Item 1. Description of Business.
General Development of Business
Akorn, Inc. (Akorn or the Company) manufactures, markets and distributes an extensive line of therapeutic, diagnostic and surgical pharmaceutical and over-the-counter ophthalmic products. In addition, through its wholly-owned subsidiary Akorn Manufacturing, Inc., doing business as Taylor Pharmaceuticals (Taylor), the Company manufactures and distributes injectable pharmaceutical products and provides sterile contract manufacturing services to a number of large and small pharmaceutical companies. Akorn is a Louisiana corporation founded in 1971. For most of its 25 year history, the Company has been headquartered in Abita Springs, Louisiana, a suburb of New Orleans. Recently, the Company announced that it would be moving its headquarters and most of its Ophthalmic Division operations to Lincolnshire, Illinois, a suburb of Chicago.
Prior to the fiscal year beginning July 1, 1989, the Company purchased its entire ophthalmic product line on a contract basis from several suppliers, who packaged and labeled the products under the Company's name. In September 1989, in order to more vertically integrate its operations, the Company acquired Walnut Pharmaceuticals, Inc. (Walnut), a manufacturing facility in Los Angeles, California that was capable of manufacturing sterile ophthalmic solutions, suspensions, and human injectable products, among other products. This facility operated until mid 1991, at which time the facility was closed due to current Good Manufacturing Practices (cGMP) concerns.
In January 1992, the Company acquired Taylor of Decatur, Illinois. Akorn immediately began the process of transferring to Taylor the operations formerly conducted at the Los Angeles facility while maintaining the sterile contract manufacturing business conducted by Taylor. In May 1996, the Company acquired Pasadena Research Laboratories, Inc. (PRL), a developer and distributor of injectable products, and merged PRL into Taylor, thereby creating a fully- integrated injectable pharmaceutical company. The merger also expanded Taylor's current product line.
Upon its acquisition of PRL, the Company reorganized its operations into two divisions, the Ophthalmic Division and the Injectable Division. The Ophthalmic Division, which operates through Akorn, consists of the marketing and distribution of ophthalmic products. The Injectable Division, which is operated through Taylor, consists of the injectable products manufacturing and distribution business and contract manufacturing business. For information regarding sales, operating income and identifiable assets for each of the Company's segments, see Note R to the financial statements included in Item 8 of this report.
Ophthalmic Distribution Business
The Company distributes a complete line of therapeutic, diagnostic and over-the-counter ophthalmic pharmaceutical products as well as other surgical and office-based non-pharmaceutical products. The Company's therapeutic ophthalmic pharmaceutical product line is extensive and includes antibiotics, anti-infectives, steroids, steroid combinations, glaucoma medications, decongestants/antihistamines, and anti-edema medications. Diagnostic products, primarily for use in doctors' offices, include a complete line of mydriatics and cycloplegics, anesthetics, topical stains, gonioscopic solutions and others. Surgical products available from Akorn 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. Ophthalmic over-the-counter products include various artificial tear solutions, preservative-free lubricating ointments, lid cleansers, vitamin supplements and contact lens accessories.
Injectable Manufacturing and Distribution Business
Taylor markets a line of over 55 niche injectable pharmaceutical products through the newly acquired operations of PRL. Founded in 1936, PRL had over 50 years of history in the generic small volume parenteral market. The niche injectable products sold are used in the treatment of a broad spectrum of indications, including rheumatoid arthritis and pain management.
Contract Manufacturing Business
Taylor also manufactures sterile products on a contract basis for third parties. The majority of Taylor contracts are short-term in nature and operate on the basis of signed purchase orders. However, Taylor is in the process of developing longer-term contracts with minimum quantity requirements in order to strengthen the commitments from its contract customers. Because of the present nature of Taylor's contracts, its contract manufacturing is more volatile than the ophthalmic distribution and injectable distribution segments. Given that sales to contract customers are large in relation to the distribution segments, sharp reductions in contract manufacturing sales can occur should customers discontinue the contract for any reason.
Sales and Marketing
While the Company's distributed ophthalmic and injectable product lines include some unique products, the majority are non-proprietary. As a result, the Company relies on its expertise in marketing, distribution, development, and low cost manufacturing in order to maintain and increase market share.
The Company maintains an efficient three-pronged ophthalmic distribution sales effort. This effort includes 24 outside sales representatives who, together with two district managers, make personal calls on customers in the Northeast, Southeast, Midwest and West regions of the country. In addition, the Company maintains an in-house telemarketing and a customer service sales group of 21 persons and a direct-mail marketing effort. Ophthalmic distribution customers consist primarily of ophthalmologists, optometrists, independent pharmacies, and full-service wholesalers whose customers include hospitals and other institutions.
The Company's sales and marketing efforts in the injectable distribution business include seven telemarketing and customer service representatives and direct-mail activities. Injectable distribution customers consist primarily of hospitals and specialty physicians. In addition, the Company has established several strategic alliances to help distribute its injectable products to Group Purchasing Organizations (GPOs). The GPO market is expected to become a significant component of sales to the injectable distribution segment as the Company aggressively expands its generic injectable product offering to include more high volume products. The Company also intends to build a key account sales force for the injectable segment over the next several years as new products are introduced.
The Company's sales and marketing efforts in the contract manufacturing business have been limited to personal contact with major pharmaceutical companies and limited trade journal advertisements. Attendance at manufacturing trade shows and an aggressive marketing of the full-service capabilities of Taylor's contract operations have recently begun. The Company's contract customers include several large pharmaceutical companies. Throughout Taylor's history, it has performed contract manufacturing services for some of the largest pharmaceutical companies.
The Company stresses its service, quality and cost as means to attract and keep customers.
Research and Development
The acquisition of Taylor provided the Company with resources to begin its research and development program, which began in the last quarter of fiscal 1992 and has since expanded. As of December 31, 1996, the Company had three new ophthalmic Abbreviated New Drug Applications (ANDAs) in various stages of development for products which the Company has not previously manufactured. See "Government Regulation" these products, along with a recently approved ANDA product which the Company will market upon patent expiration of the innovator product, have a current aggregate brand market of approximately $150 million. In addition, by December 31, 1996, the Company had eleven injectable products in various stages of development. These injectable products have a current aggregate brand market of approximately $500 million. Several of these products require ANDA submission while others are considered Category B products (see "Government Regulation") and therefore do not require FDA approval. No assurance can be given as to whether the Company will develop marketable products based on these filings or as to the size of the market for any such products.
The Company has targeted its research and development efforts over the next three years on 25 to 30 additional ophthalmic and injectable products, the patents on which have expired or will expire in the near future. No assurance can be given as to whether any Company products will be developed as a result of these efforts or as to when any such products may be produced and marketed by the Company. Production and marketing of any such products are expected to take several years.
The Company also maintains an aggressive product licensing effort. This effort allows the Company to use its strength in marketing ophthalmic and injectable products. The Company also anticipates manufacturing many of the licensed products.
At December 31, 1996, 15 full-time employees of the Company were involved in research and development and product licensing. The Company's research and development expenditures for the six month period ended December 31, 1996 were $948,000. For the twelve month periods ended June 30, 1996, 1995 and 1994 these expenditures totaled $1.9 million, $1.7 million and $1.4 million, respectively.
The Company expects its research and development expenditures to increase in calendar 1997.
Employee Relations
The Company has 295 full-time employees, of whom 95 are employed in its Ophthalmic Division, 198 are employed in its Injectable Division, and 2 are employed in its Corporate Division. The Company enjoys good relations with its employees, none of whom are represented by a collective bargaining agent.
Competition
The manufacture and distribution of ophthalmic and injectable 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 larger financial and other resources, including a larger volume of sales, more sales personnel and larger facilities than the Company.
The competitors which are dominant in the ophthalmic distribution industry are Alcon Laboratories, Inc., Allergan Pharmaceuticals, Inc., Steris Pharmaceuticals, Inc. (Steris) and Bausch & Lomb, Inc. (B&L). The Company competes primarily on the basis of price and service. The Company's principal suppliers of ophthalmic products, Steris and B&L are in direct competition with the Company in several markets. Both generic and name brand companies compete in the injectable generic distribution industry and include Abbott Labs, Gensia, Marsam, Steris, Elkin Sin and American Regent.
The manufacturing of sterile products must be performed under the most rigorous FDA-mandated Good Manufacturing Practices. Therefore the barriers to entry in the manufacturing of sterile products are very high. The number of independent contract manufacturers of sterile products continues to decline as a result of these barriers. Taylor's competitors in this area, generally, are larger companies with greater financial and other resources.
Product Supply
Since the acquisition of Taylor in 1992, the Company has been steadily regaining control of the supply of its ophthalmic pharmaceutical products, which had been impacted by the closure of the Los Angeles facility in 1991. The only unaffiliated supplier of products which accounted for more than 10% of the Company's ophthalmic distribution sales during the six month period ended December 31, 1996 was Sight Pharmaceuticals, Inc. (a division of B&L). This company supplied products accounting for approximately 15% of the Company's net ophthalmic distribution sales for the period.
The Company uses several suppliers for its injectable distribution business, none of which accounted for 10% or more of net injectable distribution sales in 1996. Several of the leading products distributed by this segment are in the process of being transferred to Taylor's manufacturing facilities. The Company intends to produce the majority of its high volume injectable distribution products over the next several years.
Government Regulation
All pharmaceutical manufacturers and distributors are subject to extensive regulation by the federal government, principally by the FDA and, to a lesser extent, by state governments. 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, safety, labeling, storage, record keeping, approval, pricing, advertising, and promotion of products by the Company and its subsidiaries. Included among the requirements of these statutes is that the manufacturer's methods conform to cGMPs provided for in FDA regulations. Pursuant to its powers under the FDA Act, 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 of the government to approve new drug applications, and criminal prosecution. The FDA also has authority to revoke approval of drug products.
Except in the case of drugs identified as Category B in the FDA Act, FDA approval is required before any drug can be manufactured and marketed. New drugs require the filing of a New Drug Application (NDA) with the FDA, which requires clinical studies demonstrating the safety and efficacy of the drug and compliance with additional regulatory requirements.
Abbreviated procedures are available for obtaining FDA approval for those generic drugs which are equivalents of existing brand name drugs, such as certain drugs that had been manufactured at the Los Angeles facility and are expected to be manufactured by Taylor. In order to obtain approval of a new generic drug, the Company files an Abbreviated New Drug Application (ANDA) with the FDA. An ANDA is similar to a NDA, except that the FDA waives the requirement of conducting clinical studies of safety and efficacy. Instead, for drugs which contain the same ingredients as drugs already approved for use in the United States, the FDA ordinarily requires data showing that the generic drug formulation is equivalent to the brand name drug and that the product is stable in its formulation.
