INCOME (LOSS) BEFORE INCOME TAXES........................... (32,225) 3,506 10,639 Income tax (benefit) provision.............................. (12,614) 1,319 3,969 -------- ------- ------- NET INCOME (LOSS)......................................... $(19,611) $ 2,187 $ 6,670 ======== ======= ======= NET INCOME (LOSS) PER SHARE: BASIC.................................................. $ (1.01) $ 0.11 $ 0.37 ======== ======= ======= DILUTED................................................ $ (1.01) $ 0.11 $ 0.36 ======== ======= ======= WEIGHTED AVERAGE SHARES OUTSTANDING: BASIC.................................................. 19,337 19,030 18,269 ======== ======= ======= DILUTED................................................ 19,337 19,721 18,573 ======== ======= =======
See notes to consolidated financial statements. 27 AKORN, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS) (UNAUDITED)
COMMON STOCK ---------------------- RETAINED SHARES EARNINGS/ TREASURY OUTSTANDING AMOUNT (DEFICIT) STOCK TOTAL ----------- ------- --------- -------- -------- Balances at January 1, 1999................. 18,122 $17,952 $ 8,328 $ -- $ 26,280 Net income.................................. -- -- 6,670 -- 6,670 Treasury stock received in lieu of cash..... (9) -- -- (35) (35) Exercise of stock options................... 476 1,228 -- -- 1,228 Management bonus paid in stock.............. 27 109 -- -- 109 Treasury stock reissued..................... 9 (6) -- 35 29 Employee stock purchase plan................ 26 109 -- -- 109 ------ ------- -------- ---- -------- Balances at December 31, 1999............... 18,651 19,392 14,998 -- 34,390 Net income.................................. -- -- 2,187 -- 2,187 Exercise of stock options................... 576 3,105 -- -- 3,105 Employee stock purchase plan................ 20 150 -- -- 150 ------ ------- -------- ---- -------- Balances at December 31, 2000............... 19,247 22,647 17,185 -- 39,832 Net loss.................................... -- -- (19,611) -- (19,611) Warrants issued in connection with convertible debentures.................... -- 1,516 -- -- 1,516 Exercise of stock options................... 175 583 -- -- 583 Employee stock purchase plan................ 44 138 -- -- 138 ------ ------- -------- ---- -------- Balances at December 31, 2001............... 19,466 $24,884 $ (2,426) $ -- $ 22,458 ====== ======= ======== ==== ========
See notes to consolidated financial statements. 28 AKORN, INC. CONSOLIDATED STATEMENTS OF CASH FLOW (DOLLARS IN THOUSANDS) (UNAUDITED)
YEARS ENDED DECEMBER 31, ------------------------------ 2001 2000 1999 -------- -------- -------- OPERATING ACTIVITIES Net income (loss)........................................... $(19,611) $ 2,187 $ 6,670 Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities: Depreciation and amortization.......................... 4,286 3,539 3,161 Impairment of long-lived assets........................ 2,132 -- -- Loss (gain) on disposal of fixed assets................ 78 -- (245) Stock bonus............................................ -- -- 109 Deferred income taxes.................................. (5,647) (756) 763 Other.................................................. -- -- (6) Changes in operating assets and liabilities: Accounts receivable.................................. 18,242 (6,449) (6,992) Income taxes recoverable............................. (6,540) -- -- Inventory, prepaid expenses and other assets......... 6,351 2,173 (5,213) Trade accounts payable, accrued expenses and other liabilities....................................... 611 718 1,750 Income taxes payable................................. (556) (1,050) 134 -------- -------- -------- NET CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES......... (654) 362 131 INVESTING ACTIVITIES Purchases of property, plant and equipment.................. (3,626) (15,239) (6,157) Proceeds from disposal of fixed assets...................... -- -- 629 Purchase of product intangibles and product licensing fees...................................................... (500) (2,449) (705) -------- -------- -------- NET CASH USED IN INVESTING ACTIVITIES....................... (4,126) (17,688) (6,233) FINANCING ACTIVITIES Proceeds from exercise of stock options..................... 721 3,255 1,337 Repayments of long-term debt................................ (1,153) (22,206) (22,584) Proceeds from issuance of long-term debt.................... 8,034 37,100 26,800 Proceeds from issuance of stock warrants.................... 1,516 -- -- Amortization of bond discount............................... 210 -- -- Principal payments under capital lease obligations.......... -- (41) (162) -------- -------- -------- NET CASH PROVIDED BY FINANCING ACTIVITIES................... 9,328 18,108 5,391 -------- -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ 4,548 782 (711) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.............. 807 25 736 -------- -------- -------- CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 5,355 $ 807 $ 25 ======== ======== ========
See notes to consolidated financial statements. 29 AKORN, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Consolidation: The accompanying consolidated financial statements include the accounts of Akorn, Inc. and its wholly owned subsidiary, Akorn (New Jersey), Inc. (collectively, the "Company"). Intercompany transactions and balances have been eliminated in consolidation. During 2000, the Company dissolved the inactive subsidiaries Compass Vision, Inc., Spectrum Scientific Pharmaceuticals, Inc. and Walnut Pharmaceuticals, Inc. The dissolution of these subsidiaries did not have a material impact on the balances and activities of the Company. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates. Significant estimates and assumptions relate to the allowance for uncollectibles, the allowance for chargebacks and rebates, the reserve for slow-moving and obsolete inventory, the reserve for returned goods, the carrying value of intangible assets and the carrying value of deferred tax assets. Revenue Recognition: The Company recognizes sales upon the shipment of goods, provided that all obligations of the Company have been fulfilled and collection of the related receivable is probable. Provision is made at the time of sale for estimated product returns. Royalty revenue is recognized when earned and is based on net sales figures that often include deductions for costs of unsaleable returns. Cash Equivalents: The Company considers all highly liquid investments with a maturity of three months or less, when purchased, to be cash equivalents. Inventory: Inventory is stated at the lower of cost (average cost method) or market (see Note E). Provision is made for slow-moving, unsalable or obsolete items. Intangibles: Intangibles consist primarily of product licensing and other such costs that are capitalized and amortized on the straight-line method over the lives of the related license periods or the estimated life of the acquired product, which range from 17 months to 18 years. Accumulated amortization at December 31, 2001 and 2000 was $7,132,000 and $5,954,000, respectively. The Company annually assesses the impairment of intangibles based on several factors, including estimated fair market value and anticipated cash flows. Property, Plant and Equipment: Property, plant and equipment is stated at cost, less accumulated depreciation. Depreciation is provided using the straight-line method in amounts considered sufficient to amortize the cost of the assets to operations over their estimated service lives. The average estimated service lives of buildings, leasehold improvements, furniture and equipment, and automobiles are approximately 30, 10, 8, and 5 years, respectively. Allowance for Chargebacks and Rebates: The Company accrues an estimate of the difference between the gross sales price of certain products sold to wholesalers and the expected resale prices of such products under contractual arrangements with third parties, such as hospitals and group purchasing organizations at the time of sale. As part of the Company's sales terms to wholesale customers, it agrees to reimburse wholesalers for such differentials between wholesale prices and contract prices. Because this allowance relates to amounts not yet collected from the wholesalers, this allowance is recorded as a reduction of the account receivable balance. Similarly, the Company records an allowance for rebates related to contracts and other programs with wholesalers. The balance for these allowances was $4,190,000 and $3,296,000 as of December 31, 2001 and 2000, respectively. Income Taxes: The Company files a consolidated federal income tax return with its subsidiary. Deferred income taxes are provided in the financial statements to account for the tax effects of temporary differences 30 NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) resulting from reporting revenues and expenses for income tax purposes in periods different from those used for financial reporting purposes. The Company records a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized. Fair Value of Financial Instruments: The Company's financial instruments include cash, accounts receivable, accounts payable and term debt. The fair values of cash, accounts receivable and accounts payable approximate fair value because of the short maturity of these instruments. The carrying amounts of the Company's bank borrowings under its credit facility approximate fair value because the interest rates are reset periodically to reflect current market rates. Net Income Per Common Share: Basic net income per common share is based upon weighted average common shares outstanding. Diluted net income per common share is based upon the weighted average number of common shares outstanding, including the dilutive effect of stock options, warrants and convertible debt using the treasury stock method. The following table shows basic and diluted earnings per share computations for the years ended December 31, 2001, 2000 and 1999 (in thousands, except per share information):
YEARS ENDED DECEMBER 31, ------------------------------ 2001 2000 1999 -------- ------- ------- Net income (loss) per share -- basic: Net income (loss)......................................... $(19,611) $ 2,187 $ 6,670 Weighted average number of shares outstanding............. 19,337 19,030 18,269 Net income (loss) per share -- basic........................ $ (1.01) $ 0.11 $ 0.37 ======== ======= ======= Net income (loss) per share -- diluted: Net income (loss)......................................... $(19,611) $ 2,187 $ 6,670 Net income (loss) adjustment for interest on convertible debt................................................... -- -- -- -------- ------- ------- Net income (loss), as adjusted............................ $(19,611) $ 2,187 $ 6,670 ======== ======= ======= Weighted average number of shares outstanding............. 19,337 19,030 18,269 Additional shares assuming conversion of convertible debt and convertible interest on debt(1).................... -- -- -- Additional shares assuming conversion of warrants(2)...... -- -- -- Additional shares assuming conversion of options(3)....... -- 691 304 -------- ------- ------- Weighted average number of shares outstanding, as adjusted............................................... 19,337 19,721 18,573 ======== ======= ======= Net income (loss) per share -- diluted...................... $ (1.01) $ 0.11 $ 0.36 ======== ======= =======
