Note 2 — Restatement of previously filed financial information

Overview

Akorn, Inc. is filing this Annual Report on Form 10-K for the year ended December 31, 2015 which contains consolidated financial statements for the years ended December 31, 2014 and 2013 and quarterly unaudited financial information for the quarter and year to date periods ended March 31, 2014 and 2015, June 30, 2014 and 2015, September 30, 2014 and 2015, and December 31, 2014 and 2015, respectively. The consolidated financial statements for the year ended December 31, 2014 and for the quarter and year to date periods ended March 31, 2014, June 30, 2014 and September 30, 2014 have been restated. The restatement of the consolidated financial statements for the year ended December 31, 2014 and quarter and year to date periods ended March 31, 2014, June 30, 2014 and September 30, 2014 included herein restates and replaces Akorn’s previously issued, audited annual financial statements and previously issued, unaudited quarterly and year to date financial statements and related financial information, which was originally filed on Form10-Q with the Securities and Exchange Commission (“SEC”) on May 12, 2014 and the Form 10-K which was originally filed with the SEC on March 17, 2015 and subsequently amended on Form 10-K/A on April 30, 2015. The restatements principally adjusts Akorn’s accounting of net revenue and pretax income from continuing operations as a result of identified errors primarily related to understatements of rebates and contractual allowances. Solely for purposes of bringing Akorn’s Registration Statement on Form S-8 current, Akorn may decide to file with the SEC separate Forms 10-Q including the financial statements for the quarter and year to date periods ended March 31, 2015, June 30, 2015 and September 30, 2015, but otherwise the Company does not intend to file the foregoing Forms 10-Q.

Background

On April 24, 2015, the Company issued a press release announcing that the Audit Committee of the Company’s Board of Directors, upon the recommendation of the Company’s management, concluded that the previously issued financial statements for the quarterly periods ending June 30, 2014, September 30, 2014 and December 31, 2014 along with the annual period ending December 31, 2014 should not be relied upon because of errors in the financial statements in those associated periods. The Company issued a press release announcing that the Audit Committee of the Company’s Board of Directors, upon the recommendation of the Company’s management, concluded that the previously issued financial statements for the quarterly period ending March 31, 2014 should not be relied upon because of errors in those financial statements.

In connection with the foregoing, upon the recommendation of Akorn’s management and Board of Directors, the Audit Committee commenced an independent investigation which included review of accounting errors and other issues involving transactions related to sales to wholesalers, direct purchasers and other related transactions. The Audit Committee investigation also identified two additional accounting matters that warranted further examination and review, and the investigation was expanded to cover these matters: (i) customer payment term modifications and related revenue recognition practices, timing and disclosures for 2013 through 2015 and (ii) returns processing delays.

The Audit Committee investigation was conducted by independent counsel with the assistance of outside accounting consultants. The investigation is complete, although the Audit Committee’s independent counsel and outside accounting consultants continue to provide forensic and investigative support in connection with certain matters discussed in Note 22 — “Legal Proceedings”. The Audit Committee’s conclusions did not include a finding of fraud or intentional misconduct by Akorn’s management or accounting personnel.

Based on the independent internal investigation, our review of our financial records and other work completed by our management, the Audit Committee, along with management, has determined these errors are primarily associated with the rebates and contractual allowance estimates made by the Company, with a substantial majority of these errors relating to companies and products acquired in 2014, including the purchase price allocations for these acquisitions.

Concurrent with the completion of the filing of this Form 10-K, the Company issued a press release announcing that the Audit Committee of the Company’s Board of Directors, upon the recommendation of the Company’s management, concluded that the previously issued financial statements for the quarterly period ending March 31, 2014 should not be relied upon because of an error in the financial statements in this period in relation to the treatment of deferred financing fees. This error was aggregated with the other previous errors identified and restated through the filing of this Form 10-K.