Over the past several years, the FDA has increased its scrutiny of the operations of generic drug manufacturers like the Company and has increased the time required for its approval of ANDAs and NDAs submitted by such companies. In addition, the Office of Generic Drugs of the FDA, the division which monitors and approves ANDAs, has increased its scrutiny regarding concentrations of inactive ingredients for generic drugs as compared to the innovator drug. This change has resulted in an increase in the time spent on formulating ANDA products.
The Company also manufactures and distributes several controlled-drug substances, the distribution and handling of which are regulated by the Drug Enforcement Agency (DEA). Strict compliance with DEA regulations is necessary to continue distribution of controlled drugs. Failure to comply with regulations can result in fines or seizure of product.
Item 1A.
Item 1A. Executive Officers of the Registrant.
The following table sets forth the executive officers of the Company as of February 28, 1997. Each officer serves as such at the pleasure of the Board of Directors.
Officer Name Age Position with the Company - ------------- ----- --------------------------
John N. Kapoor, Ph.D. 53 Chairman of the Board and Chief Executive Officer
Floyd Benjamin 53 Executive Vice President of the Company and President of the Injectable Division
R. Scott Zion 46 Senior Vice President of the Company and General Manager of the Ophthalmic Division
Rita J. McConville 38 Vice President of the Company, Chief Financial Officer and Secretary
Item 2.
Item 2. Description of Property.
Currently, the Company's ophthalmic executive offices, sales and distribution center are based in two adjacent buildings totaling approximately 30,000 square feet located on ten acres of land in Abita Springs, Louisiana. The Company plans to sell and/or lease these facilities once the relocation of these operations to Lincolnshire, Illinois is completed.
The Company recently signed a lease for approximately 11,000 square feet of office space in Lincolnshire, Illinois. This space will be used primarily for the Ophthalmic Division sales and marketing and financial accounting operations, along with all corporate operations of the Company. Additional space will also be available for certain sales and marketing activities of the Injectable Division.
The Company also 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, also in Decatur, Illinois. The Company also leases 7,000 square feet of office and warehousing space in San Clemente, California for use in the injectable distribution segment, including sales, distribution and executive offices. This space, along with available space in Decatur, Illinois, is considered adequate to accommodate growth in the injectable distribution and contract manufacturing operations for the foreseeable future.
Item 3.
Item 3.Legal Proceedings.
From time to time the Company becomes involved, in the ordinary course of its business, in legal actions and claims. The amount, if any, of ultimate liability with respect to such matters cannot be determined. Management believes, however, that any such liability will not have a material effect on the Company's financial position.
Item 4.
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, 1996.
PART II
Item 5.
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 February 28, 1997, the Company estimated that the number of holders of its Common Stock was approximately 3,000, including record holders and individual participants in security position listings.
High and low prices per NASDAQ for the periods indicated were:
Low High ------ ------- Six Months Ended December 31, 1996: 1st Quarter $ 2.06 $ 3.50 2nd Quarter 1.63 2.44
Fiscal Year Ended June 30, 1996: 1st Quarter $ 2.25 $ 2.81 2nd Quarter 2.06 3.13 3rd Quarter 2.44 3.19 4th Quarter 2.53 3.50
Fiscal Year Ended June 30, 1995: 1st Quarter $ 2.38 $ 3.19 2nd Quarter 2.94 4.00 3rd Quarter 2.88 3.63 4th Quarter 2.25 3.31
The Company's Board of Directors decided to suspend the payment of dividends in the first fiscal quarter of 1992. Any such future payments will be, in part, contingent upon the level of the Company's research and development efforts and expansion of operations. The Company's loan agreement includes restrictions on the payment of dividends. During fiscal 1996, dividends paid of $583,000 pertain to Subchapter S distributions made to former PRL shareholders for pre-acquisition earnings.
Item 6.
Item 6. Selected Consolidated Financial Data.
In October 1996, the Board of Directors of the Company determined to change the Company's fiscal year from the year ending June 30 to the year ending December 31. The following table sets forth selected consolidated financial information for the Company for the six month transition period ended December 31, 1996 and for the five years ended June 30, 1996:
All of the information shown in the table above for the five year period ended June 30, 1996 has been restated to reflect the combined operations of Akorn and Pasadena Research Laboratories, Inc. (PRL). The information shown in the table for 1992 has been restated to reflect the combined operations of Akorn and Taylor.
(1) For information regarding the effects of unusual, infrequently occurring or year end adjustments on reported results for the twelve month periods ended June 30, 1994 through 1996, and for the six month period ended December 31, 1996, see Notes B, E and P to the financial statements included in Item 8 of this report.
(2) Dividends paid pertain to Subchapter S distributions made to former PRL shareholders for pre-acquisition earnings.
(3) Includes the reversal of the provision for a litigation judgment ($0.7 million), the reduction of estimated costs of reorganizing manufacturing operations ($0.4 million), and income tax benefits ($0.3 million).
(4) Includes charges for the reorganization of manufacturing operations ($5.3 million), acquisition costs of Taylor ($1.3 million), and provision for a litigation judgment ($0.8 million).
Item 7.
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 financial statements.
RESULTS OF OPERATIONS
COMPARISON OF SIX MONTHS ENDED DECEMBER 31, 1996 AND 1995
Effective July 1, 1996, the Company changed its fiscal year end from June 30 to December 31. The table below includes the summary income statement for the six month periods ended December 31, 1996 and 1995 which should be considered for the discussions which follow.
Six Months Ended December 31 1996 1995 _____________________________ (in thousands, except per share amounts)
Net Sales: Ophthalmic distribution $ 10,271 $ 11,119 Injectable distribution 3,119 1,673 Contract manufacturing 3,129 4,157 ____________ _____________ 16,519 16,949
Cost of goods sold 10,761 10,472 ____________ _____________ GROSS PROFIT 5,758 6,477
Selling, general and administrative expenses 4,819 4,701 Research and development 809 478 ____________ _____________ 5,628 5,179 ____________ _____________ OPERATING INCOME 130 1,298
Interest and other income (expense) net (60) (9) ____________ _____________ INCOME BEFORE INCOME TAXES 70 1,289
Income taxes 26 493 ____________ _____________ NET INCOME $ 44 $ 796 ============ ============= NET INCOME PER SHARE $ - $ .05 ============ ============= Net Sales
The Company's consolidated net sales declined 3% to $16.5 million for the six months ended December 31, 1996 as compared to the same period in 1995. Ophthalmic distribution sales declined 8% from the comparable period in 1995. This decline is primarily related to the effect of the Company's decision to discontinue its practice of giving discounts to wholesalers at the end of every quarter effective with the quarter ended June 30, 1996. The effect of this decision was mainly realized in the quarter ended September 30, 1996, as sales for this division for the quarter ended December 31, 1996 were $5.4 million, or flat with sales for the quarter ended December 31, 1995.
While this decision has resulted in lower sales volumes, it is expected to have a positive impact on margins in the future and it has allowed for the better management and projection of sales for the division. The generic pharmaceutical market continues to experience price erosion which has impacted sales and margins. However, the patent of the most significant therapeutic ophthalmic pharmaceutical product (Timolol Maleate) will expire in late March 1997. As previously announced, the Company has received pre-approval from the FDA to manufacture and sell this product as a generic pharmaceutical and is aggressively pursuing negotiations with wholesalers and chain pharmacies for the stocking of this product once patent expiration occurs. The Company's core business of sales to practitioners remains solid and margins are relatively stable. Efforts of the ophthalmic division sales and marketing group, now headed by the recently hired General Manager R. Scott Zion, will continue to be focused in this area.
For the six months ended December 31, 1996, injectable distribution sales nearly doubled as compared to the same period in 1995. This increase includes the effects of the acquisition of an injectable product line from Janssen Pharmaceutica, Inc. (Janssen) on July 1, 1996. Prior to the acquisition, sales of this product line were reported as contract manufacturing sales. Sales of the Janssen product line for the six month period ended December 31, 1996 were $1.1 million. In addition, the injectable distribution segment has experienced growth on several of its high-margin niche products.
Since the merger of Taylor with Pasadena Research Laboratories, Inc. (PRL) in May 1996, the Company has redirected a significant amount of its R&D efforts towards the development of generic injectable products that will enhance the current product portfolio offering of the injectable distribution segment. Several Category B products are expected to be available for sale in early 1997, pending the outcome of the Company's R&D efforts.
For the six months ended December 31, 1996, contract manufacturing sales declined 25% from the comparable period in 1995. This decline is primarily attributable to the transfer of sales of the Janssen product line to the injectable distribution segment as noted above. Since the merger with PRL, and the addition of new management, the Company has increased its marketing efforts in the area of contract manufacturing. This marketing effort focuses on Taylor's ability to provide a full range of services, including product development, regulatory and sterile manufacturing. These efforts are expected to help establish more long- term relationships with contract customers.
Gross Profit
Consolidated gross profit declined 10% to $5.8 million in the six months ended December 31, 1996 compared to $6.5 million for the same period of the previous year, with gross profit margin declining approximately three percentage points to 34.9%. Gross profit margin for the ophthalmic distribution segment improved slightly by one percentage point. While gross profit margin improved in the injectable distribution segment, reduced volume in the contract manufacturing segment resulted in an overall decline in consolidated gross profit margin due to underabsorption of overhead.
In August 1996, the Company took steps to reduce a significant portion of its fixed and variable costs in the manufacturing operations. However, low plant volume related to weakness in the contract manufacturing segment and lower ophthalmic production due to high inventory levels caused by the change in wholesaler discounting policies, had a negative impact on manufacturing margins.
In the quarter ended December 31, 1996, the Company increased its reserve for estimated unsaleable inventory by approximately $260,000. This change in estimate is reported as a decrease in gross profit. Excluding this change in estimate, the gross margin of the six months ended December 31, 1996 and 1995 was 36.4% and 38.2%, respectively.
The Company anticipates that gross margins will continue to be impacted by price erosion on generic pharmaceuticals. However, with anticipated growth in certain higher margin niche products, the Company's overall gross margins should remain relatively stable during 1997. As the injectable segment begins the marketing of more commodity generic products, overall Company margins are expected to decline beyond 1997.
Selling, General and Administrative Expenses
Selling, general and administrative (S,G&A) expenses increased 3% during the six months ended December 31, 1996 as compared to the same period in 1995. This slight increase is primarily associated with changes in the timing of certain large promotional expenses for the Ophthalmic Division and enhanced sales and marketing efforts in the contract manufacturing and injectable distribution segments.In the quarter ended December 31, 1996, the Company reduced its reserve for products being transferred from the Company's previous manufacturing facilities (site transfers) by $207,000, primarily due to the decision not to pursue an exclusive raw material source on one of these products. The percentage of S,G&A expenses to sales increased to 29.2% for the six months ended December 31, 1996 from 27.7% in the comparable prior year period.