--------------- (1) For fiscal 2001, debt and interest convertible into 2,519 shares of common stock was excluded from the computation of diluted earnings per share, as the inclusion of such shares would be antidilutive. (2) For fiscal 2001, warrants to purchase 1,667 shares of common stock were excluded from the computation of diluted earnings per share, as the inclusion of such shares would be antidilutive. (3) For fiscal 2001 and 2000, options to purchase 3,226 and 145 shares of common stock, respectively, were excluded from the computation of diluted earnings per share as the inclusion of such shares would be antidilutive. NOTE B -- NONCASH TRANSACTIONS In July 2001, the Company amended a license agreement with The Johns Hopkins University Applied Physics Laboratory (See Note C). As part of that amendment, the Company delivered research and development equipment in lieu of a $100,000 payment. The Company recorded a gain of $51,000 upon transference of the equipment. 31 NOTE B -- NONCASH TRANSACTIONS -- (CONTINUED) In August 1999, a former employee exercised options for 23,352 shares of the Company's common stock. The individual tendered approximately 8,800 shares of the Company's outstanding stock as consideration for the option exercise, which was recorded as treasury stock. The net effect of this transaction was to increase common stock and paid in capital by $35,028 and increase treasury stock by $35,028. NOTE C -- PRODUCT AND OTHER ACQUISITIONS In April 2000, the Company entered into a worldwide license agreement with The Johns Hopkins University Applied Physics Laboratory. This license provides the Company exclusive rights to two patents covering the methodology and instrumentation for a method of treating age-related macular degeneration. Upon signing the agreement, the Company made an initial payment under the agreement of $1,484,500. In July 2001, this license agreement was amended such that the Company relinquished the international rights to the two patents in exchange for a reduced financial obligation. The Company retained the exclusive rights in the U.S. Future payments of $600,000 were required under terms of the amendment. As of December 31, 2001, $300,000 remains due under the terms of the agreement and was payable on or before March 31, 2002. The Company did not make the remaining $300,000 payment on or before March 31,2002 and is currently attempting to negotiate a resolution to a dispute that has arisen over the license agreement. See Note T for further discussion. In March 1999, the Company purchased the Paredrine NDA and trade name from Pharmics for $62,500 in cash. The acquisition cost has been allocated to intangibles and will be amortized over 15 years. In February 1999, the Company paid $400,000 to Eastman Kodak to license IC Green raw material manufacturing processes. The acquisition cost has been allocated to intangibles and will be amortized over 15 years. NOTE D -- ALLOWANCE FOR UNCOLLECTIBLES The activity in the allowance for uncollectibles for the periods indicated is as follows (in thousands):
YEARS ENDED DECEMBER 31, ------------------------ 2001 2000 1999 ------- ---- ----- Balance at beginning of year................................ $ 801 $226 $ 425 Provision for bad debts..................................... 12,000 607 161 Specific reversal of doubtful account....................... -- -- (300) Accounts written off........................................ (9,095) (32) (60) ------- ---- ----- Balance at end of year...................................... $ 3,706 $801 $ 226 ======= ==== =====
NOTE E -- INVENTORY The components of inventory are as follows (in thousands):
DECEMBER 31, ----------------- 2001 2000 ------ ------- Finished goods.............................................. $2,906 $ 5,014 Work in process............................................. 1,082 3,644 Raw materials and supplies.................................. 4,147 5,400 ------ ------- $8,135 $14,058 ====== =======
Inventory at December 31, 2001 and 2000 is reported net of reserves for slow-moving, unsalable and obsolete items of $1,845,000 and $3,171,000, respectively. 32 NOTE F -- PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment consists of the following (in thousands):
DECEMBER 31, -------------------- 2001 2000 -------- -------- Land........................................................ $ 396 $ 396 Buildings and leasehold improvements........................ 8,208 8,204 Furniture and equipment..................................... 25,724 21,508 Automobiles................................................. 55 55 -------- -------- 34,383 30,163 Accumulated depreciation.................................... (16,440) (13,697) -------- -------- 17,943 16,466 Construction in progress.................................... 15,575 17,565 -------- -------- $ 33,518 $ 34,031 ======== ========
Construction in progress represents capital expenditures principally related to the Company's lyophilization project that will enable the Company to perform processes in-house, which are currently being performed by a sub-contractor. NOTE G -- FINANCING ARRANGEMENTS The Company's long-term debt consists of (in thousands):
DECEMBER 31, ------------------ 2001 2000 ------- ------- Credit Agreement with The Northern Trust Company............ $44,800 $44,400 Subordinated convertible debentures......................... 5,000 -- Mortgages payable secured by real property located in Decatur, Illinois......................................... 2,189 2,442 Promissory note to NeoPharm, Inc............................ 3,250 -- ------- ------- 55,239 46,842 Less unamortized discount on subordinated convertible debentures................................................ 1,306 -- Less current portion........................................ 45,072 7,753 ------- ------- Long-term debt.............................................. $ 8,861 $39,089 ======= =======
Maturities of debt are as follows (in thousands): Year ending December 31: 2002........................................................ 45,072 2003........................................................ 293 2004........................................................ 316 2005........................................................ 340 2006........................................................ 8,616 Thereafter.................................................. 602 ------- Total............................................. $55,239 =======
33 NOTE G -- FINANCING ARRANGEMENTS -- (CONTINUED) In December 1997, the Company entered into a $15,000,000 revolving credit agreement with The Northern Trust Company, which was increased to $25,000,000 on June 30, 1998 and to $45,000,000 on December 28, 1999. This Amended and Restated Credit Agreement (the "Credit Agreement") is secured by substantially all of the assets of the Company and its subsidiaries and contains a number or restrictive covenants. The covenants include, among other things, minimum levels of net worth, net income and monthly EBITDA and a minimum borrowing base (as defined) and a limitation on capital expenditures. There were outstanding borrowings of $44,800,000 and $44,400,000 at December 31, 2001 and 2000, respectively. The interest rate as of December 31, 2001 was 7.75%. On April 16, 2001 the revolving credit agreement was amended (the "2001 Amendment") and included, among other things, extension of the term of the agreement, establishment of a payment schedule, revision of the method by which the interest rate will be determined, and the amendment and addition of certain covenants. The 2001 Amendment also required the Company to obtain subordinated debt of $3 million by May 15, 2001 and waived certain covenant violations through March 31, 2001. The 2001 Amendment required payments throughout 2001 totaling $7.5 million, with the balance of $37.5 million due January 1, 2002. The method used to calculate interest was changed to the prime rate plus 300 basis points. Previously, the interest rate was computed at the federal funds rate or LIBOR plus an applicable percentage, depending on certain financial ratios. On July 12, 2001 the Company entered into a Forbearance Agreement (the "Agreement") with its senior lenders under which the lenders agreed to forbear from taking action against the Company to enforce their rights under the currently existing Amended and Restated Credit Agreement until January 2, 2002. As part of the Agreement, the Company acknowledged the existence of certain events of default. These events included a default on a $1.3 million principal payment, failure to timely make monthly interest payments due on May 31, 2001 and June 30, 2001 (these interest payments were subsequently made on July 27, 2001) and failure to receive $3.0 million of cash proceeds of subordinated debt by May 15, 2001 (these proceeds were subsequently received on July 13, 2001). The Company received two extensions, which extended the Agreement to February 1, 2002 and March 15, 2002, respectively. Both of these extensions carried the same reporting requirements and covenants while establishing new cash receipts covenants for the months of January and February in 2002. On April 12, 2002, in lieu of further extending the Agreement, the Company entered into an amendment to the Credit Agreement (the "2002 Amendment"), effective January 1, 2002. The 2002 Amendment included, among other things, extension of the term of the agreement, establishment of a payment schedule and the amendment and addition of certain covenants. The new covenants include minimum levels of cash receipts, limitations on capital expenditures, a $750,000 per quarter limitation on product returns and required amortization of the loan principal. The agreement also prohibits the Company from declaring any cash dividends on its common stock and identifies certain conditions in which the principal and interest on the credit agreement would become immediately due and payable. These conditions include: (a) an action by the FDA which results in a partial or total suspension of production or shipment of products, (b) failure to invite the FDA in for re-inspection of the Decatur manufacturing facilities by June 1, 2002, (c) failure to make a written response, within 10 days, to the FDA, with a copy to the lender, to any written communication received from the FDA after January 1, 2002 that raises any deficiencies, (d) imposition of fines against the Company in an aggregate amount greater than $250,000, (e) a cessation in public trading of Akorn stock other than a cessation of trading generally in the United States securities market, (f) restatement of or adjustment to the operating results of the Company in an amount greater than $27,000,000, (g) failure to enter into an engagement letter with an investment banker for the underwriting of an offering of equity securities by June 15, 2002, (h) failure to not be party to an engagement letter at any time after June 15, 2002 or (i) experience any material adverse action taken by the FDA, the SEC, the DEA or any other Governmental Authority based on an alleged failure to comply with laws or regulations. Management believes it will be able to comply with the covenants during 2002. In the event that the Company is not in compliance with the covenants during 2002 and does not negotiate amended covenants and/or obtain a waiver thereto, 34 NOTE G -- FINANCING ARRANGEMENTS -- (CONTINUED) then the debt holder, at its option, may demand immediate payment of all outstanding amounts due it. The amended credit agreement requires a minimum payment of $5.6 million, which relates to an estimated federal tax refund, with the balance of $39.2 million due June 30, 2002. The estimated $5.6 million tax refund must be remitted within three days of receipt from the Internal Revenue Service. The Company is also obligated to remit any additional federal tax refunds received above the estimated $5.6 million. The current credit facility matures on June 30, 2002. On July 12, 2001 as required under the terms of the Agreement, the Company entered into a $5,000,000 subordinated debt transaction with the John N. Kapoor Trust dtd. 9/20/89 (the "Trust"), the sole trustee and sole beneficiary of which is Dr. John N. Kapoor, the Company's current CEO and Chairman of the Board of Directors. The transaction is evidenced by a Convertible Bridge Loan and Warrant Agreement (the "Trust Agreement") in which the Trust agreed to provide two separate tranches of funding in the amounts of $3,000,000 ("Tranche A" which