ITEM 1. DESCRIPTION OF BUSINESS
Akorn, Inc. ("Akorn" or the "Company") manufactures and markets diagnostic and therapeutic pharmaceuticals in specialty areas such as ophthalmology, rheumatology, anesthesia and antidotes, among others. The Company also markets ophthalmic surgical instruments and related products. Customers include physicians, optometrists, wholesalers, group purchasing organizations and other pharmaceutical companies. The Company also provides contract manufacturing services. Akorn is a Louisiana corporation founded in 1971 in Abita Springs, Louisiana, a suburb of New Orleans. In 1997, the Company relocated its headquarters and certain operations to Illinois.
In May 1996, the Company acquired Pasadena Research Laboratories, Inc., a developer and distributor of injectable pharmaceutical products. Subsequently, the Company reorganized its operations into two segments, ophthalmic and injectable. For information regarding sales, operating income and identifiable assets for each of the Company's segments, see Note N to the consolidated financial statements included in Item 8 of this report.
Ophthalmic Segment. The Company markets an extensive line of diagnostic and therapeutic ophthalmic pharmaceutical products as well surgical instruments and related supplies. Diagnostic products, primarily used in the office setting, include mydriatics and cycloplegics, anesthetics, topical stains, gonioscopic solutions, angiography dyes and others. Therapeutic products, sold primarily to wholesalers and other national account customers, include antibiotics, anti-infectives, steroids, steroid combinations, glaucoma medications, decongestants/antihistamines and anti-edema medications. Surgical products include surgical knives and other surgical instruments, balanced salt solution, post-operative kits, surgical tapes, eye shields, anti-ultraviolet goggles, facial drape supports and other supplies. Non-pharmaceutical products include various artificial tear solutions, preservative-free lubricating ointments, lid cleansers, vitamin supplements and contact lens accessories.
Injectable Segment. The Company markets a line of specialty injectable pharmaceutical products, including anesthesia products used in the treatment of rheumatoid arthritis and pain management. These products are marketed to wholesalers and other national account customers as well as directly to medical specialists. Akorn also provides contract manufacturing services to pharmaceutical and biotech companies.
Manufacturing. The Company has two manufacturing facilities located in Decatur, Illinois and Somerset, New Jersey. See "Item 2. Description of Property." The Company manufactures a diverse group of sterile pharmaceutical products, including solutions, ointments and suspensions for its ophthalmic and injectable segments. The Company is also in the process of adding freeze dried (lyophilized) manufacturing capabilities at its Decatur facility. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Factors That May Effect Future Results -- Dependence on Development of Pharmaceutical Products and Manufacturing Capabilities."
Sales and Marketing. While the Company is working to expand its proprietary product base through internal development and, to a lesser extent, acquisitions, the majority of current products are non-proprietary. The Company relies on its efforts in marketing, distribution, development and low cost manufacturing to maintain and increase market share.
The ophthalmic segment uses a three-tiered sales effort. Outside sales representatives, with two field managers, sell directly to physicians and group practices. In-house sales (telemarketing) and customer service (catalog sales) sell to optometrists and other customers. A national accounts group sells to wholesalers, retail chains and other group purchasing organizations. This national accounts group also markets the Company's injectable pharmaceutical products which the Company also sells through telemarketing and direct mail activities to individual specialty physicians and hospitals. The injectable segment does not utilize a field sales force at this time. The segment may add such a force in the future as it introduces proprietary products. The injectable segment markets its contract manufacturing services through direct mail, trade shows and direct industry contacts.
Research and Development. As of December 31, 1999, the Company had 42 Abbreviated New Drug Applications ("ANDAs") for generic pharmaceuticals in various stages of development. The Company has filed 14 of these ANDAs and had 4 ANDAs approved in 1999. See "Government Regulation." The Company expects to continue to file ANDAs on a regular basis as pharmaceutical products of its competitors come off patent allowing the Company to compete by marketing generic equivalents. The Company had one New Drug Application ("NDA"), for Paremyd, on file at December 31, 1999. The Company is also developing four indications for ophthalmic products for which it currently anticipates filing NDAs. See Note C to the consolidated financial statements included in Item 8 of this report. One is an indication for Indocyanine Green to treat age related macular degeneration. If the Company's developmental efforts are successful, the Company currently anticipates filing this NDA within the next four years and estimates the market size for this product to be $350 million. A second anticipated NDA filing is for a new delivery system for the pharmaceutical Timolol, which is used in the treatment of glaucoma. If the Company's developmental efforts are successful, the Company currently anticipates filing this NDA within the next three years and estimates the market size for this product to be $270 million. A third anticipated NDA filing is for Piroxicam ophthalmic solution which is an anti-inflammatory to be used during cataract surgery. The Company began conducting additional clinical studies on this product in the third quarter of 1999 and anticipates filing an NDA by the end of this year. The Company estimates the market for this product to be $75 million. Finally, the Company currently anticipates filing an NDA for an indication for Indocyanine Green to treat white cataracts. The Company estimates the market for this product to be $6 to $10 million. Pre-clinical and clinical trials required in connection with the development of pharmaceutical products are performed by contract research organizations under the direction of Company personnel. No assurance can be given as to whether the Company will file these NDAs, or any ANDAs, when anticipated, will develop marketable products based on these filings or as to the actual size of the market for any such products. See "Government Regulation" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Factors That May Effect Future Results--Dependence on Development of Pharmaceutical Products and Manufacturing Capabilities".