Research and Development
Research and development (R&D) expense for the six months ended December 31, 1996 increased by 69% to $809,000, compared to $478,000 for the same period in 1995. This increase reflects a change in the mix of products under development due to a reduced emphasis on site transfers. The estimated cost of these site transfers has been previously accrued and therefore does not have an effect on R&D expense as reported in the statements of income. In addition, through most of the six months ended December 31, 1996, the Company continued the aggressive R&D efforts that had been ongoing at PRL through contractual arrangements
As noted previously, the Company has redirected a significant portion of its R&D efforts to injectable products in response to the PRL merger. These efforts include development of new products and the in-house manufacture of products distributed by the injectable distribution segment. The Company also continues the development of a non-steroidal, anti-inflammatory drug (NSAID) for ophthalmic use which was licensed from Pfizer Inc. (Pfizer). Phase III studies for the NSAID are expected to begin in early 1997. As of December 31, 1996, approximately $600,000 of funds received from Pfizer remain available for the financing of this project. Based on the above, it is anticipated that R&D expense will increase in 1997. However, the Company will continue to monitor such expenses in light of operating performance.
Interest and other income/expense
Interest and other expense, net increased $51,000 for the six months ended December 31, 1996 as compared to the same period in 1995. This increase is primarily related to the increase in interest expense associated with a greater average outstanding loan balance on the Company's term debt. The primary increase in the term debt resulted from the borrowing of $1.5 million in July 1996 in connection with the acquisition of the Janssen product line which included certain production equipment for the products.
The Company anticipates that interest expense will increase significantly in 1997 as a result of the new long-term debt associated with the Janssen product acquisition and 1997 anticipated capital improvements. A portion of this interest is expected to be capitalized during 1997 during validation and construction periods.
Income taxes
The effective tax rate for the six months ended December 31, 1996 and 1995 was 36.9% and 38.2%, respectively. The Company has reached a preliminary settlement with the Internal Revenue Service (IRS) regarding proposed adjustments made during the examination of tax returns for the periods of 1988 through 1993 which the Company appealed. These proposed adjustments primarily related to the timing of deductions taken for tax purposes in connection with the reorganization of the Company's manufacturing operations in 1991. The settlement which has been obtained through the appeals process must be approved by the Joint Committee on Taxation. Adjustments to reflect the proposed settlement, primarily related to interest of approximately $300,000 to $400,000 have been made in previous financial statements.
Net Income
Net income for the six months ended December 31, 1996 was approximately break-even compared to the prior year income of $796,000 or five cents per share, primarily due to the low overhead absorption in the Company's manufacturing facility and the increase in R&D expenditures noted above.
COMPARISON OF THE TWELVE MONTHS ENDED JUNE 30, 1996, 1995 AND 1994
In the following discussions, references to financial results during a given year relate to the twelve-month period ending June 30 of that year, unless otherwise indicated.
Net Sales
The Company's consolidated net sales declined 10% to $33.9 million in 1996 compared to the prior year. This follows a 20% increase in the prior year as compared with 1994. The following table sets forth, for the periods indicated, net sales by segment, excluding intersegment sales:
Years Ended June 30 1996 1995 1994 _________________________________________ (In millions) Ophthalmic distribution $ 20.8 $ 23.8 $ 20.7 Injectable distribution 4.2 4.6 2.9 Contract manufacturing 8.9 9.1 7.7 _________________________________________ Total net sales $ 33.9 $ 37.5 $ 31.3 =========================================
Ophthalmic distribution sales include a broad range of therapeutic, diagnostic, surgical and office-based products. Ophthalmic distribution sales declined 13% in 1996 as compared to 1995 and increased 15% in 1995 as compared to 1994. The decline in sales for 1996 is attributable primarily to two factors. These include the loss of sales for AK-Con-A, the Company's previously best-selling allergy product, and the discontinuance of certain discounting practices with wholesalers in the fourth quarter of 1996 discussed above.
As previously announced, AK-Con-A was converted to over-the-counter status by the FDA, which required the filing of a NDA. Sales of AK-Con- A were discontinued in October 1994, pending FDA approval of the NDA. The Company received approval of the OTC version of the product in January 1996. The OTC version is being marketed through a joint venture with Pfizer. Royalties earned under this joint venture totaled $333,000 in fiscal 1996. Sales of AK-Con-A were approximately $2 million and $1.4 million, respectively, in 1995 and 1994.
As discussed above, in the fourth quarter of 1996, the Company discontinued the practice employed by the Ophthalmic Division of giving discounts to wholesalers at the end of every quarter. The Company was willing to forego the additional sales in the quarter in an effort to maintain margins at an acceptable rate in the future. Because of the discontinuance of this practice, the Company estimates that sales for the quarter and fiscal year ended June 30, 1996 were negatively impacted by approximately $1 million.
Excluding the effects of the loss of AK-Con-A and the discontinuance of the wholesaler discounting practice, sales for the ophthalmic segment were relatively flat. Continued erosion of generic pricing along with some product shortages have offset sales increases in other products during 1996. The Company continues to experience increases in its sales of surgical products which includes surgical instruments and surgical packs. The surgical products area will continue to be a major focus for the ophthalmic segment since margins are generally higher than for generic pharmaceuticals and sales are controlled more directly by physicians, a customer base which has been traditionally a strength for Akorn.
In 1995, ophthalmic distribution sales were enhanced by sales of AK- Con-A, the introduction of several new surgical products, including new surgical instruments and surgical packs, and sales of the Company's generic therapeutic products.
Injectable distribution sales (attributable to PRL, which was acquired by the Company on May 31, 1996 in a pooling of interests transaction) declined 9% in 1996 as compared to 1995 and increased 59% in 1995 as compared to 1994. The current year decline is primarily attributable to delays in new product introductions and additional competition on a few of the Company's injectable products. The sales increase in 1995 is primarily attributable to an expanded offering of certain grandfathered products, including this segment's lead product for the treatment of rheumatoid arthritis. In addition, in 1995, the Company established several marketing alliances which gave it an entree into the Group Purchasing Organization (GPO) market for injectables.
Contract manufacturing sales were relatively flat in 1996 versus 1995 and increased 18% in 1995 as compared to 1994. Contract sales for 1995 were enhanced by a new contract from Janssen, which increased sales significantly beginning in the second half of fiscal 1994. Sales to Janssen accounted for 12% and 13% of consolidated net sales in 1996 and 1995, respectively. Janssen had recently notified the Company that it would be transferring the production of certain products during fiscal 1996 and 1997 to its own facilities in Puerto Rico. Such products accounted for $1.3 million and $1.4 million in contract manufacturing sales for 1996 and 1995, respectively.
As noted above, effective July 1, 1996, Janssen agreed to transfer to the Company ownership of three injectable products in the analgesia/anesthesia area, two of which previously had been produced for Janssen by Taylor, but which Janssen had determined to discontinue. These products accounted for approximately $2.6 million and $2.9 million in sales for Taylor in 1996 and 1995, respectively. The acquisition of these products will help maintain plant volume from these products and has provided the injectable distribution segment with two highly recognized products.
Income and Expenses
The following table sets forth the relationship to sales of various income statement items:
Years Ended June 30
1996 1995 1994 -------------------------------------
Net sales 100.0% 100.0% 100.0% Cost of goods sold 64.8 59.5 57.8 --------------------------------------
Gross margin 35.2 40.5 42.2
Selling, general and administrative expenses 26.4 27.7 30.8 Research and development 3.6 2.4 2.9 Acquisition and severance costs 2.0 - - ---------------------------------------
Operating income 3.2 10.4 8.5
Interest and other income (expense), net (.3) (.4) (.3) --------------------------------------
Income before income taxes 2.9 10.0 8.2
Income taxes .6 3.3 .5 ---------------------------------------
Net income 2.3% 6.7% 7.7% =======================================
Gross Profit
The consolidated gross margin percentage declined by 5.3 percentage points from 40.5% in 1995 to 35.2% in 1996. The decline in gross profit margin is primarily due to continued price pressure in the ophthalmic generic pharmaceuticals area due to competition, as well as the loss of the Company's high margin sales of AK-Con-A. In addition, lower plant throughput, primarily in the second half of fiscal 1996, resulted in margin declines for the contract manufacturing segment. Also, in the second half of fiscal 1996, the Company increased its estimate for unsaleable inventory by approximately $500,000. In the quarter ended June 30, 1996, the Company increased its estimate for wholesaler chargebacks by approximately $250,000. These changes in estimate are reported as a decrease in gross margin. Excluding these changes, the gross margin for 1996 was 37.4%, a 3.1 percentage point decline from 1995.
The gross margin percentage declined 1.7 percentage points from 42.2% in 1994 to 40.5% in 1995. The decline in gross margin percentage in 1995 is primarily due to the effects of price increases from manufacturers (primarily in the second half of the fiscal year), which were not fully offset by price increases to customers. In addition, a shift in the mix of lower margin catalog products added to the decline in gross margin. The decline in gross margin was more prevalent in the second half of the fiscal year as a result of the loss of sales from AK- Con-A discussed earlier.
Selling, General and Administrative Expenses
Selling, general and administrative expenses as a percentage of net sales declined 1.3 percentage points from 27.7% in 1995 to 26.4% in 1996. In the quarter ended March 31, 1996, the Company decided to no longer pursue ANDAs for several ophthalmic site transfer products. This decision was based on the cost of the ANDAs versus the future incremental profit to be derived from the sales of these products, given changed market conditions. This change in estimate was also based on the Company's recent decision to enter into the injectable distribution marketplace and the need to redeploy R&D resources for the pursuit of injectable ANDAs. The total amount of the accrual reversed was approximately $316,000 and is included as a reduction in S,G&A expenses. During the quarter ended March 31, 1995, the Company, based on evaluations made by management, changed the estimated liability related to aged customer credits. This resulted in a reduction in S,G&A expenses of approximately $330,000.
The decline in S,G&A expenses as a percentage of net sales, in spite of the decrease in sales from 1995 to 1996, is primarily due to the decision to eliminate approximately $1 million to $1.5 million of S,G&A expenses and other manufacturing operating expenses in response to a slowing in sales growth during the third quarter of fiscal 1995.
Selling, general and administrative expenses as a percentage of net sales declined 3.1 percentage points from 30.8% in 1994 to 27.7% in 1995 primarily due to the Company's operating leverage and the increase in net sales from 1994 to 1995.
Research and Development
R&D expense increased 36% in 1996 as compared to 1995. This increase was primarily attributable to the increase in R&D associated with the recently acquired operations of PRL. Prior to fiscal 1996, PRL had very little R&D expense. Research and development expense was relatively flat in 1995 as compared to 1994. In 1995, the Company maintained a stable mix of new ophthalmic ANDAs and site-transfers from its previous manufacturing facility in Los Angeles.