was received on July 13) and $2,000,000 ("Tranche B" which was received on August 16). As part of the consideration provided to the Trust for the subordinated debt, the Company issued the Trust two warrants which allow the Trust to purchase 1,000,000 shares of common stock at a price of $2.85 per share and another 667,000 shares of common stock at a price of $2.25 per share. The exercise price for each warrant represented a 25% premium over the share price at the time of the Trust's commitment to provide the subordinated debt. Under the terms of the Trust Agreement, the subordinated debt will bear interest at prime plus 3%, which is the same rate the Company pays on its senior debt. Interest will not be paid to the Trust, but will instead accrue as required by the terms of a subordination agreement which was entered into between the Trust and the Company's senior lenders. The convertible feature of the Trust Agreement, as amended, allows for conversion of the subordinated debt plus interest into common stock of the Company, at a price of $2.28 per share of common stock for Tranche A and $1.80 per share of common stock for Tranche B. The Company, in accordance with Accounting Principles Board ("APB") Opinion No. 14, recorded the subordinated debt transaction such that the convertible debt and warrants have been assigned independent values. The fair value of the warrants was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yield of 0%, (ii) expected volatility of 79%, (iii) risk free rate of 4.75%, and (iv) expected life of 5 years. As a result, the Company assigned a value of $1,516,000 to the warrants and recorded this amount as additional paid in capital. The remaining $3,484,000 was recorded as long-term debt. The resultant bond discount, equivalent to the value assigned to the warrants, will be amortized and charged to interest expense over the life of the subordinated debt. As of December 31, 2001, there was no available credit under the Amended and Restated Credit Agreement. Future working capital needs will be highly dependent upon the Company's ability to improve gross margins, control expenses and collect its past due receivables. Management believes that existing cash, cash flow from operations and the subordinated debt proceeds will be sufficient to meet the cash needs of the business for the next twelve months, but that additional funding will be needed to refund the current bank debt. If available funds, cash generated from operations and subordinated debt proceeds are insufficient to meet immediate liquidity requirements, further financing and/or reductions of existing operations will be required. There are no guarantees that such financing will be available or available on acceptable terms. Further, such additional financing may require the granting of rights, preferences or privileges senior to those rights of the common stock and existing stockholders may experience substantial dilution of their ownership interests. The Company will need to refinance or extend the maturity of the bank credit agreement, as it does not anticipate sufficient cash to make the June 30, 2002 scheduled payment. In December 2001, the Company entered into a $3,250,000 five-year loan with NeoPharm, Inc. ("NeoPharm") to fund Akorn's efforts to complete its lyophilization facility located in Decatur, Illinois. Under the terms of the Promissory Note, dated December 20, 2001, interest will accrue at the initial rate of 3.6% and will be reset quarterly based upon NeoPharm's average return on its cash and readily tradable long and short-term securities during the previous calendar quarter. The principal and accrued interest is due and 35 NOTE G -- FINANCING ARRANGEMENTS -- (CONTINUED) payable on or before maturity on December 20, 2006. The note provides that Akorn will use the proceeds of the loan solely to validate and complete the lyophilization facility located in Decatur, Illinois. The Promissory Note is subordinated to Akorn's senior debt owed to The Northern Trust Company but is senior to Akorn's subordinated debt owed to the Trust. The note was executed in conjunction with a Processing Agreement that provides NeoPharm, Inc. with the option of securing at least 15% of the capacity of Akorn's lyophilization facility each year. Dr. John N. Kapoor, the Company's chairman and chief executive officer is also chairman of NeoPharm and holds a substantial stock position in that company as well as in the Company. Commensurate with the completion of the Promissory Note between the Company and NeoPharm, the Company entered into an agreement with the Trust, which amended the Trust Agreement. The amendment extended the Trust Agreement to terminate concurrently with the Promissory Note on December 20, 2006. The amendment also made it possible for the Trust to convert the interest accrued on the $3,000,000 tranche into common stock of the Company. Previously, the Trust could only convert the interest accrued on the $2,000,000 tranche. The change related to the convertibility of the interest accrued on the $3,000,000 tranche requires that shareholder approval be received by August 31, 2002. In June 1998, the Company entered into a $3,000,000 mortgage agreement with Standard Mortgage Investors, LLC of which there were outstanding borrowings of $2,189,000 and $2,442,000 at December 31, 2001 and 2000, respectively. The principal balance is paid over 10 years, with the final payment due in June 2007. The mortgage note bears an interest rate of 7.375% and is secured by the real property located in Decatur, Illinois. The fair value of the debt obligations approximated the recorded value as of December 31, 2001. The promissory note between the Company and NeoPharm, Inc. earns interest at a rate that is lower than the Company's current borrowing rate with its senior lenders. Accordingly, the computed fair value of the debt, which the Company estimates to be approximately $2,650,000 would be lower than the current carrying value of $3,250,000. However, the Company believes that settlement at any computed fair value less than the current carrying value would not be possible nor prudent due to the nature of the agreement and the purposes for which the debt was secured. The Company is currently using the proceeds of the debt to complete the lyophilization facility at its Decatur location as well as address other necessary capital expenditures. NOTE H -- LEASING ARRANGEMENTS The Company leased certain equipment under capital leasing arrangements that expired in 2000. Property, plant and equipment includes the following amounts relating to such capital leases (in thousands):
DECEMBER 31, --------------- 2001 2000 ---- ----- Furniture and equipment..................................... $-- $ 806 Less accumulated depreciation............................... -- (806) --- ----- $-- $ -- === =====
Depreciation expense provided on these assets was $109,000 and $157,000 for the years ended December 31, 2000 and 1999, respectively. The Company leases real and personal property in the normal course of business under various operating leases, including non-cancelable and month-to-month agreements. Payments under these leases were $1,841,000, $1,159,000 and $906,000 for the years ended December 31, 2001, 2000 and 1999, respectively. 36 NOTE H -- LEASING ARRANGEMENTS -- (CONTINUED) The following is a schedule, by year, of future minimum rental payments required under non-cancelable operating leases (in thousands): Years ended December 31, 2002........................................................ $1,749 2003........................................................ 1,219 2004........................................................ 1,149 2005........................................................ 1,145 2006........................................................ 1,129 2007........................................................ 1,127 2008........................................................ 331 ------ Total Minimum Payments Required............................. $7,849 ======
The Company currently sub-lets portions of its leased space. Rental income under these sub-leases was $56,000, $227,000 and $211,000 in 2001, 2000 and 1999, respectively. NOTE I -- STOCK OPTIONS AND EMPLOYEE STOCK PURCHASE PLAN Under the 1988 Incentive Compensation Program (the "Incentive Program") any officer or key employee of the Company is eligible to receive options as designated by the Company's Board of Directors. As of December 31, 2001, 6,500,000 shares of the Company's Common Stock are reserved for issuance under the Incentive Program. The exercise price of the options granted under the Incentive Program may not be less than 50 percent of the fair market value of the shares subject to the option on the date of grant, as determined by the Board of Directors. All options granted under the Incentive Program during the years ended December 31, 2001, 2000 and 1999 have exercise prices equivalent to the market value of the Company's Common Stock on the date of grant. Options granted under the Incentive Program generally vest over a period of three years and expire within a period of five years. Under the 1991 Stock Option Plan for Directors (the "Directors' Plan") persons elected as directors of the Company are granted nonqualified options at the fair market value of the shares subject to option on the date of the grant. As of December 31, 2001, 500,000 shares of the Company's Common Stock are reserved for issuance under the Directors' Plan. Options granted under the Directors' Plan vest immediately and expire five years from the date of grant. A summary of the status of the Company's stock options as of December 31, 2001, 2000 and 1999 and changes during the years ended December 31, 2001, 2000 and 1999 is presented below (shares in thousands):
YEARS ENDED DECEMBER 31, -------------------------------------------------------------- 2001 2000 1999 ------------------ ------------------ ------------------ WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE EXERCISE EXERCISE EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE ------ -------- ------ -------- ------ -------- Outstanding at beginning of period.......... 1,827 $4.78 1,901 $3.64 1,952 $3.16 Granted..................................... 2,039 $3.05 644 $6.80 777 $4.53 Exercised................................... (175) $2.48 (576) $3.14 (478) $2.71 Expired/Canceled............................ (465) $5.40 (142) $5.30 (350) $4.19 ----- ----- ----- Outstanding at end of period................ 3,226 $3.72 1,827 $4.78 1,901 $3.64 ===== ===== ===== Options exercisable at end of period........ 1,735 $3.92 1,054 $4.08 1,088 $3.19 Options available for future grant.......... 1,660 1,234 1,736 Weighted average fair value of options granted during the period................. $2.02 $5.17 $2.37
37 NOTE I -- STOCK OPTIONS AND EMPLOYEE STOCK PURCHASE PLAN -- (CONTINUED) The fair value of each option granted during the year ended December 31, 2001 is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yield of 0%, (ii) expected volatility of 79%, (iii) risk-free interest rate of 4.4% and (iv) expected life of 5 years. The fair value of each option granted during the year ended December 31, 2000 is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yield of 0%, (ii) expected volatility of 98%, (iii) risk-free interest rate of 5.0% and (iv) expected life of 5 years. The fair value of each option granted during the year ended December 31, 1999 is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yield of 0%, (ii) expected volatility of 51%, (iii) risk-free interest rate of 6.5% and (iv) expected life of 5 years. The following table summarizes information about stock options outstanding at December 31, 2001 (shares in thousands):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------------ ---------------------------------- NUMBER NUMBER OUTSTANDING WEIGHTED AVERAGE EXERCISABLE AT DECEMBER 31, REMAINING WEIGHTED AVERAGE DECEMBER 31, WEIGHTED AVERAGE RANGE OF EXERCISE PRICES 2001 CONTRACTUAL LIFE EXERCISE PRICE 2001 EXERCISE PRICE ------------------------ -------------- ---------------- ---------------- -------------- ---------------- $1.74 -- $2.05......... 216 3.9 years $ 2.01 200 $ 2.03 $2.13 -- $2.19......... 173 0.5 years $ 2.14 173 $ 2.14 $2.25 -- $2.60......... 1,085 4.2 years $ 2.30 309 $ 2.30 $2.81 -- $2.99......... 64 2.7 years $ 2.91 38 $ 2.85 $3.00 -- $4.00......... 337 4.3 years $ 3.42 132 $ 3.56 $4.06 -- $4.82......... 367 1.9 years $ 4.19 299 $ 4.17 $5.00 -- $5.57......... 568 2.9 years $ 5.16 334 $ 5.13 $6.06 -- $6.25......... 301 3.1 years $ 6.24 173 $ 6.25 $7.71 -- $8.38......... 55 2.7 years $ 7.99 37 $ 8.10 $9.31 -- $9.50......... 50 3.3 years $ 9.46 35 $ 9.45 $10.06 -- $11.88....... 10 3.7 years $10.97 5 $10.97 ----- ----- 3,226 1,735 ===== =====