The following errors were identified by the Audit Committee and the Company and are corrected through the restatement of the three months ended March 31, 2014, three and six months ended June 30, 2014, the three and nine months ended September 30, 2014 and the year ended December 31, 2014:

(a)

The Company understated the rebate reserve estimate related to inventory in the wholesale channel (the “pipeline reserve”). Historically, the Company estimated the downstream rebate obligation related to inventory on hand with wholesalers at period end based on contractual rebate rates applied to quantity and value of reported inventory on hand at wholesalers. This allowed for the appropriate recognition of net revenue as the downstream liabilities were recorded in the same period as the sale. In 2014, the pipeline reserve calculated by the Company reflected most fees owed to wholesalers, but it did not accurately take into account the entire population of potential downstream rebate obligations, which significantly changed subsequent to the acquisitions completed in the year, and general consolidation in the industry during that period. The Company subsequently revised its pipeline reserve calculation to include the entire population of potential downstream rebate obligations. The Company’s revised calculation resulted in an increased pipeline reserve, increasing rebates and contractual allowances and decreasing net revenue. These pipeline reserve errors resulted in a reduction of net revenues of $1.4 million in the three month period ended June 30, 2014, $8.1 million and $9.5 million in the three and nine month period ended September 30, 2014 and $1.0 million and $10.5 million in the three and twelve month period ended December 31, 2014, respectively.

(b)

The Company identified errors in its estimates and year-end cutoff related to certain revenue deductions, namely rebates, billbacks, failure to supply, price protection penalties and other contractual adjustments. It is the Company’s policy to recognize liabilities such as those discussed above when probable and estimable in accordance with US GAAP. The items were determined to be errors as the information necessary to record the reserves for these items was generally known or knowable as of the financial statement dates. The recognition of these gross to net revenue reserves resulted in an increased rebate and contractual allowance reserves and decreased net revenue. These estimates and cut-off errors resulted in a reduction of net revenues of $1.7 million in the three month period ended June 30, 2014, $2.9 million and $4.6 million in the three and nine month period ended September 30, 2014 and $16.5 million and $21.0 million in the three and twelve month period ended December 31, 2014, respectively. In addition, for a portion of a transaction with a single customer, revenue was recognized despite a lack of sufficient evidence on which to properly recognize such revenue in accordance with ASC 605 –“Revenue Recognition”, which error resulted in a reduction of net revenues of $2.9 million in the three and twelve month period ended December 31, 2014.

The Company’s corrected methodology and accrual remediation process relating to revenue and receivable reductions are designed to appropriately estimate and recognize its contractual allowances for gross to net revenue reserves in the correct period.

Additionally, the Company has restated certain balances to reflect various non-cash adjustments that the Company previously concluded, at the time of the original filing on Form 10-K with the SEC on March 17, 2015 and as subsequently amended on Form 10-K/A on April 30, 2015, based on its evaluation of both quantitative and qualitative factors, were not material, except with respect to item (h) below which was identified as a material error on May 7, 2016. The Company performed additional procedures to validate the accuracy of the adjustments. Ultimately, in association with and evaluation of the cumulative adjustments related to the rebate and contractual allowance balances and the otherwise previously immaterial adjustments, the previously immaterial adjustments warranted restatement in this Form 10-K. These previously immaterial adjustments included:

(c)

Accounts receivable cut-off errors associated with the restatement periods. The Company revised its sales in-transit calculations to reflect applicable deductions from gross revenue and aligned the Company’s accounts receivable cut-off policies across its newly acquired subsidiaries.

(d)

Recognition of previously unrecorded liabilities incurred prior, but relating to the restatement periods.

(e)

Allocation of assets acquired and liabilities assumed due to acquisitions consummated in the year ended December 31, 2014.

(f)

Inaccurate cost capitalization of ancillary inventoriable costs as of and for the year ended December 31, 2014. The Company adjusted its inventory balances, primarily to include freight-in, to reflect all costs incurred in bringing an article to its existing condition and location.

(g)

Reclassification of certain credit balances from trade accounts receivable to trade accounts payable.

(h)

Inaccurate amortization of commitment fees incurred to consummate term loan debt across the life of the term loans.

(i)

Other individually immaterial adjustments and tax effects.

Effects of Restatement on Previously Filed December 31, 2014 Form 10-K

The tables below present the effect of the financial statement adjustments related to the restatement discussed above of the Company’s previously reported financial statements as of and for the year ended December 31, 2014.

The effect of the restatement on the previously filed condensed consolidated balance sheet as of December 31, 2014 is as follows, in thousands:

	December 31, 2014
	As Previously Reported			Restatement Adjustment				As Restated
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	70,680		$	(1	)	(i)	$	70,679
Trade accounts receivable, net	220,716			(33,171		)	(a), (b), (c)	187,545
Inventories, net	131,310			3,887			(d), (f)	135,197
Deferred taxes, current	33,480			4,931			(e), (i)	38,411
Available for sale security, current	7,268			—				7,268
Prepaid expenses and other current assets	30,875			6,186			(c), (d), (e)	37,061