Throughout 1995 and the first half of 1996, the Company incurred R&D costs associated with its NDA for the over-the-counter version of AK- Con-A in connection with the licensing arrangement with Pfizer. This NDA was approved in January 1996. Costs associated with this NDA have been capitalized in connection with the long-term contract for manufacturing and royalty rights. The Company also continued its work on an NDA for the ophthalmic NSAID Piroxicam licensed from Pfizer. The first $1 million of costs associated with this NDA are offset by funds obtained from Pfizer. Total cash expenditures for all research and development activities were approximately $1.9 million, $1.7 million and $1.4 million in 1996, 1995 and 1994, respectively.
As noted above, with the acquisition of PRL, the Company expects to increase its mix of injectable Category B and ANDA products. PRL had several ANDA filings in process through joint venture arrangements. Some of these arrangements have continued subsequent to the acquisition and some of the projects have been brought in house. The Company has also continued to develop other injectable products for manufacture by Taylor. Several of the products currently marketed and distributed by the injectable distribution segment do not require FDA approval and production of such products will be transferred to the Taylor facilities as soon as practicable
Acquisition and Severance Costs
In connection with the merger of PRL and Taylor, the Company recorded certain charges in the fourth quarter of fiscal 1996 for transaction costs ($110,000) and transitional costs ($568,000) associated with the realignment of the Company into two separate reporting divisions. The transaction costs include legal, accounting and other directly related acquisition costs. Transitional costs consist primarily of provisions for severance related costs.
Operating Income
Operating income in 1996 of $1.1 million or 3.2% of sales was 72% lower than 1995 operating income of $3.9 million. The decline in operating income for 1996 is attributable to several factors noted above. These include acquisition and severance costs, the loss of high-margin sales of AK-Con-A, the Company's decision to discontinue wholesaler discounting practices in the fourth quarter, and the changes in estimate noted above. In addition, the overall reduction in gross margins for the Company, primarily associated with increased price sensitivity for ophthalmic generic pharmaceuticals, reduced operating margins.
Operating income in 1995 was $3.9 million or 10.4% of sales compared to the 1994 amount of $2.7 million or 8.5% of sales. The increase in 1995 operating income was primarily the result of increased sales and operating leverage, coupled with stable research and development expenses. The sales increase was somewhat offset by the decline in gross margin resulting from cost increases of products distributed but not manufactured and continued price sensitivity in the generic ophthalmic pharmaceutical market.
Interest and Other Income (Expense)
Net interest and other expense declined $60,000 from 1995 to 1996. During these periods, interest income remained relatively constant. Interest expense increased significantly in 1996 to $441,000 as compared to $25,000 in 1995. Most interest expense in 1995 was capitalized in connection with construction at Taylor's facilities in Decatur, Illinois. The increase in interest expense in 1996 was offset by a gain on the sale of marketable equity securities of $80,000. In 1995, a $308,000 decline in market value of an equity investment was determined to be other than temporary. This determination was based on the significant deterioration in the value of the investment and the evaluation that a price recovery was not imminent.
From 1994 to 1995, net interest and other expense increased $91,000. During these periods, interest income remained relatively constant. Interest expense declined in 1995 from $181,000 to $25,000. As noted above, the majority of interest expense in 1995 was capitalized. The loss of $308,000 related to the decline in market value of an equity investment more than offset the decline in interest expense.
Income Taxes
The Company's consolidated effective income tax rate was 19.3%, 33.0% and 6.1% for 1996, 1995 and 1994, respectively. The effective rate for 1996 varies from the statutory rates primarily due to the inclusion of net income for PRL prior to the acquisition date as a result of the pooling of interests. PRL was a Subchapter S corporation and therefore was not subject to corporate income taxes. The effects of pre- acquisition earnings or loss of PRL did not have a material effect on the 1995 or 1994 effective rate since such income or loss was immaterial to consolidated pretax income.
The effective rate for 1994 varies from the statutory rates primarily due to the effects of adoption of Statement of Financial Accounting Standards Board (SFAS) No. 109, "Accounting for Income Taxes," effective July 1, 1993. Under SFAS 109, the Company was able to recognize estimated future tax benefits attributable to expenses recorded for book purposes but not currently deductible for tax purposes. In July 1993, the Company recorded a net deferred tax asset in the amount of $896,000 along with a 100% valuation reserve to reflect the uncertainties surrounding the ultimate realization of the benefits. In the fourth quarter of fiscal 1994, the Company decided to reverse the entire remaining balance of the valuation reserve since uncertainties regarding the ultimate realization of the benefits were reduced to a relatively low level. This resulted in the recording of a $384,000 ($.03 cents per share) benefit in the fourth quarter.
Net Income
Net income declined $1.7 million or $.10 cents per share in 1996 from $2.5 million or $.15 cents per share in 1995. The decline in sales along with certain unusual, infrequently occurring adjustments noted previously, including acquisition and severance costs, and certain other changes in accounting estimates, are the primary reasons for the decline in net income.
Net income increased $100,000 or $.01 cent per share from $2.4 million or $.14 cents per share in 1994 to $2.5 million or $.15 cents per share in 1995. This marginal increase, in spite of the significant increase in operating income in 1995, is due to the lower effective tax rate incurred in 1994 as a result of the adoption of SFAS 109 and full realization of the benefit of deferred tax assets.
FINANCIAL CONDITION AND LIQUIDITY
Management assesses the Company's liquidity by its ability to generate cash to fund its operations. The significant components in managing liquidity are: funds generated by operations; levels of working capital items including accounts receivable, inventories, wholesaler chargeback accruals and accounts payable; capital expenditure and debt repayment requirements; adequacy of available lines of credit; and availability of long-term capital at competitive prices. In December 1996, the Company successfully obtained the restructuring of its existing debt facilities. The restructuring , which was completed in March 1997, included the following:
* an increase in the current working capital line of credit from $2.5 million to $3.0 million * a consolidation of all term debt into one note, with an increase in available term funding from $1.2 million to $2.0 million, resulting in maximum term financing of $7 million * reduction in the interest rate on all the facilities to prime rate * postponement of principal repayments on the term facility until January 1998 * Restructuring of loan covenants based on current financial condition and cash flow of the Company
With this restructuring in place, the Company is confident that it can meet its capital requirements for 1997.
The Company traditionally has generated cash from operations in excess of working capital requirements. The net cash provided by operating activities was $2.5 million for the six months ended December 31, 1996. For the twelve months ended June 30, 1996, 1995 and 1994, net cash provided by operating activities was $10,000, $712,000, and $2.2 million, respectively. The increase in cash provided by operating activities for the six months ended December 31, 1996 is primarily related to the increase in accruals for wholesaler chargebacks (see Note A to the financial statements). This increase in the chargeback accrual is primarily related to the Janssen product line which has a significant price difference between the wholesale price and the majority of contract prices for the products. This accrual has stabilized as of December 31, 1996.
The decline in cash provided from operating activities in 1996 and 1995 is primarily related to the increase in inventory associated with new product additions and a continual increase in the amount of products produced in-house which require Akorn to inventory related raw materials and components. Also in 1996, the majority of new contract manufacturing business requires that the Company inventory raw materials and components. In 1995, cash provided from operations was also negatively impacted by a decrease in the average days outstanding for payables. This decline was due to more timely payments to vendors by the Company resulting from the availability of working capital credit lines.
The Company recently announced that it would be moving its Corporate offices and the majority of its Ophthalmic Distribution offices to Lincolnshire, Illinois. The costs of this relocation, for which a charge will be made in the quarter ended March 31, 1997, are estimated to be in the range of $850,000 to $950,000 after taxes. These costs include severance, asset write downs and relocation costs, the cash portion of which are expected to be financed by current cash, available lines of credit, and operating cash flows. In 1997, the Company will also continue to fund the development of the NDA for Piroxicam discussed previously which will be funded primarily from funds received from Pfizer.
In addition to these short-term needs, the Company will be required to make payments of additional interest and taxes, currently estimated to be approximately $300,000 to $400,000, in connection with the anticipated settlement of the IRS appeal discussed above. The timing of the payment of this settlement will be based on the length of the Joint Committee approval process. Also, in connection with the Janssen product line acquisition, the Company is required to provide certain products to Janssen in 1997, at no cost, estimated not to exceed $100,000, should certain contingent events occur.
Net cash utilized for investing activities during the six month period ended December 31, 1996 of approximately $2.0 million, includes $2.0 million of property, plant and equipment additions, primarily for equipment acquired for the Janssen products, and $340,000 for the allocated portion of the product line itself. These additions were partially offset by net sales of investments of $326,000. The remainder of these investing activities were funded through $1.5 million of bank financing. The Company has plans for capital improvements of $1.5 million to $2 million in 1997. These improvements are for both requirements to meet current FDA and DEA regulations as well as upgrades to the Company's management information systems. These improvements will be financed through available term debt financing through the Company's prime banking institution.
The Company used net cash of $36,000 in its financing activities during the six months ended December 31, 1996, as principal repayments on capital leases, and both long-term and short-term debt slightly exceeded the $1.5 million of borrowings for the Janssen product line acquisition.
SELECTED QUARTERLY DATA
In Thousands, Except Per Share Amounts
All of the information shown in the table above for the two years ended June 30, 1996 has been restated to reflect the combined operations of Akorn and PRL. For information regarding unusual, infrequently occurring or year end adjustments, see notes B, E and P to the financial statements included in Item 8
Item 8. Financial Statements and Supplementary Data.
The following financial statements are included in Part II, Item 7 of this Form 10-K.
Report of Independent Auditors.............................................. 18 Consolidated Balance Sheets as of December 31, 1996 and June 30, 1996 and 1995.................................................................... 19 Consolidated Statements of Operations for the six months ended December 31, 1996 and for the years ended June 30, 1996, 1995 and 1994............... 20 Consolidated Statements of Shareholders' Equity for the six months ended December 31, 1996 and for the years ended June 30, 1996, 1995 and 1994...... 21 Consolidated Statements of Cash Flows for the six months ended December 31, 1996 and for the years ended June 30, 1996, 1995 and 1994............... 22 Notes to Consolidated Financial Statements.................................. 23
Report of Deloitte & Touche LLP
Independent Auditors
To the Board of Directors and Shareholders of
Akorn, Inc.
We have audited the accompanying consolidated balance sheets of Akorn,
Inc. and subsidiaries as of December 31, 1996, and June 30, 1996 and
1995, and the related consolidated statements of operations,
shareholders' equity, and cash flows for the six months ended December
31, 1996 and for each of the three years in the period ended June 30,
1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material aspects, the financial position of Akorn, Inc. and
subsidiaries at December 31 1996, and June 30, 1996 and 1995, and the
results of their operations and their cash flows for the six months
ended December 31, 1996 and for each of the three years in the period
ended June 30, 1996 in conformity with generally accepted accounting
principles.
As discussed in Note O to the consolidated financial statements, the
Company changed its method of accounting for income taxes in 1994.
Also, as discussed in Note E to the consolidated financial statements,
the Company changed its method of accounting for certain investments in
debt and equity securities in 1995.