The Company applies APB Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock option plans. Had compensation cost for the Company's stock-based compensation plans been determined based on Statement of Financial Accounting Standards ("SFAS") No. 123, the Company's net income and net income per share for the years ended December 31, 2001, 2000 and 1999 would have been the pro forma amounts indicated below (in thousands, except per share amounts):
YEARS ENDED DECEMBER 31, ----------------------------------------------------------------------- 2001 2000 1999 --------------------- --------------------- --------------------- AS AS AS REPORTED PRO FORMA REPORTED PRO FORMA REPORTED PRO FORMA -------- --------- -------- --------- -------- --------- Net income (loss)................... $(19,611) $(21,365) $2,187 $ 421 $6,670 $5,939 ======== ======== ====== ===== ====== ====== Net income (loss) per share -- diluted.................. $ (1.01) $ (1.10) $ 0.11 $0.02 $ 0.36 $ 0.32 ======== ======== ====== ===== ====== ======
The Akorn, Inc. Employee Stock Purchase Plan permits eligible employees to acquire shares of the Company's common stock through payroll deductions not exceeding 15% of base wages, at a 15% discount from market price. A maximum of 1,000,000 shares of the Company's common stock may be acquired under the terms of the Plan. Purchases of shares issued from treasury stock approximated 7,000 shares during the year ended December 31, 1999. New shares issued under the plan approximated 44,000 in 2001, 20,000 in 2000, and 26,000 in 1999. 38 NOTE J -- INCOME TAXES The income tax provision (benefit) consisted of the following (in thousands):
CURRENT DEFERRED TOTAL ------- -------- -------- Year ended December 31, 2001: Federal.................................................. $(3,639) $(6,303) $ (9,942) State.................................................... (253) (2,419) (2,672) ------- ------- -------- $(3,891) $(8,722) $(12,614) ======= ======= ======== Year ended December 31, 2000: Federal.................................................. $ 1,680 $ (629) $ 1,051 State.................................................... 395 (127) 268 ------- ------- -------- $ 2,075 $ (756) $ 1,319 ======= ======= ======== Year ended December 31, 1999: Federal.................................................. $ 2,561 $ 636 $ 3,197 State.................................................... 645 127 772 ------- ------- -------- $ 3,206 $ 763 $ 3,969 ======= ======= ========
Income tax expense (benefit) differs from the "expected" tax expense (benefit) computed by applying the U.S. Federal corporate income tax rate of 34% to income before income taxes as follows (in thousands):
YEARS ENDED DECEMBER 31, ---------------------------- 2001 2000 1999 -------- ------ ------ Computed "expected" tax expense (benefit)................... $(10,956) $1,192 $3,618 Change in income taxes resulting from: State income taxes, net of federal income tax benefits.... (1,597) 177 510 Other, net................................................ (61) (50) (159) -------- ------ ------ Income tax expense (benefit)................................ $(12,614) $1,319 $3,969 ======== ====== ======
Deferred tax assets (liabilities) at December 31, 2001 and 2000 include (in thousands):
DECEMBER 31, DECEMBER 31, 2001 2000 ------------ ------------ Other accrued expenses...................................... $ 2,537 $ 1,688 Intangible assets, net...................................... 510 545 Property, plant and equipment, net.......................... (2,593) (2,332) Net operating loss carry forwards........................... 5,052 -- Other, net.................................................. 328 286 ------- ------- $ 5,834 $ 187 ======= =======
The deferred taxes are classified in the accompanying balance sheets as follows (in thousands):
DECEMBER 31, DECEMBER 31, 2001 2000 ------------ ------------ Deferred tax asset -- current............................... $2,069 $ 2,016 Deferred tax asset (liability) -- noncurrent................ 3,765 (1,829) ------ ------- $5,834 $ 187 ====== =======
Management concluded that it was more likely than not that all of the net deferred tax assets will be realized through future taxable earnings. Accordingly, no valuation allowance is recorded. 39 NOTE K -- CHANGES IN ACCOUNTING ESTIMATES The Company accrues an estimate of the difference between the gross sales price of certain products sold to wholesalers and the expected resale prices of such products under contractual arrangements with third parties such as hospitals and group purchasing organizations at the time of sale to the wholesaler. Similarly, the Company records an allowance for rebates related to contracts and other programs with wholesalers. These allowances are reflected as a reduction of account receivable balances. The Company evaluates the allowance balances against actual chargebacks and rebates processed by wholesalers. Actual chargebacks and rebates processed can vary materially from period to period. The Company has an increasing number of contracts and other programs with wholesalers, each incorporating various numbers and types of chargebacks and rebates. The recorded allowance amount reflects the Company's current estimate of the chargeback and rebate amounts wholesalers have earned under these various contracts and programs. In May 2001, the Company completed an analysis of its March 31, 2001 allowance for chargebacks and rebates and determined that an increase from the allowance of $3,296,000 at December 31, 2000 was necessary. In performing such analysis, the Company utilized recently obtained reports of wholesaler's inventory information, which had not been previously obtained or utilized. Based on the wholesaler's March 31, 2001 inventories and historical chargeback and rebate activity, the Company recorded an allowance of $6,961,000, which resulted in an expense of $12,000,000 for the three months ended March 31, 2001. During the quarter ended June 30, 2001, the Company further refined its estimates of the chargeback and rebate liability determining that an additional $2,250,000 provision needed to be recorded. This additional increase to the allowance was necessary to reflect the continuing shift of sales to customers who purchase their products through group purchasing organizations and buying groups. The Company had previously seen a much greater level of list price business than is occurring in the current business environment. The Company records an allowance for estimated product returns. This allowance is reflected as a reduction of account receivable balances. The Company evaluates the allowance balance against actual returns processed. Actual returns processed can vary materially from period to period. Based on the wholesaler's inventory information, the Company increased its allowance for potential product returns to $2,232,000 at March 31, 2001 from $232,000 at December 31, 2000. The provision for the three months ended March 31, 2001 was $2,559,000. The allowance for potential product returns was $548,000 at December 31, 2001. The Company records an allowance for doubtful accounts, which reflects trade receivable balances owed to the Company that are believed to be uncollectible. This allowance is reflected as a reduction of account receivable balances. The expense related to doubtful accounts is reflected in SG&A expenses. Based upon its recent unsuccessful efforts to collect past due balances, the Company updated its analysis of potentially uncollectible trade receivable balances and recorded a total bad debt provision for the year of $12,000,000. The Company recorded $7,520,000 and $4,610,00 in the first and second quarter of 2001, respectively and reduced the allowance $130,000 in the fourth quarter of 2001. As a result, and after the effect of balances written off, the allowance for doubtful accounts increased to $3,706,000 at December 31, 2001 from $801,000 at December 31, 2000. The Company records an allowance for discounts and allowances, which reflects discounts and allowances available to certain customers based on agreed upon terms of sale. This allowance is reflected as a reduction of account receivable balances. The Company evaluates the allowance balance against actual discounts taken. The Company records an estimate for slow-moving and obsolete inventory based upon recent historical sales by unit. The Company evaluates the potential sales of its products over their remaining lives and estimates the amount that may expire before being sold. In the fourth quarter of 2000, the Company increased this reserve by $2,700,000 to account for slow moving and obsolete inventory primarily related to products purchased from third parties in 1998 and 1999 for which the original sales forecast overestimated actual demand. 40 NOTE K -- CHANGES IN ACCOUNTING ESTIMATES -- (CONTINUED) In the first quarter of 2001, based on sales trends and forecasted sales activity by product, the Company increased its allowance for inventory obsolescence to $4,583,000. The provision for the three months ended March 31, 2001 was $1,500,000. The allowance for inventory obsolescence was $1,845,000 at December 31, 2001. All other increases to the allowances for chargebacks and rebates, returns, doubtful accounts, discounts and allowances and inventory obsolescence occurred as part of the normal recording of product sales. NOTE L -- RETIREMENT PLAN All employees who have attained the age of 21 are eligible for participation in the Company's 401(k) Plan. The plan-related expense recognized for the years ended December 31, 2001, 2000 and 1999 totaled $234,000, $285,000 and $220,000, respectively. The employer's matching contribution is a percentage of the amount contributed by each employee and is funded on a current basis. NOTE M -- INDUSTRY SEGMENT INFORMATION The Company classifies its operations into three business segments, ophthalmic, injectable and contract services. The ophthalmic segment manufactures, markets and distributes diagnostic and therapeutic pharmaceuticals and surgical instruments and related supplies. The injectable segment manufactures, markets and distributes injectable pharmaceuticals, primarily in niche markets. Selected financial information by industry segment is presented below (in thousands):
YEARS ENDED DECEMBER 31, ------------------------------ 2001 2000 1999 -------- ------- ------- Revenues Ophthalmic.................................................. $ 17,443 $28,221 $32,467 Injectable.................................................. 9,859 25,196 22,736 Contract services........................................... 14,946 13,510 9,429 -------- ------- ------- Total revenues....................................... $ 42,248 $66,927 $64,632 ======== ======= ======= Gross profit Ophthalmic.................................................. $ (245) $ 9,251 $16,873 Injectable.................................................. 2,936 16,287 13,346 Contract services........................................... 4,410 3,299 3,258 -------- ------- ------- Total gross profit................................... 7,101 28,837 33,477 Operating expenses.......................................... 35,617 23,048 21,355 -------- ------- ------- Total operating income (loss)........................ (28,516) 5,789 12,122 Interest and other (expense), net........................... (3,709) (2,283) (1,483) -------- ------- ------- Income (loss) before income taxes........................... $(32,225) $ 3,506 $10,639 ======== ======= =======