TOTAL CURRENT ASSETS	494,329			(18,168		)		476,161
PROPERTY, PLANT AND EQUIPMENT, NET	143,788			408			(c), (d)	144,196
OTHER LONG-TERM ASSETS
Goodwill	278,774			6,509			(e)	285,283
Product licensing rights, net	704,218			573			(e)	704,791
Other intangibles, net	259,141			(3,529		)	(e)	255,612
Deferred financing costs, net	21,560			2,144			(c), (d), (h)	23,704
Deferred taxes, non-current	3,020			(936		)	(i)	2,084
Long-term investments	208			3			(i)	211
Other non-current assets	1,863			—				1,863

TOTAL OTHER LONG-TERM ASSETS	1,268,784			4,764				1,273,548

TOTAL ASSETS	$	1,906,901		$	(12,996	)		$	1,893,905

LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Trade accounts payable	$	44,116		$	3,201		(c), (d)	$	47,317
Purchase consideration payable, current	7,481			3,489			(e)	10,970
Income taxes payable	1			(1)			(i)	—
Accrued royalties	13,041			163			(d)	13,204
Accrued compensation	13,467			—				13,467
Current maturities of long-term debt	10,450			—				10,450
Accrued administrative fees	27,774			13,096			(b), (d)	40,870
Accrued expenses and other liabilities	17,835			(3,259		)	(c), (d), (e)	14,576

TOTAL CURRENT LIABILITIES	134,165			16,689				150,854
LONG-TERM LIABILITIES
Long-term debt	1,114,481			—				1,114,481
Deferred tax liability, non-current	268,968			460			(e)	269,428
Lease incentive obligations and other long-term liabilities	2,536			300			(c), (d)	2,836

TOTAL LONG-TERM LIABILITIES	1,385,985			759				1,386,745

TOTAL LIABILITIES	1,520,150			17,448				1,537,599

SHAREHOLDERS’ EQUITY
Common stock, no par value — 150,000,000 shares authorized; 111,734,901 shares issued and outstanding at December 31, 2014	351,235			(8,983		)	(i)	342,252
Warrants to acquire common stock	—			—				—
Retained earnings	50,711			(21,461		)	(a), (b), (c), (d), (e), (f)	29,250
Accumulated other comprehensive loss	(15,195		)	—				(15,195		)

TOTAL SHAREHOLDERS’ EQUITY	386,751			(30,444		)		356,307

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,906,901		$	(12,996	)		$	1,893,905

The effect of the restatement on the previously filed consolidated income statement for the year ended December 31, 2014 is as follows, in thousands except per share amounts:

	Year ended December 31, 2014
	As Previously Reported			Restatement Adjustment				As Restated
REVENUES	$	593,078		$	(38,030	)	(a), (b), (c)	$	555,048
Cost of sales (exclusive of amortization of intangibles, included within operating expenses below)	295,488			(1,800		)	(c), (d), (f)	293,688

GROSS PROFIT	297,590			(36,230		)		261,360

Selling, general and administrative expenses	95,463			(2,508		)	(c), (d)	92,955
Acquisition-related costs	32,147			693			(c), (d)	32,840
Research and development expenses	29,199			2,057			(c), (d)	31,256
Amortization of intangibles	44,066			(573		)	(e)	43,493

TOTAL OPERATING EXPENSES	200,875			(331		)		200,544

OPERATING INCOME	96,715			(35,899		)		60,816

Amortization of deferred financing costs	(12,129		)	2,144			(c), (d), (h)	(9,985		)
Interest expense, net	(35,657		)	—				(35,657		)
Gain from product divestiture	9,807			(510		)	(e)	9,297
Other non-operating income, net	400			471			(c), (d)	871

INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	59,136			(33,794		)		25,342
Income tax provision	23,288			(12,334		)	(i)	10,954

INCOME FROM CONTINUING OPERATIONS	$	35,848		$	(21,460	)		$	14,388
Loss from discontinued operations, net of tax	$	(503	)	$	(1	)	(i)	$	(504	)

CONSOLIDATED NET INCOME	$	35,345		$	(21,461	)		$	13,884

CONSOLIDATED NET INCOME PER COMMON SHARE:
Income from continuing operations, basic	$	0.35		$	(0.21	)		$	0.14
Loss from discontinued operations, basic	$	(0.01	)	$	—			$	(0.01	)

CONSOLIDATED NET INCOME, BASIC	$	0.34		$	(0.21	)		$	0.13

Income from continuing operations, diluted	$	0.34		$	(0.21	)		$	0.13
Loss from discontinued operations, diluted	$	(0.01	)	$	0.01			$	—