New Orleans, Louisiana
March 7, 1997
AKORN, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
AKORN, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except per Share Data)
AKORN, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In Thousands)
AKORN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in Thousands)
Notes to Consolidated Financial Statements
Akorn, Inc.
Note A - Summary of Significant Accounting Policies
Consolidation: The accompanying consolidated financial statements include the accounts of Akorn, Inc. (the Company) and its wholly owned subsidiaries, Spectrum Scientific Pharmaceuticals, Inc. (Spectrum), Walnut Pharmaceuticals, Inc. (Walnut) and Akorn Manufacturing, Inc., doing business as Taylor Pharmaceuticals (Taylor). Intercompany transactions and balances have been eliminated in consolidation.
The Company acquired Pasadena Research Laboratories, Inc. (PRL) effective May 31, 1996 in a business combination accounted for as a pooling of interests. The acquired operations of PRL were merged into Taylor's operations subsequent to the acquisition (see Note B). Accordingly, all financial information presented has been restated to include the operations of PRL.
Change in Fiscal Year End: Effective July 1, 1996, the Company changed its fiscal year end from June 30 to December 31. The following table sets forth the results of operations for the transition period ended December 31, 1996 and the unaudited results of operations for the six months ended December 31, 1995, the prior period comparable to the transition period:
(Unaudited) Six Months Six Months Ended Ended December 31 December 31 1996 1995 ________________________________________ (in thousands, except per share amounts)
Net sales $ 16,519 $ 16,949 Gross profit 5,758 6,477 Income before income taxes 70 1,289 Provision for income taxes 26 493 Net income 44 796 Net income per share $ - $ .05
Revenue Recognition: The Company recognizes sales upon the shipment of goods.
Cash Equivalents: The Company considers all highly liquid investments with a maturity of three months or less, when purchased, to be cash equivalents.
Investments: Effective July 1, 1994, the Company adopted Statement of Financial Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities." The Company records short- term and long-term investments under the provisions of this Statement (see Note E).
Inventory: Inventory is stated at the lower of cost (average cost method) or market (see Note G). Provision is made for slow-moving, unsalable and obsolete items.
Intangibles: Intangibles consist primarily of product licensing costs which are capitalized at cost and amortized on the straight-line method over the lives of the related license periods, which range from 5 years to 15 years. For the six month period ended December 31, 1996, amortization expense was $54,001. Amortization expense for the years ended June 30, 1996, 1995 and 1994 was $53,328, $144,820 and $82,143, respectively. Accumulated amortization at December 31, 1996 and June 30, 1996 and 1995 was $323,829, $269,828 and $216,500, respectively.
Property, Plant and Equipment: Property, plant and equipment are 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 and leasehold improvements, furniture and equipment, and automobiles are approximately 30, 8, and 5 years, respectively. Depreciation expense for the six months ended December 31, 1996 and for the years ended June 30, 1996, 1995 and 1994 was $650,629, $896,537, $800,330 and $559,321, respectively.
Under an agreement with Pfizer, Inc. (see Note I) the Company received reimbursement for the purchase of certain equipment. The total amount reimbursed was approximately $593,000, which was received by June 30, 1995. The Company accounted for these reimbursements by reducing its carrying value of the associated equipment.
Accrual for Chargebacks: The Company records an estimate for the difference between gross sales of certain products to wholesalers and expected resales of such products under contractual arrangements with third parties such as hospitals and group purchasing organizations as a reduction of sales. As part of the Company's sale terms with wholesalers, it agrees to reimburse wholesalers for such differentials between wholesale prices and contract prices. The portion of this accrual which relates to wholesaler sales that have not yet been collected is reported as a reduction to accounts receivable. The portion of this accrual which relates to wholesaler sales which have been collected is reported as a liability in the balance sheet. For the products acquired from Janssen (Note D), the wholesale price is significantly greater than the contract prices. Accordingly, the liability for accrued chargebacks increased significantly at December 31, 1996.
Interest Capitalization: The Company capitalizes interest during periods of construction of qualifying assets. For the six months ended December 31, 1996 and for the year ended June 30, 1995, the Company capitalized interest costs of $39,880 and $282,007, respectively relating to construction. No interest was capitalized during years ended June 30, 1996 or 1994.
Stock-Based Compensation: Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compansation," (SFAS 123) encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. The Company has chosen to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and related interpretations and has adopted the disclosure-only provisions of SFAS 123. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company's stock at the date of the grant over the amount an employee must pay to acquire the stock. See Note L.
Income Taxes: Deferred income taxes are provided in the financial statements, where necessary, to account for the tax effects of temporary differences resulting from reporting revenues and expenses for income tax purposes in periods different from those used for financial reporting purposes. The temporary differences result primarily from the use of different methods of accounting for depreciation and amortization, provisions for bad debts, inventory reserves and accrued reorganization and severance costs, and pre-funded development costs.
Fair Value of Financial Instruments: The carrying value of the Company's financial instruments, including cash, short-term investments, receivables, payables, and certain accrued liabilities approximate fair market value due to their short-term nature. The fair value of the Company's long-term debt at December 31, 1996 and June 30, 1996 and 1995, based upon available market information, approximated its carrying value.
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 from those estimates.
Note B - Acquisition of Pasadena Research Laboratories, Inc.
On May 31, 1996, the Company acquired Pasadena Research Laboratories, Inc. in a business combination accounted for as a pooling of interests. PRL is a specialized distributor of injectable pharmaceuticals. Pursuant to the merger agreement, the Company issued 1.4 million shares of its common stock in exchange for all of the outstanding shares of PRL. As part of the acquisition, PRL was merged into the operations of Taylor and the Company was realigned into two separate reporting divisions, an ophthalmic division and an injectable division.
The Company's financial statements for each of the three years in the period ended June 30, 1996, as contained herein, have been restated to include the results of PRL for all periods presented. Combined and separate results of operations of the Company and PRL during the periods preceding the merger are presented below.
Akorn PRL Combined _________________________________ (in thousands) Eleven months ended May 31, 1996 (unaudited): Net sales $ 27,361 $ 3,684 $ 31,045 Net income 675 409 1,084
Fiscal year ended June 30, 1995: Net sales 32,863 4,642 37,505 Net income 2,280 226 2,506
Fiscal year ended June 30, 1994: Sales 28,404 2,862 31,266 Net income (loss) 2,721 (306) 2,415
The combined financial results presented above include no significant adjustments to conform the accounting policies of the two companies.
In connection with the merger, the Company recorded certain charges in the fourth quarter of the fiscal year ended June 30, 1996 for transaction costs ($109,534) and transitional costs ($567,772) associated with the realignment of the Company into two separate reporting divisions. The transaction costs include legal, accounting and other directly related acquisition costs. Transitional costs consist primarily of provisions for severance related costs.
Note C - Reorganization of Manufacturing Operations
On January 15, 1992, the Company acquired Akorn Manufacturing, Inc., which does business as Taylor Pharmaceuticals (Taylor), in a business combination accounted for as a pooling of interests. Taylor is a contract manufacturer of sterile pharmaceuticals, which it produces and delivers pursuant to contracts with third parties.
As part of the acquisition, the Company paid a finder's fee to an affiliate of Dr. John N. Kapoor, Chairman of the Board (the affiliate). This finder's fee was in the form of 250,000 shares of Company Common Stock valued at $3.50 per share. Of the total shares issued, 125,000 were subject to forfeiture if the market price of the Company's Common Stock did not reach at least $5.00 per share by January 15, 1996. In August 1995, the Company, the affiliate and Dr. Kapoor entered into an agreement under which (i) the forfeiture period was extended to January 15, 1998, (ii) forfeiture would not occur in the event that persons unaffiliated with Dr. Kapoor acquire beneficial ownership of more than 50% of the outstanding common stock of the Company and (iii) Dr. Kapoor waived his right to receive $40,000 otherwise payable to him by the Company for serving as Chairman of the Board in fiscal 1996.
Following the Taylor acquisition, the Company began the process of transferring the manufacture of its product line from previously-owned manufacturing facilities to the Taylor facility. At that time, the Company estimated the cost of completing the FDA approval process at Taylor for products previously manufactured elsewhere and recorded a provision for reorganization costs.
As of December 31, 1996 and June 30, 1996 and 1995, the balances remaining in accrued reorganization costs associated with the transfer process were $108,000, $306,000 and $727,000, respectively. It is anticipated that the filing of all such product approvals will be completed by the end of 1997.
Note D - Acquisition of Injectable Product Line
Effective July 1, 1996, the Company entered into an agreement with Janssen Pharmaceutica, Inc. (Janssen) to acquire the rights to distribute an injectable product line in the anesthesia/analgesia area. As part of this agreement, the Company also acquired certain high-speed inspection equipment. Pursuant to the agreement, the acquisition transfers ownership of the NDAs for the three products, as well as the trade names and trademarks in the United States. In exchange for these product licenses and equipment, the Company paid Janssen $1.6 million on the effective date of the agreement which was financed primarily through a $1.5 million credit facility with the Company's commercial bank. In accordance with the agreement, Akorn will be required to provide certain other products to Janssen, at no cost, having a value expected not to exceed $100,000. The portion of the acquisition costs allocated to the acquired products ($340,000) will be amortized over 15 years.
Note E - Investments
Effective July 1, 1994, the Company adopted Statement of Financial Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities". This Statement requires certain securities to be classified into one of three reporting categories (held-to- maturity, available-for-sale or trading). The Company completed a review of its securities relative to SFAS 115 and classified its investments in debt securities as held-to-maturity. As of June 30, 1996 and 1995, investments of $902,000 and $1,439,000, respectively include U.S. government securities and municipal bonds which have contractual maturities within one year and are being reported at amortized cost, which approximates fair market value.
The Company classified its investment in equity securities as available-for-sale, requiring that they be carried at fair value with any unrealized gain or loss reflected as a component of shareholders' equity. Such investments had a fair market value of approximately $130,000 at June 30, 1995. The Company held no equity investments at December 31, 1996 or June 30, 1996.
At June 30, 1994, the cost of the Company's marketable equity securities exceeded the market value by $32,044. Therefore, a valuation allowance was established by a charge to shareholders' equity representing the net unrealized loss. During fiscal 1995, this allowance was increased by $275,661 due to the continuous decline in market value. At March 31, 1995, management determined the loss to be permanent given the significant decline in market value since June 30, 1994 and the unlikelihood of a recovery in value. Therefore, the $307,705 unrealized loss previously charged to shareholders' equity was accounted for as a realized loss in the 1995 statement of operations. At June 30, 1995, the market value of the marketable equity securities exceeded the adjusted cost, subsequent to the write-down noted above, by $87,397; therefore, an unrealized gain was recorded as a component of shareholders' equity to reflect this increase in value. During fiscal 1996, the Company sold its investment in marketable equity securities for an amount in excess of adjusted cost. Accordingly, the unrealized gain previously charged to shareholders' equity was reversed and a realized gain of $79,859 was recorded in the 1996 statement of operations.