The Company does not identify assets by segment for internal purposes. NOTE N -- COMMITMENTS AND CONTINGENCIES The Company is a party in legal proceedings and potential claims arising in the ordinary course of its business. See Note G -- Financing Arrangements and Note T -- Subsequent Events. Despite the inherent uncertainties of litigation, management of the Company at this time does not believe that such proceedings will have a material adverse impact on the consolidated financial position, results of operations, or cash flows of the Company. 41 NOTE O -- SUPPLEMENTAL CASH FLOW INFORMATION (IN THOUSANDS)
YEARS ENDED DECEMBER 31, -------------------------- 2001 2000 1999 ------ ------ ------ Interest and taxes paid: Interest (net of amounts capitalized)..................... $3,308 $2,596 $1,245 Income taxes.............................................. 38 1,625 2,860 Noncash investing and financing activities: Treasury stock received for exercise of stock options..... -- -- 35 Intangible asset received in exchange for research equipment.............................................. 100 -- --
NOTE P -- RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivatives Instruments and Hedging Activities." SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. SFAS No. 133, as amended by SFAS No. 137 and No. 138, was effective for the Company's fiscal 2001 financial statements and was adopted by the Company on January 1, 2001. Adoption of these standards did not have a material effect on the Company's financial position or results of operations. In July 2001, the FASB approved three statements, SFAS 141, "Business Combinations," SFAS 142, "Goodwill and Other Intangible Assets," and SFAS 143, "Accounting for Asset Retirement Obligations." SFAS 141 supercedes APB Opinion No. 16, "Business Combinations," and eliminates the pooling-of-interests method of accounting for business combinations, thus requiring all business combinations be accounted for using the purchase method. In addition, in applying the purchase method, SFAS 141 changes the criteria for recognizing intangible assets apart from goodwill. The following criteria is to be considered in determining the recognition of the intangible assets: (1) the intangible asset arises from contractual or other legal rights, or (2) the intangible asset is separable or dividable from the acquired entity and capable of being sold, transferred, licensed, rented, or exchanged. The requirements of SFAS 141 are effective for all business combinations completed after June 30, 2001. The adoption of this new standard did not have a material impact on the Company's financial statements. SFAS 142 supercedes APB Opinion No. 17, "Intangible Assets," and requires goodwill and other intangible assets that have an indefinite useful life to no longer be amortized; however, these assets must be reviewed at least annually for impairment. The Company has adopted SFAS 142 as of January 1, 2002. The Company is currently evaluating the impact of this new standard on the Company's financial statements. SFAS 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The Company has adopted SFAS 143 as of January 1, 2002. The adoption of this new standard did not have a material impact on the Company's financial statements. In August 2001 the FASB issued SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." This statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supercedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." This statement also supercedes the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations -- Reporting the Effects of Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for the disposal of a segment of a business (as previously defined in that Opinion). SFAS No. 144 is effective January 1, 2002. The adoption of this new standard did not have a material impact on the Company's financial statements. 42 NOTE Q -- CUSTOMER CONCENTRATION No single customer accounted for more than 10% of the Company's revenues during 2001 or 1999. During 2000, the Company realized approximately 12% of its revenues from one customer. This customer is a distributor of the Company's products as well as a distributor of a broad range of health care products for many companies in the health care sector. This customer is not the end user of the Company's products. If sales to this customer were to diminish or cease, the Company believes that the end users of its products would find no difficulty obtaining the Company's products either directly from the Company or from another distributor. The account receivable balance for this customer was approximately 22% of gross trade receivables at December 31, 2000. NOTE R -- DISCONTINUED PRODUCTS In May 2001, the Company decided to no longer sell one of its products due to uncertainty of product availability from a third-party manufacturer, rising manufacturing costs and delays in obtaining FDA approval to manufacture the product in-house. The Company recorded an asset impairment charge of $1,170,000 related to manufacturing equipment specific to the product and an asset impairment charge of $140,000 related to the remaining balance of the product acquisition intangible asset during the first quarter of 2001. In November 2001, the Company decided to no longer sell one of its products due to unavailability of raw material at a competitive price and declining market share. The Company recorded an asset impairment charge of $725,000 related to the remaining balance of the product acquisition intangible asset during the fourth quarter of 2001. NOTE S -- RESTRUCTURING CHARGES During 2001, the Company adopted a restructuring program with aggressive actions to properly size its operations to current business conditions. These actions were designed to reduce costs and improve operating efficiencies. The program included, among other items, severance of employees, plant-closing costs related to the Company's San Clemente, CA sales office and rent for unused facilities under lease in San Clemente and Lincolnshire, IL. The restructuring, affecting all three business segments, reduced the Company's workforce by 50 employees, representing 12.5% of the total workforce. Activities previously executed in San Clemente have been relocated to the Company's headquarters. The restructuring program costs are included in selling, general and administrative expenses in the accompanying consolidated statement of income and resulted in a charge to operations of approximately $1,117,000 consisting of severance costs of $398,000, lease costs of $625,000 and other costs of $94,000. At December 31, 2001, the amount remaining in the accruals for the restructuring program was approximately $528,000. Approximately $315,000 of the restructuring accrual will be paid by June 30, 2002 and the remainder will be paid over the lease term, which expires in April 2003. NOTE T -- SUBSEQUENT EVENTS On January 25, 2002, the Company and Novadaq Technologies, Inc. ("Novadaq") reached a settlement of a dispute involving the two companies. Under terms of a revised agreement, Novadaq will assume all costs associated with development of certain devices and procedures for use in fluorescene angiography. The Company, in consideration of foregoing any share of future net profits, will obtain an equity ownership interest in Novadaq and the right to be the exclusive supplier of ICG for use in Novadaq's diagnostic procedures. In addition, Antonio R. Pera, Akorn's President and Chief Operating Officer, was named to Novadaq's Board of Directors. In conjunction with the revised agreement, Novadaq and the Company have agreed to withdraw from arbitration proceedings that were currently in process at the time. On March 21, the Company announced that it had been notified by the U.S. Patent and trademark Office that U.S. patent number 6,352,663 titled Methods for diagnosing and treating abnormal vasculature using fluorescent dye angiography and dye enhanced photocoagulation had been issued to the Company. This was one of the three U.S. patents on file as of December 31, 2001. 43 NOTE T -- SUBSEQUENT EVENTS -- (CONTINUED) After the close of business on March 27, 2002, the Company received a letter informing it that the staff of the Securities and Exchange Commission's regional office in Denver, Colorado, plans to recommend to the Commission that it bring an enforcement action for injunctive relief against the Company. Based on the letter, the Company believes the recommended action would concern the Company's alleged misstatement, in quarterly and annual Securities and Exchange Commission filing and earnings press releases, of its income for fiscal year 2000 by allegedly failing to reserve for doubtful accounts receivable and overstating its accounts receivable balance. The Company has also learned that certain of its former officers, as well as a current employee have received similar notifications. The Company disagrees with the staff's proposed recommendation and allegations; it has been invited to submit its views as to why an enforcement action should not be brought, and intends to do so. Because the proposed enforcement action relates to matters in a prior fiscal year, it is not anticipated that these proceedings will have any material impact on the Company's Consolidated Balance Sheet as of December 31, 2001 or on the Company's 2002 or future operating results. The Company is party to a License Agreement with The Johns Hopkins University, Applied Physics Laboratory ("JHU/APL") effective April 26, 2000, and amended effective July 15, 2001 (See Note C). Pursuant to the License Agreement, the Company licensed two patents from JHU/APL for the development and commercialization of a diagnosis and treatment for age-related macular degeneration ("AMD") using Indocyanine Green ("ICG"). A dispute has arisen between the Company and JHU/APL concerning the License Agreement. Specifically, JHU/APL has challenged the Company's performance under the License Agreement and alleged that the Company is in breach of the License Agreement. The Company's has denied JHU/APL's allegations and contends that it has performed in accordance with the terms of the License Agreement. As a result of the dispute, on March 29, 2002, the Company commenced a lawsuit in the U.S. District Court for the Northern District of Illinois, seeking declaratory and other relief against JHU/APL. On Monday, April 1, 2002, the Company and JHU/APL agreed, through counsel, to attempt to negotiate a resolution to the present dispute. If negotiations prove unsuccessful, the Company and JHU/APL will seek to mediate the dispute. Failing that, the litigation would proceed forward. The Company has an intangible asset valued at $2,084,500 recorded as a result of the License Agreement, as amended. Unsuccessful resolution of the dispute could result in a revaluation of this intangible asset. On March 6, 2002, the Company received a letter from the United States Attorney's Office, Central District of Illinois, Springfield, Illinois, advising the Company that the United States Drug Enforcement Administration had referred a matter to that office for a possible civil legal action for alleged violations of the Comprehensive Drug Abuse Prevention Control Act of 1970, 21 U.S.C. sec. 801, et. seq. and regulations promulgated under the Act. The Company is cooperating fully with the government and anticipates that any action under this matter will not have a material impact on its financial statements. 44 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth the directors and executive officers of the Company as of March 15, 2002. Each officer serves as such at the pleasure of the Board of Directors.