CONSOLIDATED NET INCOME, DILUTED	$	0.33		$	(0.20	)		$	0.13

SHARES USED IN COMPUTING CONSOLIDATED NET INCOME PER COMMON SHARE:
BASIC	103,480			—				103,480

DILUTED	123,110			(13,522)				109,588

COMPREHENSIVE INCOME:
Consolidated net income	$	35,345		$	(21,461	)		$	13,884
Unrealized holding loss on available-for-sale securities, net of tax of $663	(1,124		)	—				(1,124		)
Foreign currency translation loss, net of tax of $877 for the year ended December 31, 2014	(1,704		)	—				(1,704		)

COMPREHENSIVE INCOME	$	32,517		$	(21,461	)		$	11,056

The effect of the restatement on the previously filed consolidated statement of cash flows for the year ended December 31, 2014 is as follows, in thousands:

	Year ended December 31, 2014
	As Previously Reported			Restatement Adjustment				As Restated
OPERATING ACTIVITIES:
Consolidated net income	$	35,345		$	(21,461	)	(a), (b), (c), (d), (e), (f)	$	13,884
Loss from discontinued operations, net of tax	503			1			(i)	504
Adjustments to reconcile consolidated net income to net cash provided by operating activities:
Depreciation and amortization	58,538			(707		)	(c), (d)	57,831
Amortization of deferred financing fees	12,129			(2,145		)	(c), (d), (h)	9,984
Amortization of favorable (unfavorable) contracts	72			(1		)	(i)	71
Amortization of inventory step-up	20,798			—				20,798
Non-cash stock compensation expense	7,542			210			(i)	7,752
Non-cash interest expense	4,871			—				4,871
Non-cash gain on bargain purchase	—			—				—
Gain from product divestiture	(9,807		)	478			(e)	(9,329		)
Deferred income taxes, net	25,293			(42,804		)	(e)	(17,511		)
Excess tax benefit from stock compensation	(38,710		)	9,193			(e)	(29,517		)
Non-cash settlement of product warranty liability	—			—				—
Equity in earnings of unconsolidated joint venture	—			—				—
Loss on extinguishment of debt	990			—				990
Gain on sale of available for sale security	(7		)	—				(7		)
Changes in operating assets and liabilities, net of business acquisitons:
Trade accounts receivable, net	(95,470		)	22,674			(a), (b), (c)	(72,796		)
Inventories, net	(15,262		)	(4,123		)	(c), (d), (f)	(19,385		)
Prepaid expenses and other current assets	(13,180		)	43,552			(c), (d)	30,372
Trade accounts payable	11,024			2,939			(c), (d)	13,963
Accrued expenses and other liabilities	26,249			1,718			(c), (d)	27,967

NET CASH PROVIDED BY OPERATING ACTIVITIES	30,918			9,254				40,442
INVESTING ACTIVITIES:
Payments for acquisitions and equity investments, net of cash acquired	(987,802		)	374			(e)	(987,428		)
Proceeds from disposal of assets	59,361			___			(e)	59,361
Payments for other intangible assets	(8,532		)	(376		)	(c), (d)	(8,908		)
Purchases of property, plant and equipment	(29,568		)	(331		)	(c), (d)	(29,899		)
Distributions from unconsolidated joint venture	—			—				—

NET CASH USED IN INVESTING ACTIVITIES	(966,541		)	(333)				(966,874		)
FINANCING ACTIVITIES:
Proceeds from issuances of debt	1,045,000			—				1,045,000
Proceeds under stock option and stock purchase plans	8,842			—				8,842
Payments of contingent acquisition liabilities	(15,000		)	—				(15,000		)
Debt financing costs	(28,366		)	1			(i)	(28,365		)
Proceeds from warrant exercises	8,171			—				8,171
Excess tax benefits from stock compensation	38,710			(9,193		)	(i)	29,517
Debt repayment	(85,049		)	—				(85,049		)

NET CASH PROVIDED BY FINANCING ACTIVITIES	972,308			(9,192		)		963,116

Effect of changes in exchange rates on cash and cash equivalents	(183		)	—				(183		)

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS	36,502			(1		)		36,501
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR	34,178			—				34,178

CASH AND CASH EQUIVALENTS AT END OF YEAR	$	70,680		$	(1	)		$	70,679

Taken together, these adjustments result in no material impact on the Company’s cash and cash equivalents at December 31, 2014 or the Company’s cash and cash equivalents balance as of December 31, 2014.