Note F - Allowance for Uncollectibles The activity in the allowance for uncollectibles is as follows for the periods indicated:
Note G - Inventory
The components of inventory are as follows:
December 31 June 30 1996 1996 1995 __________________________________________ (in thousands) Finished goods $ 5,181 $ 5,376 $ 4,239 Work in process 1,375 1,311 1,043 Raw materials and supplies 2,282 2,173 1,194 __________________________________________ $ 8,838 $ 8,860 $ 6,476 ==========================================
Inventory at December 31, 1996 and June 30, 1996 and 1995 is reported net of reserves of $589,007, $681,920 and $352,143, respectively, for slow-moving, unsalable and obsolete items.
The activity in the inventory reserve is as follows for the periods indicated:
Six months ended December 31 Years ended June 30 1996 1996 1995 1994 __________________________________________________ (in thousands)
Balance at beginning of year $ 682 $ 352 $ 290 $ 427 Provision for slow-moving, unsalable and obsolete items 279 701 100 7 Inventory written off (372) (371) (38) (144) _________________________________________________
Balance at end of year $ 589 $ 682 $ 352 $ 290 =================================================
Note H - Property, Plant and Equipment
Property, plant and equipment consists of the following:
December 31 June 30 1996 1996 1995 ____________________________________________ (in thousands) Land $ 479 $ 479 $ 479 Buildings and leasehold improvements 8,217 7,738 5,516 Furniture and equipment 11,238 10,139 7,880 Automobiles 135 166 133 ______________________________________________ 20,069 18,522 14,008 Accumulated depreciation (8,415) (7,771) (6,875) ______________________________________________ 11,654 10,751 7,133 Construction in progress 1,179 773 3,927 ______________________________________________ $ 12,833 $ 11,524 $11,060 ==============================================
Note I - Pre-Funded Development Costs
In April 1994, the Company entered into a series of agreements with Pfizer Inc. (Pfizer) regarding the cross-licensing of several ophthalmic pharmaceutical products. Under this arrangement Akorn granted a license to Pfizer on an Akorn product then under development (the licensed product), and agreed to provide manufacturing services and marketing assistance for the licensed product. In exchange, Akorn received (1) a royalty stream on sales of the licensed product, (2) an exclusive, royalty-free license to manufacture and market a Pfizer prescription ophthalmic non-steroidal anti-inflammatory drug (NSAID), and (3) non- exclusive rights to market an existing Pfizer ophthalmic antibiotic.
As part of this agreement, in fiscal 1994 Pfizer paid the Company an advance of $1 million to be used to fund the costs of developing the NSAID, which are estimated at $1.8 million. The Company intends to recognize the pre-funded balance as an offset to development costs as these expenses are incurred. During the six months ended December 31, 1996 and during fiscal 1996 and 1995, the Company incurred $138,829, $297,463 and $29,012, respectively, of development costs which were charged against the pre-funded balance. The Company's current projections indicate that the remaining costs of development will be paid over the next 15 - 18 months.
In addition, the agreement stipulated that Pfizer would reimburse Akorn for one-half of the costs to obtain FDA approval on the licensed product, including the cost of certain agreed upon equipment acquisitions required for the manufacturing of the licensed product. A New Drug Application (NDA) was filed for the licensed product on June 8, 1994. During the year ended June 30, 1996, the Company obtained FDA approval of the NDA for the licensed product. Therefore, in accordance with the agreement, Pfizer paid the Company an advance royalty of $1 million for the initial year sales of the licensed product. The Company is recognizing this deferred revenue balance over a one year period beginning in March 1996.
Note J - Financing Arrangements
The Company's short-term borrowings are summarized as follows:
The $2.5 million Line of Credit and the short-term note payable are pursuant to the credit facility amended during fiscal 1996 as further described below.
Long-term debt consists of:
In September 1992, the Company entered into an agreement to obtain up to $2.5 million of credit financing from the John N. Kapoor Trust (the Trust), an affiliate of John N. Kapoor, Chairman of the Board. Under the terms of the agreement, the Trust, which held warrants to purchase 2 million shares of stock at prices ranging from $1.50 to $2.00 through November 15, 1995, was required to exercise 1,666,667 of those warrants at $1.50 per share on or prior to November 15, 1993. On that date, the Trust exercised the entire two million warrants for a total of $3 million, of which $1.6 million was used to repay debt to the Trust and the remaining $1.4 million was received in cash. Interest expense related to this indebtedness was $61,334 in 1994.
As part of the September 1992 arrangement, the Company granted a new warrant to the Trust to purchase an additional 1 million shares at $2.00 per share, exercisable for five years. Upon the issuance of this warrant, Dr. Kapoor became entitled to designate an additional individual as a director of the Company.
In 1995 the Company entered into a $6.3 million loan agreement with First National Bank of Commerce to obtain financing for the expansion of its manufacturing facilities in Decatur, Illinois and to refinance existing debt. During fiscal 1996, the loan agreement was amended to provide additional financing and to adjust the interest rate and principal payment requirements for certain facilities. The amendments increased the total loan commitment to $10.1 million including: (1) $2.6 million Term loan, (2) $1.3 million Term loan, (3) $2.5 million Line of Credit, (4) $1.5 million Term loan for financing of Janssen acquisition, (see Note D), (5) $1.6 million Revolver/Term loan, and (6) $600,000 short-term financing for IRS settlements (see Note O).
In March 1997, the loan agreement was further amended with an effective date of December 31, 1996. This amendment provided for (1) the consolidation of the term facilities into one revolver/term loan of $7 million, (2) the deferral of principal payments on the revolver/term loan until January 1998, (3) an increase in the line of credit to $3.0 million, and (4) the reduction in the interest rate on all facilities to prime rate. As of December 31, 1996, $2 million remained available to be drawn under the revolver/term loan.
Borrowings under the loan agreements are collateralized by substantially all of the Company's receivables, inventory and property, plant and equipment. In addition, the Company is required to comply with positive and negative loan covenants, including restrictions on the payment of dividends and maintenance of specified financial covenants, including minimum net worth and working capital. Accordingly, as of December 31, 1996, the Company is prohibited from paying dividends without the prior approval by the bank.
Note K- Leasing Arrangements
The Company leases certain equipment under capital leasing arrangements which expire through the year 2000.
Property, plant and equipment includes the following amounts relating to such capital leases:
December 31 June 30 1996 1996 1995 ____________________________________________ (in thousands)
Furniture and equipment $ 806 $ 806 $ 100 Less accumulated depreciation (226) (147) (53) _____________________________________________ 580 659 47 Construction in progress - - 706 _____________________________________________ $ 580 $ 659 $ 753 =============================================
Depreciation expense provided on these assets was $78,517, $94,254, $25,822 and $18,833 for the six months ended December 31, 1996 and for the years ended June 30, 1996, 1995 and 1994, respectively.
The following is a schedule by years of future minimum lease payments under these capital leases together with the present value of the net minimum lease payments (in thousands).
Years ending December 31:
1997 $ 186 1998 173 1999 173 2000 43 ___________ Total Minimum Lease Payments 575 Less: Amount Representing Interest (71) ___________ Present Value of Net Minimum Lease Payments $ 504 ===========
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 $38,051, $73,196, $169,825 and $198,072 for the six month period ended December 31, 1996 and for the years ended June 30, 1996, 1995 and 1994, respectively. During fiscal 1993, the Company entered into a sublease agreement for one of its leased facilities. Sublease rentals were $113,326 and $111,164, respectively, for fiscal years ended June 30, 1995 and 1994. This agreement expired effective May 1995, in conjunction with the expiration of the primary lease.
The following is a schedule by years of future minimum rental payments required under these non-cancelable operating leases (in thousands).
Years ended December 31:
1997 $ 49 1998 19 1999 8 ___________ Total Minimum Payments Required $ 76 ===========
Note L - Stock Options and Warrants
The Company has two stock option plans and one stock purchase plan. The first stock option plan is the 1988 Incentive Compensation Program (the Incentive Program). Under the Incentive Program any officer or key employee of the Company is eligible to receive options when designated by the Company's Board of Directors. As of December 31, 1996, the number of shares of the Company's Common Stock which may be issued under the Incentive Program upon the exercise of options may not exceed 2,000,000 shares. This maximum allowable shares was increased to 3,000,000 shares by way of vote of shareholders effective February 28, 1997. The exercise price of the options granted under the Incentive Program will be determined by the Board of Directors but may not be less than 50% of the fair market value of the shares subject to the option on the date of grant. All options granted under the Incentive Program during the six months ended December 31, 1996 and the years ended June 30, 1996, 1995 and 1994 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.
The second stock option plan is the Akorn, Inc. Stock Option Plan for Directors (the Directors' Plan). The Directors' Plan provides for the grant of nonqualified options to persons elected as directors of the Company at the fair market value of the shares subject to option on the date of grant. The total number of shares of the Company's Common Stock for which stock options may be granted under the Directors' Plan may not exceed 500,000 shares. 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, 1996 and June 30, 1996, 1995 and 1994 and changes during the six months ended December 31, 1996 and the years ended June 30, 1996, 1995 and 1994 is presented below (shares in thousands):
The fair value of each option granted during the six months ended December 31, 1996 and the fiscal year ended June 30, 1996 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 28%, (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, 1996 (shares in thousands):
In accordance with APB 25 no stock-based expense was recorded during any of the periods presented herein. Had compensation cost for the Company's grants for stock-based compensation plans for the six months ended December 31, 1996 and the fiscal year ended June 30, 1996 been determined consistent with SFAS 123, the Company's net income and net income per share for these respective periods would approximate the following proforma amounts (in thousands, except per share data):
Six months ended Years ended December 31, 1996 June 30, 1996 __________________________________________ As As Reported Proforma Reported Proforma ________ _________ _________ _________
Net income, (loss) $ 44 $ (40) $ 788 $ 769 ======== ========= ========= ========= Net income per share $ - $ - $ .05 $ .05 ======== ========= ========= =========
In addition to these plans, the Company has issued a total of 3 million warrants ranging from $1.50 to $2.00 per share, in connection with several transactions (See Note J). As of December 31, 1996, 1 million of these warrants remain outstanding and exercisable at $2.00 per share.
Note M - Employee Stock Purchase Plan
All employees who have been employed by the Company for twelve continuous months are eligible to participate in the Akorn, Inc. Employee Stock Purchase Plan (the Purchase Plan). Participating employees may elect to contribute up to 15% of their gross compensation towards the purchase of the Company's Common Stock. At the end of each quarter, the amount contributed is applied to acquire, on behalf of the participating employees, the Company's Common Stock at a purchase price equal to 85% of the current market price. A maximum of 1,000,000 shares of the Company's Common Stock may be acquired under the terms of the Purchase Plan. Purchases of shares were issued from treasury stock under the Purchase Plan and amounted to 18,000, 56,000, 72,000, and 58,000 shares, respectively, during the six months ended December 31, 1996 and the years ended June 30, 1996, 1995 and 1994.