NAME AGE POSITION WITH THE COMPANY ---- --- ------------------------- John N. Kapoor, Ph.D. ........ 58 Chief Executive Officer, Director, Chairman of the Board Antonio R. Pera............... 44 President, Chief Operating Officer and Director Ben J. Pothast................ 40 Vice President, Chief Financial Officer, Secretary and Treasurer Daniel E. Bruhl, M.D. ........ 59 Director Doyle S. Gaw.................. 70 Director Jerry N. Ellis................ 64 Director
Dr. Bruhl, Mr. Gaw and Mr. Ellis comprise Akorn's audit committee and Dr. Bruhl and Mr. Gaw comprise Akorn's compensation committee. John N. Kapoor, Ph.D. Dr. Kapoor has served as Chief Executive Officer of the Company since March 2001. Dr. Kapoor has served as Chairman of the Board of the Company since May 1995 and from December 1991 to January 1993. Dr. Kapoor also served as acting Chairman of the Board of the Company from April 1993 to May 1995 and Chief Executive Officer of the Company from May 1996 to November 1998. Dr. Kapoor serves as Chairman of the Board of Option Care, Inc. (an infusion services and supplies company) and was Chief Executive Officer of Option Care, Inc. from August 1993 to April 1996. Dr. Kapoor is the president of E.J. Financial Enterprises, Inc., (a health care consulting and investment company) and has served as Chairman of the Board of NeoPharm, Inc. (a specialty pharmaceutical company) since July 1990. Dr. Kapoor is a director of First Horizon Pharmaceutical Corporation (a distributor of pharmaceuticals) and of Introgen Therapeutics, Inc. (a gene therapy company). Antonia R. Pera. Mr. Pera has served as President and Chief Operating Officer of the Company since June 2001. Mr. Pera is also a director of the Company. From September 1992 to June 2001, he was Vice President and General Manager of the Bedford Laboratories Division of Ben Venue Laboratories, Inc. (a manufacturer of injectable drugs), and a subsidiary of Boehringer-Ingelheim Corporation. Mr. Pera held various positions from March 1989 through September 1992 with Anaquest (Ohmeda, Inc.) (a manufacturer of inhalation anesthetics). From July 1985 to March 1989, Mr. Pera held several positions with Lyphomed, Inc. (a parenteral products and injectable drug manufacturer) including two years as General Manager of the AccuPharma Division of that Company. Mr. Pera is also a director of Novadaq Technologies, Inc., a privately held research company. Ben J. Pothast. Mr. Pothast has served as Vice President, Chief Financial Officer, Secretary and Treasurer of the Company since September 2001. From 1998 to 2001, he was Director of Financial Planning and Analysis of Moore North America (a business form printing company). From 1995 to 1998, Mr. Pothast was Director of Business Planning and Corporate Finance of GATX Corporation (a transportation and logistics company). From 1990 to 1995, he was Manager of Financial Reporting and Analysis for The Perseco Company (a packaging and logistics company). Mr. Pothast began his career at the public accounting firm of Ernst & Young. Daniel E. Bruhl, M.D. Dr. Bruhl has served as a Director of the Company since 1983. Dr. Bruhl is an ophthalmologist, President of the Surgery Center of Fort Worth and a director of Medsynergies, Inc., (private 45 ophthalmology practice management company). Dr. Bruhl was a director of Surgical Care Affiliates (outpatient surgery center company) from 1983 to 1996, when it merged with Healthsouth Corporation. Doyle S. Gaw. Mr. Gaw has served as a Director of the Company since 1975. Mr. Gaw is a private investor. Jerry N. Ellis. Mr. Ellis has served as a Director of the Company since 2001. Mr. Ellis is an Adjunct Professor in the Department of Accounting at The University of Iowa. Mr. Ellis was a consultant to Arthur Andersen, LLP from 1994 to 2000 and a Partner at Arthur Andersen in the Dallas, Madrid and Chicago offices from 1973 to 1994. Mr. Ellis is a director of First Horizon Pharmaceutical Corporation (a distributor of pharmaceuticals). SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE During 2001, Mr. Pothast, an officer of the Company, failed to file timely with the Securities and Exchange Commission one Form 3 to report initial holdings. During 2001, Mr. Gaw, Dr. Bruhl, Dr. Kapoor and Mr. Ellis, all directors of the Company, failed to file timely with the Securities and Exchange Commission one Form 4 to report current transactions, as required by Section 16(a) of the Securities Exchange Act of 1934. All such transactions have been reported on amended statements or annual statements on Form 5. ITEM 11. EXECUTIVE COMPENSATION The following table summarizes the compensation paid by the Company for services rendered during the years ended December 31, 2001, 2000 and 1999 to each person who, during 2001, served as the chief executive officer of the Company and to each other executive officer of the Company whose total annual salary and bonus for 2001 exceeded $100,000 (each a "Named Executive Officer"). SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ------------ ANNUAL COMPENSATION SECURITIES ---------------------------------------------------- UNDERLYING ALL OTHER(1) NAME AND PRINCIPAL TIME PERIOD SALARY BONUS(2) OPTIONS/SARS COMPENSATION ------------------ ---------------------------- -------- -------- ------------ ------------ John N. Kapoor(3).... Year ended December 31, 2001 $ 2,083 -- 500,000 $ -- Chief Executive Year ended December 31, 2000 50,000 -- 5,000 -- Officer Year ended December 31, 1999 47,917 -- 5,000 -- Antonio R. Pera(4)... Year ended December 31, 2001 145,176 -- 500,000 11,486 President and Chief Year ended December 31, 2000 -- -- -- -- Operating Officer Year ended December 31, 1999 -- -- -- -- Floyd Benjamin(5).... Year ended December 31, 2001 123,477 -- 70,000 12,591 Year ended December 31, 2000 274,205 -- 105,000 38,826 Year ended December 31, 1999 246,184 137,116 305,000 11,700 Harold Koch Jr.(6)... Year ended December 31, 2001 56,874 -- 25,000 113,203 Year ended December 31, 2000 158,617 -- 40,000 11,600 Year ended December 31, 1999 147,928 36,540 10,000 11,600 Rita J. McConville(7)...... Year ended December 31, 2001 89,162 -- 30,000 56,763 Year ended December 31, 2000 151,716 -- 55,000 3,500 Year ended December 31, 1999 138,600 33,301 30,000 3,333
--------------- (1) Represents contributions to the Company's Savings and Retirement Plan, except as indicated in notes (4), (5), (6) and (7). (2) Represents bonuses awarded for 1998 and 1999 performance paid in 1999 and 2000, except for Mr. Benjamin, whose 1998 bonus was paid partially in 1998 and partially in 1999 ($55,916). There were no executive officer bonuses awarded for 2000 or 2001. (3) Dr. Kapoor receives $50,000 annually for his services as Chairman. Amounts due Dr. Kapoor for 2001 were not paid as agreed upon between the Company, Dr. Kapoor and the Company's senior lender. 46 (4) Mr. Pera became President and COO of the Company on June 4, 2001. His "Other Compensation" for 2001 includes $7,000 for auto allowance and $4,486 for Company sponsored life insurance. (5) Mr. Benjamin served as Chief Executive Officer from May 3, 1996 to March 21, 2001. His "Other Compensation" for 2001 includes $4,000 for auto allowance, $5,539 for country club membership and $763 for spousal travel. His "Other Compensation" for 2000 and 1999 includes $9,600 auto allowance. His "Other Compensation" for 2000 includes $23,372 for country club membership and $4,104 for spousal travel. Mr. Benjamin's employment with the Company terminated May 30, 2001. (6) Mr. Koch served as an officer of the Company from May 12, 2000 to April 13, 2001. His "Other Compensation" includes $111,177 severance in 2001, $923 auto allowance in 2001 and $7,200 auto allowance for 2000 and 1999. Mr. Koch's employment with the Company terminated April 13, 2001. (7) Ms. McConville served as Chief Financial Officer from February 28, 1997 to March 21, 2001. Her "Other Compensation" includes $54,686 severance in 2001. Ms. McConville's employment with the Company terminated July 13, 2001. OPTION/SAR GRANTS IN LAST FISCAL YEAR The following table sets forth certain information with respect to stock options granted to each of the Named Executive Officers in the fiscal year ended December 31, 2001, including the potential realizable value over the five-year term of the options, based on assumed rates of stock appreciation of 5% and 10%, compounded annually. These assumed rates of appreciation comply with the rules of the Securities and Exchange Commission and do not represents Akorn's estimate of future stock price. Actual gains, if any, on stock option exercises will be dependent on the future performance of Akorn's common stock.
INDIVIDUAL GRANTS POTENTIAL REALIZABLE -------------------------------- VALUE AT ASSUMED NUMBER OF PERCENT OF TOTAL ANNUAL RATES OF STOCK SECURITIES OPTIONS/SARS EXERCISE PRICE APPRECIATION FOR UNDERLYING GRANTED TO OR BASE OPTION TERM OPTIONS/SARS EMPLOYEES IN PRICE EXPIRATION ---------------------- NAME GRANTED (#) FISCAL YEAR ($/SH) DATE 5%($) 10%($) ---- ------------ ---------------- -------- ---------- --------- --------- John N. Kapoor.............. 500,000(1) 25% $2.25 3/29/06 $310,817 $686,824 Antonio R. Pera............. 500,000(1) 25% 2.33 6/4/06 321,868 711,244 Floyd Benjamin.............. 60,000(1) 3% 5.31 2/1/06 88,023 194,508 10,000(2) NM 1.74 5/16/06 4,807 10,623 Harold Koch Jr.............. 25,000(1) 1% 5.31 2/1/06 36,676 81,045 Rita J. McConville.......... 25,000(1) 1% 5.31 2/1/06 36,676 81,045 5,000(2) NM 1.74 5/16/06 2,404 5,311
--------------- NM -- Not Meaningful (1) Issued pursuant to the Amended and Restated 1988 Incentive Compensation Program. (2) Issued pursuant to the Amended and Restated 1988 Incentive Compensation Program as part of the Company salary reduction program. 47 AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION/SAR VALUES
NUMBER OF VALUE OF SECURITIES UNDERLYING UNEXERCISED UNEXERCISED IN-THE-MONEY OPTIONS/SARS OPTIONS/SARS AT AT FY-END(#) FY-END($)(1) SHARES --------------------- --------------- ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/ NAME EXERCISE(#) REALIZED($) UNEXERCISABLE UNEXERCISABLE ---- ----------- ----------- --------------------- -------------------- John N. Kapoor................. -- -- 263,438/375,000 475,698/843,750 Antonio R. Pera................ -- -- 125,000/375,000 291,250/873,750 Floyd Benjamin................. -- -- 430,000/175,000 126,600/8,700 Harold Koch Jr................. -- -- 37,500/40,000 21,875/-- Rita J. McConville (2)......... 45,000 49,790 86,250/-- --/--