Note N - Earnings Per Share
Earnings per share is based upon the weighted average number of common shares outstanding. The computation of the weighted average number of shares outstanding includes the effect of dilutive stock options and warrants using the treasury stock method. The weighted average number of shares outstanding used in the per share computations was 16,763,740, 16,787,635, 16,799,350 and 16,710,885 shares for the six month period ended December 31, 1996 and for the years ended June 30, 1996, 1995 and 1994, respectively.
Note O - Income Taxes
Effective July 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." This standard requires recognition of future tax benefits, attributable to deductible temporary differences between the financial statement and income tax bases of assets and liabilities, to the extent that realization of such benefits is more likely than not. Financial statements of prior years were not restated and the cumulative effect of the accounting change was not material due to the uncertainties that existed at July 1, 1993 concerning the ultimate realization of future tax benefits. As indicated at Note P, uncertainties regarding the ultimate realization of future tax benefits were reduced to a relatively low level by the fourth quarter of fiscal 1994, thereby justifying removal of the valuation allowance applicable to the deferred tax asset.
The components of income tax expense (benefit) are as follows:
Six months ended December 31 Years ended June 30 1996 1996 1995 1994 ________________________________________________ (in thousands)
Current: Federal $(557) $ 756 $ 1,177 $ 481 State (68) 11 53 61 ________________________________________________ (625) 767 1,230 542 ________________________________________________ Deferred: Federal 581 (516) 2 (343) State 70 (62) - (41) _________________________________________________ 651 (578) 2 (384) _________________________________________________ $ 26 $ 189 $ 1,232 $ 158 =================================================
A reconciliation of income tax expense at the federal statutory rate to income tax expense at the Company's effective rate is as follows:
Six months ended December 31 Years ended June 30 1996 1996 1995 1994 _______________________________________________ (in thousands)
Computed tax expense at expected statutory rate $ 24 $ 332 $ 1,271 $ 875 State income tax expense, net of federal tax benefits 2 4 32 41 Pre-merger (earnings) loss of PRL - (139) (84) 98 Change in valuation allowance applicable to deferred tax assets - - - (896) Other - (8) 13 40 _______________________________________________
Income tax expense $ 26 $ 189 $ 1,232 $ 158 ______________________________________________ Effective tax rate 37.1% 19.3% 33.0% 6.1% ==============================================
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities are as follows:
December 31 June 30 1996 1996 1995 _______________________________________ Deferred Tax Assets: (in thousands) Reserves for reorganization costs not currently deductible $ 40 $ 118 $ 376 Other reserves not currently deductible 711 658 380 Difference between book and tax bases of intangible assets - 436 43 Pre-funded development costs 253 305 - Other 132 133 103 _______________________________________ Total 1,136 1,650 902
Deferred Tax Liabilities: Difference between book and tax bases of property, plant and equipment $ (537) $ (478) $ (367) Difference between book and tax bases of intangible assets (99) Other (191) (212) (153) ________________________________________ Total (827) (690) (520) ________________________________________ Net deferred tax asset $ 309 $ 960 $ 382 ========================================
The net deferred tax asset is classified in the accompanying balance sheets as follows:
December 31 June 30 1996 1996 1995 ___________________________________ (in thousands)
Deferred income tax asset-current $ 1,101 $ 1,157 $ 709 Deferred income tax liability non-current (792) (197) (327) ____________________________________ $ 309 $ 960 $ 382 =====================================
Income taxes refunded during the years ended June 30, 1996 and 1994 were $178,690 and $282,641, respectively.
The Company has reached a preliminary settlement with the Internal Revenue Service (IRS) regarding proposed adjustments made during the examination of tax returns for the periods of 1988 through 1993 which the Company has been appealing. These proposed adjustments primarily related to the timing of deductions taken for tax purposes in connection with the reorganization of the Company's manufacturing operations in 1991. The preliminary settlement which has been obtained through the appeals process must be approved by the Joint Committee of the IRS. Adjustments to reflect the proposed settlement have been made in previous financial statements.
Note P - Changes in Accounting Estimates
During the fourth quarter of the year ended June 30, 1996, the Company revised its estimate for recording chargeback accruals. As a result, a reduction in net sales of $250,000 ($.01 per share, net of tax) was recorded during the quarter ended June 30, 1996.
In addition, during the quarters ended March 31, June 30 and December 31, 1996, the Company increased its estimate for unsaleable inventory by approximately $300,000 ($.01 per share, net of tax), $200,000 ($.01 per share net of tax), and $260,000 ($.01 per share net of tax), respectively. These changes in estimate are reported as an increase in cost of goods sold.
In the quarter ended March 31, 1996, the Company decided to no longer pursue Abbreviated New Drug Applications (ANDAs) for certain products which had been produced in previously-owned facilities (transferred products), and for which estimated costs of transferring such ANDAs had been accrued. This decision was based on a reevaluation of the costs of developing such products as compared to their potential market, given the emergence of alternate suppliers, since the Company suspended their production. This change in estimate was also based on the Company's decision to enter into the injectable distribution marketplace and the need to redeploy R&D resources for the pursuit of injectable ANDAs. The total amount of the accrual reversed was approximately $316,000 ($.01 per share, net of tax). In addition, in the quarter ended December 31, 1996, the Company decided not to pursue exclusive raw material source arrangements on one transferred product. This resulted in a reduction of the estimated cost of transferring this product by approximately $200,000 ($.01 per share, net of tax).
During the quarter ended March 31, 1995, an evaluation by the Company resulted in a change in the estimated liability related to aged customer credits. This change resulted in a reduction of S,G&A expenses of approximately $330,000 ($.01 per share, net of tax) for the quarter ended March 31, 1995.
As a consequence of sustained growth in sales and profitability, in particular during the latter part of the year, the Company recorded a reduction of $384,298 ($.03 per share, net of tax) to its valuation allowance for deferred tax assets in the fourth quarter of fiscal 1994.
Note Q - Supplemental Disclosures of Cash Flow Information
The following is a summary of supplemental cash flow and non-cash investing and financing information for the periods indicated:
Six months ended December 31 Years ended June 30 1996 1996 1995 1994 ___________________________________________ (in thousands)
Cash paid for:
Interest, net of amount capitalized $ 189 $ 442 $ 25 $ 176 Income taxes - 867 1,150 91
Non-cash investing and financing activities:
Treasury stock received for exercise of stock options - 123 - -
Conversion of debt to common stock - - - 1,600 Issuance of capital lease obligation - - 706 49
Note R - Industry Segment Information
The Company classifies its operations into three core business segments: (1) ophthalmic distribution, (2) injectable distribution, and (3) contract manufacturing. The ophthalmic distribution segment includes the marketing and distribution of an extensive line of ophthalmic products, including diagnostic and therapeutic pharmaceuticals, over-the-counter products and surgical instruments and supplies. The injectable distribution segment includes the marketing and distribution of specialized injectable products. The contract manufacturing segment consists of the manufacture of sterile pharmaceuticals, including human injectable products and ophthalmic solutions pursuant to contracts with others.
Selected financial information by industry segment is presented as follows:
Six months ended December 31 Years ended June 30 1996 1996 1995 1994 ____________________________________________________ (in thousands)
NET SALES Ophthalmic distribution $10,271 $20,833 $ 23,791 $ 20,694 Injectable distribution 3,119 4,160 4,642 2,862 Contract manufacturing: Sales to unaffiliated customers 3,129 8,932 9,072 7,710 Sales to affiliated customer 1,082 2,395 2,521 1,666 ____________________________________________________
17,601 36,320 40,026 32,932 Eliminations (1,082) (2,395) (2,521) (1,666) ____________________________________________________
Total net sales $ 16,519 $33,925 $37,505 $ 31,266 ==================================================== OPERATING INCOME Ophthalmic distribution $ 691 $ 1,037 $ 3,515 $ 2,821 Injectable distribution 1,370 670 238 (280) Contract manufacturing (1,562) 324 1,228 1,155 General corporate (369) (942) (1,071) (1,042) ____________________________________________________ Total operating income 130 1,089 3,910 2,654 Interest and other income (expense), net (60) (112) (172) (81) ____________________________________________________ Income before income taxes $ 70 $ 977 $ 3,738 $ 2,573 ====================================================
IDENTIFIABLE ASSETS Ophthalmic distribution $12,365 $13,287 $13,044 $12,817 Injectable distribution 2,027 1,525 1,235 968 Contract manufacturing 16,551 14,863 13,085 8,296 General corporate 151 142 127 108 ____________________________________________________ Total identifiable assets $31,094 $29,817 $ 27,491 $22,189 ====================================================
DEPRECIATION AND AMORTIZATION Ophthalmic distribution $ 209 $ 323 $ 339 $ 286 Injectable distribution 11 14 33 37 Contract manufacturing 495 639 552 433 General corporate 5 8 56 7 ____________________________________________________ Total depreciation and amortization $ 720 $ 984 $ 980 $ 763 ====================================================
CAPITAL ADDITIONS Ophthalmic distribution $ 176 $ 340 $ 354 $ 465 Injectable distribution 18 5 - 35 Contract manufacturing 1,783 1,001 5,162 1,216 General corporate 9 14 8 4 ____________________________________________________
Total capital additions $ 1,986 $1,360 $ 5,524 $ 1,720 ====================================================
For the year ended June 30, 1996, operating income for the ophthalmic distribution segment was affected by the changes in accounting estimates related to accrued costs of transferring ANDAs, chargeback accruals and inventory reserves (see Note P). In addition, for the same period, operating income for the ophthalmic distribution and contract manufacturing segments includes the effects of transaction and transitional costs associated with the realignment of the Company into two separate divisions (see Note B) totaling $110,000 and $568,000, respectively.
For the year ended June 30, 1995 operating income for the ophthalmic distribution segment includes a reduction in selling, general and administrative expense of approximately $330,000 related to a change in accounting estimate for aged customer credits.
During the years ended June 30, 1996 and 1995, the Company reported sales to one customer, Janssen Pharmaceutica, Inc., (Janssen) which accounted for approximately 12% and 13%, respectively, of consolidated net sales. The net sales attributable to Janssen were accounted for in the contract manufacturing segment. In 1995 this customer notified the Company that it will be transferring the production of certain products to its own facilities in Puerto Rico during 1997. Such products accounted for $1.3 and $1.4 million, respectively, in contract manufacturing sales for the years ended June 30, 1996 and 1995. In addition, this customer notified the Company that it will be discontinuing the sale of two other products previously produced by the contract manufacturing segment. These products accounted for approximately $2.6 and $2.9 million in sales during the years ended June 30, 1996 and 1995, respectively. Following this notification, the Company entered into discussions with this customer to assume the licenses to distribute these two injectable products and another injectable product. Effective July 1, 1996, an agreement was reached whereby Akorn acquired ownership of these NDA's, as well as the trade names and trademarks in the United States (see Note D). During the six month period ended December 31, 1996 and the year ended June 30, 1994, the Company did not derive ten percent or more of its revenues from any single customer.
The Company records sales between the segments at fully absorbed cost.
Note S - Concentration of Credit Risk
The Company specializes in the manufacturing, marketing and distribution of ophthalmic and injectable products to companies and doctors in the healthcare industry. The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. Receivables are generally due within 60 days. Credit losses have consistently been within management's expectations.
Note T - Defined Contribution Plan
The Company sponsors a qualified defined contribution plan which was established under the provisions of Internal Revenue Code Section 401(k). The plan covers all employees with six months of employment and who are 21 years of age or older. The employees can defer a portion of their compensation up to the maximum allowed by the Internal Revenue Code regulations. The plan provides for discretionary contributions by the Company on behalf of the employees. Since January 1994, the Company has made a discretionary matching contribution on a quarterly basis. During the six month period ended December 31, 1996 and the years ended June 30, 1996, 1995 and 1994, the Company recorded expenses related to the plan of $34,805, $100,615, $86,296 and $12,274, respectively.
Note U - Subsequent Events
Subsequent to the year ended December 31, 1996, the Company's board of directors decided to relocate the Ophthalmic Division operations to the Chicago area from Abita Springs, Louisiana. The Company expects to incur severance and related expenses associated with the relocation, as well as a write-down to the estimated net realizable value of the Louisiana facility. This charge, estimated to approximate $850,000 to $950,000 after taxes, will be recorded in the first quarter of calendar 1997.
The Company will also change the timing of overhead absorption in its manufacturing operations, resulting in a one-time charge in the first quarter of calendar 1997 of approximately $250,000 to $350,000 after taxes. Management does not expect these charges to affect compliance with the Company's loan covenants.
On February 28 , 1997, shareholders of the Company approved two amendments to the Company's articles of incorporation which allowed for (1) an increase in the number of authorized common shares from 20 million to 40 million and (2) the issuance of up to 5 million shares of preferred stock at the discretion of the Company's Board of Directors.
Note V - Litigation
The Company is a party in legal proceedings and potential claims arising in the ordinary course of its business. Management does not believe these matters will materially effect the Company's consolidated financial statements.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
There was no change in the principal independent accountant of the Company or any significant subsidiary of the Company during the six month transition period ended December 31, 1996 or the fiscal years ended June 30, 1996, 1995 or 1994.
PART III
Item 10.
Item 10. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act.
Information concerning directors is incorporated by reference to the Company's Definitive Proxy Statement for its 1997 Annual Meeting of Shareholders. Information concerning the Company's executive officers is included in Item 1A (Executive Officers of the Registrant) of Part I hereof.
Item 11.
Item 11. Executive Compensation.
The information called for by Item 11 is incorporated by reference to the Company's definitive Proxy Statement for its 1997 Annual Meeting of Shareholders.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information called for by Item 12 is incorporated by reference to the Company's definitive Proxy Statement for its 1997 Annual Meeting of Shareholders.
Item 13.
Item 13. Certain Relationships and Related Transactions.
The information called for by Item 13 is incorporated by reference to the Company's definitive Proxy Statement for its 1997 Annual Meeting of Shareholders.
PART IV
Item 14.
Item 14. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Those exhibits marked with an asterisk (*) refer to exhibits filed herewith and listed in the Exhibit Index which appears immediately before the first such exhibit; the other exhibits are incorporated herein by reference, as indicated in the following list.
( 2.0) Agreement and Plan of Merger dated December 17, 1991, by and among the Company, Aksub, Inc., Taylor Pharmacal Company (currently doing business as Taylor Pharmaceuticals and referred to hereinafter as "Taylor") and certain former shareholders of Taylor, incorporated by reference to the Company's report on Form 8-K dated January 15, 1992.
( 2.1) 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) *Composite Articles of Incorporation of the Company as amended through February 28, 1997.
( 3.2) *Composite of By-laws of the Company, including amendments approved through October 26, 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) Akorn, Inc. Savings and Retirement Plan effective July 1, 1984, incorporated by reference to Form 10-K for the fiscal year ended June 30, 1987.
(10.2) Stock Purchase Agreement dated November 15, 1990 by and between the John N. Kapoor Trust dated September 20, 1989, and the Company, incorporated by reference to Exhibit 10.21 to the Company's report on Form 10-K for the fiscal year ended June 30, 1991.
(10.3) Common Stock Purchase Warrant dated November 15, 1990 between the John N. Kapoor Trust dated September 20, 1989 and the Company, incorporated by reference to Exhibit 10.22 to the Company's report on Form 10-K for the fiscal year ended June 30, 1991.
(10.4) 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 10.23 to the Company's report on Form 10-K for the fiscal year ended June 30, 1991.
(10.5) Stock Registration Rights Agreement dated November 15, 1990 by and between the John N. Kapoor Trust dated September 20, 1989 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.
(10.6) Agreement dated February 15, 1991 amending Stock Purchase Agreement dated November 15, 1990 by and between the John N. Kapoor Trust dated September 20, 1989, and the Company, incorporated by reference to Exhibit 10.25 to the Company's report on Form 10-K for the fiscal year ended June 30, 1991.
(10.7) Akorn, Inc. Stock Option Plan for Directors, incorporated by reference to Exhibit 4.4 to the Company's registration statement on Form S-8, registration number 33-24970.
(10.8) Form of Akorn, Inc. Letter Agreement between the Company and its directors under the Stock Option Plan for Directors, incorporated by reference to Exhibit 4.5 to the Company's registration statement on Form S-8, registration number 33-24970.
(10.9) Akorn, Inc. 1988 Incentive Compensation Program, incorporated by reference to Exhibit 4.6 to the Company's registration statement on Form S-8, registration number 33-24970.
(10.10) Form of Akorn, Inc., Letter Agreement between the Company and its key employees and executives under the 1988 Incentive Compensation Program, incorporated by reference to Exhibit 4.7 to the Company's registration statement on Form S-8, registration number 33-24970.
(10.11) Amended and Restated Akorn, Inc. 1988 Incentive Compensation Program dated December 7, 1991, incorporated by reference to Exhibit 10.32 to the Company's report on Form 10-K for the fiscal year ended June 30, 1992.
(10.12) 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.
(10.13) Form of Stock Option Agreement under Amendment No. 1 to Amended and Restated Incentive Compensation Program, incorporated herein by reference to the Company's registration statement on Form S-8, registration number 33-70686.
(10.14) Amended and Restated Akorn, Inc. 1988 Incentive Compensation Program dated October 26, 1996, incorporated by reference to Exhibit B to the Company's definitive Proxy Statement dated January 10, 1997.
(10.15) 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.
(10.16) Form of Pledge Agreement between the Company and each shareholder of Taylor, incorporated by reference to Exhibit 10.1 of the Company's report on Form 8-K dated January 15, 1992.
(10.17) Agreement dated January 15, 1992 among the Company, the John N. Kapoor Trust dated September 20, 1989, John N. Kapoor and EJ Financial Enterprises, Inc., incorporated by reference to Exhibit 10.37 of the Company's report on Form 10-K for the fiscal year ended June 30, 1992.
(10.18) Loan Agreement dated September 3, 1992, between the Company and the John N. Kapoor Trust dated September 20, 1989, incorporated by reference to Exhibit No. 6 to Amendment No. 3 to Schedule 13D filed by John N. Kapoor and the John N. Kapoor Trust dated September 20, 1989, dated September 10, 1992.
(10.19) 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.
(10.20) Agreement, Waiver and Release, dated September 3, 1992, between the Company and the John N. Kapoor Trust dated September 20, 1989, incorporated by reference to Exhibit 10.44 of the Company's report on Form 10-K for the fiscal year ended June 30, 1992.
(10.21) Amendment No. 1 to Agreement dated January 15, 1992 among the Company, the John N. Kapoor Trust dated September 20, 1989, John N. Kapoor and EJ Financial Enterprises, Inc., incorporated by reference to Exhibit 10.23 of the Company's report on Form 10-K for the fiscal year ended June 30, 1995.
(10.22) Employment Agreement among Akorn, Inc., Taylor and Floyd Benjamin dated May 31, 1996, incorporated by reference to Exhibit 10.24 of the Company's report on Form 10-K for the fiscal year ended June 30, 1996.
(10.23) Employment Agreement between Akorn, Inc. and Barry D. LeBlanc dated as of January 1, 1996, incorporated by reference to Exhibit 10.25 of the Company's report on Form 10-K for the fiscal year ended June 30, 1996.
(10.24) Separation Agreement between Akorn, Inc. and Barry D. LeBlanc dated July 3, 1996, incorporated by reference to Exhibit 10.26 of the Company's report on Form 10-K for the fiscal year ended June 30, 1996.
(10.25) Employment Agreement between Akorn, Inc. and Eric M. Wingerter dated as of January 1, 1996, incorporated by reference to Exhibit 10.27 of the Company's report on Form 10-K for the fiscal year ended June 30, 1996.
(10.26) Employment Agreement between Akorn, Inc. and Harold O. Koch dated January 1, 1996, incorporated by reference to Exhibit 10.28 of the Company's report on Form 10-K for the fiscal year ended June 30, 1996.
(10.27) Employment Agreement between Taylor and Tim J. Toney dated as of January 1, 1996, incorporated by reference to Exhibit 10.29 of the Company's report on Form 10-K for the fiscal year ended June 30, 1996.
(11.1) *Computation of Earnings Per Share.
(21.1) *Subsidiaries of the Company.
(23.1) *Consent of Deloitte & Touche LLP
(24.1) *Power of Attorney of Floyd Benjamin.
(24.2) *Power of Attorney of Daniel E. Bruhl, M.D.
(24.3) *Power of Attorney of Doyle S. Gaw.
(27) *Financial Data Schedule
(b) Reports on Form 8-K.
None.
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, Ph.D. ____________________________ John N. Kapoor, Ph.D. Chief Executive Officer
Date: March 19, 1997
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 --------- ------- ------
/s/ John N. Kapoor, Ph.D. Chief Executive March 19, 1997 John N. Kapoor, Ph.D. Officer and Director (Principal Executive Officer)
/s/ Rita J. McConville Chief Financial Officer March 19, 1997 Rita J. McConville (Principal Financial Officer and Principal Accounting Officer)
* /s/ Floyd Benjamin Director March 19, 1997 Floyd Benjamin
* /s/ Daniel E. Bruhl, M.D. Director March 19, 1997 Daniel E. Bruhl, M.D.
* /s/ Doyle S. Gaw Director March 19, 1997 Doyle S. Gaw
*By: /s/ Rita J. McConville Rita J. McConville Attorney-in-fact