--------------- (1) Value of Unexercised in-the-Money options calculated using the 12/31/01 closing price of $4.00. (2) Ms. McConville's exercises were executed after termination of her employment with the Company. EMPLOYMENT AGREEMENTS In May 1996 the Company entered into an employment agreement with Mr. Benjamin pursuant to which Mr. Benjamin agreed to serve as Executive Vice President of the Company and President of Taylor Pharmaceuticals Inc. (a subsidiary of the Company) for an annual salary of $200,000, increased annually at the discretion of the Board of Directors, plus bonuses determined by a formula stated in the agreement. The agreement terminated January 1, 1999 upon Mr. Benjamin's appointment as President and CEO of Akorn, Inc. In May 2001 the Company entered into an employment agreement with Mr. Pera pursuant to which Mr. Pera serves as President and Chief Operating Officer of the Company. The employment agreement provides for an annual salary of $260,000, increased annually at the discretion of the Board of Directors, plus bonuses determined by a formula stated in the agreement. In addition, the employment agreement contains restrictive covenants concerning the use of confidential information, non-competition and non-solicitation of the Company's employees, both during the term of and after termination of Mr. Pera's employment with the Company. COMPENSATION COMMITTEE INTERLOCKS Dr. Bruhl and Mr. Gaw, who currently comprise the Compensation Committee, are each independent, non-employee directors of the Company. No executive officer of the Company served as a director or member of the compensation committee of (i) another entity in which one of the executive officers of such entity served on the Company's Compensation Committee, (ii) the board of directors of another entity in which one of the executive officers of such entity served on the Company's Compensation Committee, or (iii) the compensation committee of any other entity in which one of the executive officers of such entity served as a member of the Company's Board of Directors, during the year ended December 31, 2001. COMPENSATION OF DIRECTORS For services as Chairman of the Board and as a consultant to the Company, Dr. Kapoor receives a fee of $50,000 per year. Each other director who is not a salaried officer or consultant of the Company receives a fee for his services as a director of $1,000 per regular meeting of the Board of Directors, $500 per telephone meeting and $500 per committee meeting, plus reimbursement of his expenses related to those services. All directors of the Company participate in the Company's Stock Option Plan for Directors, pursuant to which each director of the Company is granted an option to acquire 5,000 shares of Company common stock on the day after each annual meeting of shareholders at which he is elected to serve as a director. Any director appointed between annual meetings is entitled to receive a pro rata portion of an option to acquire 48 5,000 shares. The Compensation Committee may, in its sole discretion, grant an option to purchase up to 100,000 shares to a person who is not already a director and who becomes a director at any time; no member of the Compensation Committee is eligible to be granted such an option and any director who has been granted such an option is not permitted to serve on the Compensation Committee for one year after such grant. Options granted under the plan vest immediately and expire five years from the date of grant. Upon joining the Board in 2001, Mr. Ellis was granted an option under the plan for 20,000 shares. The option exercise price for all options granted under the plan is the fair market value of the shares covered by the option at the time of the grant. COMPENSATION COMMITTEE REPORT The Compensation Committee of the Board of Directors reviews, analyzes and makes recommendations related to compensation packages for the Company's executive officers, evaluates the performance of the Chief Executive Officer and the Chief Operating Officer and administers the grant of stock options under the Company's Incentive Compensation Program. The Company's executive compensation policies are designed to (a) provide competitive levels of compensation to attract and retain qualified executives, (b) reward achievements in corporate performance, (c) integrate pay with annual and long-term performance goals and (d) align the interests of executives with the goals of shareholders. Compensation paid to Company executives consists of salaries, annual cash incentive bonuses and long-term incentive opportunities in the form of stock options. Salary Mr. Pera's salary for 2001 was fixed in his employment agreement. Mr. Benjamin's salary for the years ended December 31, 2000 and 1999 and the salary of Ms. McConville for the year ended December 31, 1999 were determined after considering the executive compensation policies noted above, the impact the executive has on the Company, the skills and experience the executive brings to the job, competition in the marketplace for those skills and the potential of the executive in the job. Ms. McConville's salary for 2000 and 2001 and Mr. Koch's salary for 1999, 2000 and 2001 was determined by the Chief Executive Officer. Mr. Benjamin's salary through 1998 was fixed in his employment agreement. Incentive Bonus Annual incentive compensation for executive officers during 2001, 2000 and 1999 was based on corporate earnings objectives as well as position-specific performance objectives. Mr. Pera's employment agreement specified the formula under which he was to be awarded incentive bonuses. Mr. Benjamin's employment agreement also specified the formula under which he was to be awarded incentive bonuses. Under those criteria, Mr. Benjamin did earn a bonus for 1998. Mr. Benjamin's 1998 bonus was paid partially in 1998 and partially in 1999. The bonuses awarded to Ms. McConville and Mr. Koch, as noted in the compensation table for 1998 and 1999, and to Mr. Benjamin for 1999, were paid in 1999 and 2000, respectively. There were no performance bonuses granted to executive officers for 2000 or 2001. Stock Options The Committee's practice with respect to stock options has been to grant options based upon the attainment of Company performance goals and to vest options based on the passage of time. The option grants noted in the compensation tables include grants upon initial employment and annual grants as well as grants issued under the Stock Option Plan for Directors to those named executive officers that are also directors. It is the responsibility of the Committee to address the issues raised by tax laws under which certain non-performance based compensation in excess of $1 million per year paid to executives of public companies is non-deductible to the Company and to determine whether any actions with respect to this limit need to be 49 taken by the Company. It is not anticipated that any executive officer of the Company will receive any compensation in excess of this limit. SUBMITTED BY THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS Daniel E. Bruhl,M.D. Doyle S. Gaw ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT As of March 15, 2002, the following persons were directors, nominees, Named Executive Officers (as defined in "Executive Compensation" above), or others with beneficial ownership of five percent or more of the Company's common stock.. The information set forth below has been determined in accordance with Rule 13d-3 under the Securities Exchange Act of 1934 based upon information furnished to the Company or to the Securities and Exchange Commission by the persons listed. Unless otherwise noted the address of each of the following persons is 2500 Millbrook Drive, Buffalo Grove, Illinois 60089.
SHARES PERCENT BENEFICIAL OWNER BENEFICIALLY OWNED OF CLASS ---------------- ------------------ -------- DIRECTORS AND NOMINEES John N. Kapoor, Ph.D. ...................................... 8,809,227(1) 36.64% Daniel E. Bruhl, M.D. ...................................... 316,767(2) 1.62% Doyle S. Gaw................................................ 107,860(2) 0.55% Jerry N. Ellis.............................................. 20,000(2) 0.10% Antonio R. Pera............................................. 137,500(3) 0.70% NAMED EXECUTIVE OFFICERS(4) Floyd Benjamin(5)........................................... 956,667(6) 4.77% Rita J. McConville(5)....................................... 95,178(7) 0.48% Harold Koch Jr.(5).......................................... 46,341 0.24% Directors and officers as a group (9 persons)............... 10,514,540(8) 42.33% OTHER BENEFICIAL OWNERS Wellington Management Company(9)............................ 986,200 5.04% Arjun C. Waney(10).......................................... 1,868,900 9.56%
--------------- (1) Of such 8,809,227 shares, (i) 841,000 are owned directly by the John N. Kapoor Trust dated September 20, 1989 (the "Trust") of which Dr. Kapoor is the sole trustee and beneficiary, (ii) 3,395,000 are owned by EJ financial/Akorn Management, L.P. of which Dr. Kapoor is managing general partner, (iii) 25,000 are owned directly by Dr. Kapoor, (iv) 63,600 are owned by a trust, the trustee of which is Dr. Kapoor's wife and the beneficiaries of which are their children, (v) 258,438 are issuable pursuant to options granted by the Company directly to Dr. Kapoor, (vii) 1,667,000 are issuable upon conversion of warrants issued to the John N. Kapoor Trust dated September 20, 1989, (viii) 2,426,900 are issuable upon the conversion of a convertible note held by the John N. Kapoor Trust dated September 20, 1989 and (ix) 132,289 are issuable upon the conversion of interest related to the convertible note held by the John N. Kapoor Trust dated September 20, 1989. (2) The reported shares include options to purchase shares. The shares reported for Directors Bruhl, Gaw and Ellis include options to purchase 20,000, 20,000 and 20,000 shares, respectively. In addition, Dr. Bruhl's retirement plan holds 64,266 of the listed shares. (3) The shares reported include options to purchase 137,500 shares. Under the terms of the Employment Agreement executed by and between Mr. Pera and the Company, Mr. Pera received non-qualified stock options under the Company's Amended and Restated Akorn, Inc. 1988 Incentive Compensation Program to purchase 500,000 shares of the Company's common stock. These stock options vest in four equal increments of 125,000 shares beginning at June 4, 2001. 50 (4) Dr. Kapoor and Mr. Pera are also Named Executive Officers of the Company, and information regarding their beneficial ownership is included in this table under the section, "Directors and Nominees." (5) Information reported for Mr. Benjamin, Ms. McConville and Mr. Koch is based on most recently reported information prior to their respective departures from the Company. (6) Mr. Benjamin's shares are held by a trust of which Mr. Benjamin and his wife are trustees and their child is the beneficiary. Includes 490,000 shares issuable pursuant to options granted by the Company directly to Mr. Benjamin. (7) The shares reported for Ms. McConville include options to purchase 86,250 shares. (8) Of such 10,514,540 shares, 5,283,377 are not presently outstanding, but are issuable pursuant to option rights described in the preceding footnotes. (9) The address of Wellington Management Company is 75 State Street, Boston, MA 02109. (10) Of such 1,868,900 shares, (i) 439,900 are owned by Argent Fund Management Ltd., a United Kingdom corporation having a mailing address of 67 Cheval Place, London SW7 1HP, U.K. (Argent") for which Mr. Waney serves as Chairman and Managing Director and of which 51% is owned by Mr. Waney, (ii) 608,400 are owned by First Winchester Investments Ltd., a British Virgin Islands corporation having a mailing address of 8 Church Street, St. Helier, Jersey JE4 0SG, Channel Islands, which operates as an equity fund for investors unrelated to Mr. Waney and whose investments are directed by Argent, (iii) 495,000 are owned by Mr. Waney through certain Individual Retirement Accounts maintained in the United States, and (iv) 325,600 are owned directly by Mr. Waney and his spouse. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On March 21, 2001, in consideration of Dr. John N. Kapoor assuming the positions of President and interim CEO of the Company, the Compensation Committee of the Board of Directors agreed to issue Dr. Kapoor 500,000 options under the Amended and Restated Akorn, Inc. 1988 Incentive Compensation Program in lieu of cash compensation. On July 12, 2001, the Company entered into a $5,000,000 subordinated debt transaction with the John N. Kapoor Trust dtd. 9/20/89 (the "Trust"), the sole trustee and sole beneficiary of which is Dr. John N. Kapoor, the Company's current CEO and Chairman of the Board of Directors. The transaction is evidenced by a Convertible Bridge Loan and Warrant Agreement (the "Trust Agreement") in which the Trust agreed to provide two separate tranches of funding in the amounts of $3,000,000 ("Tranche A" which was received on July 13) and $2,000,000 ("Tranche B" which was received on August 16). As part of the consideration provided to the Trust for the subordinated debt, the Company issued the Trust two warrants which allow the Trust to purchase 1,000,000 shares of common stock at a price of $2.85 per share and another 667,000 shares of common stock at a price of $2.25 per share. The exercise price for each warrant represented a 25% premium over the share price at the time of the Trust's commitment to provide the subordinated debt. Under the terms of the Trust Agreement, the subordinated debt will bear interest at prime plus 3%, which is the same rate the Company pays on its senior debt. Interest will not be paid to the Trust, but will instead accrue as required by the terms of a subordination agreement which was entered into between the Trust and the Company's senior lenders. The convertible feature of the Trust Agreement allows for conversion of the subordinated debt, and interest on Tranche B, into common stock of the Company, at a price of $2.28 per share of common stock for Tranche A and $1.80 per share of common stock for Tranche B and the interest on Tranche B. In December 2001, the Company entered into a $3,250,000 five-year loan with NeoPharm, Inc. ("NeoPharm") to fund Akorn's efforts to complete its lyophilization facility located in Decatur, Illinois. Under the terms of the promissory note, dated December 20, 2001, evidencing the loan (the Promissory Note") interest will accrue at the initial rate of 3.6% and will be reset quarterly based upon NeoPharm's average return on its cash and readily tradable long and short-term securities during the previous calendar quarter. The principal and accrued interest is due and payable on or before maturity on December 20, 2006. 51 The note provides that Akorn will use the proceeds of the loan solely to validate and complete the lyophilization facility located in Decatur, Illinois. In consideration for the loan, under a separate manufacturing agreement between the Company and NeoPharm, the Company, upon completion of the lyophilization facility, agrees to provide NeoPharm with access to at least 15% of the facilities' capacity at discounted pricing. The Promissory Note is subordinated to Akorn's senior debt owed to The Northern Trust Company but is senior to Akorn's subordinated debt owed to the Trust. Dr. John N. Kapoor, the Company's chairman and chief executive officer is also chairman of NeoPharm and holds a substantial stock position in that company as well as in the Company. Commensurate with the completion of the Promissory Note between the Company and NeoPharm, the Company entered into an agreement with the Trust, which amended the Trust Agreement. The amendment extended the Trust Agreement to terminate concurrently with the Promissory Note on December 20, 2006. The amendment also made it possible for the Trust to convert the interest accrued on the $3,000,000 tranche into common stock of the Company. Previously, the Trust could only convert the interest accrued on the $2,000,000 tranche. The change related to the convertibility of the interest accrued on the $3,000,000 tranche requires that shareholder approval be received by August 31, 2002. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a).2. Financial Statement Schedule. The following Financial Statement Schedule is filed with this Annual Report on Form 10-K on the page indicated:
Description Page ----------- ---- II. Valuation and Qualifying Accounts 48
(a).3. Exhibits Those exhibits marked with an asterisk (*) refer to exhibits filed herewith. The other exhibits are incorporated herein by reference, as indicated in the following list. (2.0) Agreement and Plan of Merger among Akorn, Inc., Taylor, and Pasadena Research Laboratories, Inc. dated May 7, 1996, incorporated by reference to the Company's report on Form 10-K for the fiscal year ended June 30, 1996. (3.1) Restated Articles of Incorporation of the Company dated September 6, 1991, incorporated by reference to Exhibit 3.1 to the Company's report on Form 10-K for the fiscal year ended June 30, 1991. (3.2) Articles of Amendment to Articles of Incorporation of the company dated February 28, 1997, incorporated by reference to Exhibit 3.2 to the Company's report on Form 10-K for the transition period from July 1, 1996 to December 31, 1996. (3.3) Current Composite of By-laws of the Company, incorporated by reference to Exhibit 3.3 to the Company's report on Form 10-K for the transition period from July 1, 1996 to December 31, 1996. (4.1) Specimen Common Stock Certificate, incorporated by reference to Exhibit 4.1 to the Company's report on Form 10-K for the fiscal year ended June 30, 1988. (10.1) Consulting Agreement dated November 15, 1990 by and between E. J. Financial Enterprises, Inc., a Delaware corporation, and the Company, incorporated by reference to Exhibit 10.24 to the Company's report on Form 10-K for the fiscal year ended June 30, 1991. (10.2) Amendment No. 1 to the Amended and Restated Akorn, Inc. 1988 Incentive Compensation Program, incorporated by reference to Exhibit 10.33 to the Company's report on Form 10-K for the fiscal year ended June 30, 1992. (10.3) 1991 Akorn, Inc. Stock Option Plan for Directors, incorporated by reference to Exhibit 4.3 to the Company's registration statement on Form S-8, registration number 33-44785.
52 (10.4) Common Stock Purchase Warrant dated September 3, 1992, issued by the Company to the John N. Kapoor Trust dated September 20, 1989, incorporated by reference to Exhibit No. 7 to Amendment No. 3 to Schedule 13D, dated September 10, 1992, filed by John N. Kapoor and the John N. Kapoor Trust dated September 20, 1989. (10.5) Amended and Restated Credit Agreement dated September 15, 1999 among the Company, Akorn (New Jersey), Inc. and The Northern Trust Company (the "Credit Agreement"), incorporated by reference to Exhibit 10.5 to the Company's report on Form 10-K for the fiscal year ended December 31, 1999. (10.6) Amendment No. 1 to the Credit Agreement dated December 28, 1999, incorporated by reference to Exhibit 10.6 to the Company's report on Form 10-K for the fiscal year ended December 31, 1999. (10.7) Amendment No. 2 to the Credit Agreement dated February 15, 2001, incorporated by reference to Exhibit 10.1 to the Company's report on Form 8-K filed on April 17, 2001. (10.8) Amendment No. 3 to the Credit Agreement dated April 16, 2001, incorporated by reference to Exhibit 10.2 to the Company's report on Form 8-K filed on April 17, 2001. (10.9) Promissory Note among the Company, Akorn (New Jersey), Inc. and The Northern Trust Company dated April 16, 2001, incorporated by reference to Exhibit 10.3 to the Company's report on Form 8-K filed on April 17, 2001. (10.10) Letter of Commitment to the Company from John. N. Kapoor, incorporated by reference to Exhibit 10.3 to the Company's report on Form 8-K filed on April 17, 2001. (10.11) Promissory Note among the Company, Akorn (New Jersey), Inc. and The Northern Trust Company dated April 16, 2001, incorporated by reference to Exhibit 10.3 to the Company's report on Form 8-K filed on April 17, 2001. (10.12) Convertible Bridge Loan and Warrant Agreement dated as of July 12, 2001, by and between Akorn, Inc. and the John N. Kapoor Trust dtd. 9/20/89, incorporated by reference to Exhibit 10.1 to the Company's report on Form 8-K filed on July 26, 2001. (10.13) The Tranche A Common Stock Purchase Warrant, dated July 12, 2001, incorporated by reference to Exhibit 10.2 to the Company's report on Form 8-K filed on July 26, 2001. (10.14) The Tranche B Common Stock Purchase Warrant, dated July 12, 2001, incorporated by reference to Exhibit 10.3 to the Company's report on Form 8-K filed on July 26, 2001. (10.15) Registration Rights Agreement dated July 12, 2001, by and between Akorn, Inc. and the John N. Kapoor Trust dtd. 9/20/89, incorporated by reference to Exhibit 10.4 to the Company's report on Form 8-K filed on July 26, 2001. (10.16) Forbearance Agreement by and among Akorn, Inc., Akorn (New Jersey), Inc. and The Northern Trust Company, dated as of July 12, 2001, incorporated by reference to Exhibit 10.5 to the Company's report on Form 8-K filed on July 26, 2001. (10.17) *Promissory Note among the Company, Akorn (New Jersey), Inc. and NeoPharm, Inc. dated December 20, 2001. (10.18) *Processing Agreement dated December 20, 2001, by and between Akorn, Inc. and NeoPharm, Inc. (10.19) *Subordination, Standby and Intercreditor Agreement dated December 20, 2001, by and between NeoPharm, Inc. and The Northern Trust Company. (10.20) *Subordination and Intercreditor Agreement dated December 20, 2001, by and between NeoPharm, Inc. and the John N. Kapoor trust dtd. 9/20/89. (10.21) *Waiver Letter dated December 20, 2001 by and between the Company, Akorn (New Jersey), Inc. and The Northern Trust Company. (10.22) *Supply Agreement dated January 4, 2002, by and between Akorn, Inc. and Novadaq Technologies, Inc. (21.1) *Subsidiaries of the Company. (b) Reports on Form 8-K.
There was no Form 8-K filed during the fourth quarter of 2001. 53 AKORN, INC. VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
ADDITIONS BALANCE AT CHARGED TO BALANCE BEGINNING COSTS AND AT END DESCRIPTION OF PERIOD EXPENSES DEDUCTIONS OF PERIOD ----------- ---------- ---------- ---------- --------- Allowance for doubtful accounts 1999..................................... $ 425,000 $ 161,000 $ (360,000) $ 226,000 2000..................................... 226,000 607,000 (32,000) 801,000 2001..................................... 801,000 12,000,000 (9,095,000) 3,706,000 Allowance for returns 1999..................................... $ -- $ 205,000 $ (205,000) $ -- 2000..................................... -- 1,159,000 (927,000) 232,000 2001..................................... 232,000 4,103,000 (3,787,000) 548,000 Allowance for discounts and allowances 1999..................................... $ -- $ -- $ -- $ -- 2000..................................... -- -- -- -- 2001..................................... -- 886,000 (743,000) 143,000 Allowance for chargebacks and rebates 1999..................................... $1,549,000 $23,793,000 $(22,168,000) $3,174,000 2000..................................... 3,174,000 29,558,000 (29,436,000) 3,296,000 2001..................................... 3,296,000 28,655,000 (27,761,000) 4,190,000 Allowance for inventory obsolescence 1999..................................... $ 572,000 $ 611,000 $ (1,049,000) $ 134,000 2000..................................... 134,000 3,983,000 (946,000) 3,171,000 2001..................................... 3,171,000 1,830,000 (3,156,000) 1,845,000
54 SIGNATURES In accordance with Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. AKORN, INC. By: /s/ JOHN N. KAPOOR ------------------------------------ John N. Kapoor Chief Executive Officer Date: April 30, 2002 In accordance with 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.
SIGNATURE TITLE DATE --------- ----- ---- Chief Executive Officer and Director April 30, 2002 --------------------------------------------- (Principal Executive Officer) John N. Kapoor, Ph.D. President, Chief Operating Officer and April 30, 2002 --------------------------------------------- Director Antonio R. Pera Chief Financial Officer April 30, 2002 --------------------------------------------- (Principal Financial Officer and Ben J. Pothast Principal Accounting Officer) Director April 30, 2002 --------------------------------------------- Jerry N. Ellis Director April 30, 2002 --------------------------------------------- Daniel E. Bruhl, M.D. Director April 30, 2002 --------------------------------------------- Doyle S. Gaw
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