The Company also maintains a business development program which identifies potential product acquisition or product licensing candidates. The Company has focused its business development efforts on niche products which complement its existing product lines and which have few or no competitors in the market.
At December 31, 1999, 22 full-time employees of the Company were involved in research and development and product licensing.
Research and development costs are expensed as incurred. Such costs amounted to $2,744,000, $4,010,000 and $1,873,000 for the years ended December 31, 1999, 1998 and 1997, respectively.
Patents and Proprietary Rights. The Company considers the protection of discoveries in connection with its development activities important to its business. The Company intends to seek patent protection in the United States and selected foreign countries where deemed appropriate. To date, the Company has received three U.S. patents and has four additional U.S. and one international patent applications pending. There can be no assurance that the Company will obtain U.S. or foreign patents or, if obtained, that they will provide substantial protection or be of commercial benefit. The Company also relies upon trademarks, trade secrets, unpatented proprietary know-how and continuing technological innovation to maintain and develop its competitive position. The Company enters into confidentiality agreements with certain of its employees pursuant to which such employees agree to assign to the Company any inventions relating to the Company's business made by them while in the Company's employ. However, there can be no assurance that others may not acquire or independently develop similar technology or, if patents are not issued with respect to products arising from research, that the Company will be able to maintain information pertinent to such research as proprietary technology or trade secrets. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Factors That May Effect Future Results--Patents and Proprietary Rights".
Employee Relations. At December 31, 1999, the Company had 349 full-time employees, of whom 309 were employed by Akorn and 40 by its wholly owned subsidiary, Akorn (New Jersey), Inc. The Company enjoys good relations with its employees, none of whom are represented by a collective bargaining agent.
Competition. The marketing and manufacturing of pharmaceutical products is highly competitive, with many established manufacturers, suppliers and distributors actively engaged in all phases of the business. Most of the Company's competitors have substantially greater financial and other resources, including greater sales volume, larger sales forces and greater manufacturing capacity. See "Management's Discussion and Analysis of Operations--Factors That May Effect Future Results--Competition; Uncertainty of Technological Change."
The companies which compete with the ophthalmic segment include Alcon Laboratories, Inc., Allergan Pharmaceuticals, Inc., Ciba Vision and Bausch & Lomb, Inc. ("B&L"). The ophthalmic segment competes primarily on the basis of price and service. The ophthalmic segment purchases some ophthalmic products from Steris Pharmaceuticals, Inc. and B&L, who are in direct competition with the Company in several markets.
The companies which compete with the injectable segment include both generic and name brand companies such as Abbott Labs, Gensia, Marsam, Steris, Elkin Sinn and American Regent. The injectable segment competes primarily on the basis of price. Competitors in the contract manufacturing business include Cook Imaging, Chesapeake Biological Laboratories, Ben Venue and Oread Laboratories. The manufacturing of sterile products must be performed under government mandated Good Manufacturing Practices.
Suppliers and Customers. No unaffiliated supplier of products accounted for more than 10% of the Company's sales in either segment during 1999, 1998 or 1997. The Company requires a supply of quality raw materials and components to manufacture and package pharmaceutical products for itself and for third parties with which it has contracted. The principal components of the Company's products are active and inactive pharmaceutical ingredients and certain packaging materials. Many of these components are available from only a single source and, in many of the Company's ANDAs and NDAs, only one supplier of raw materials has been identified. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Factors That May Effect Future Results--Dependence on Supply of Raw Materials and Components".
No single customer accounted for more than 10% of the Company's sales in either segment during 1999, 1998 or 1997.
Government Regulation. Pharmaceutical manufacturers and distributors are subject to extensive regulation by government agencies, including the Food and Drug Administration ("FDA"), the Drug Enforcement Agency ("DEA"), the Federal Trade Commission ("FTC") and other federal, state and local agencies. The federal Food, Drug and Cosmetic Act (the "FDA Act"), the Controlled Substance Act and other federal statutes and regulations govern or influence the development, testing, manufacture, labeling, storage and promotion of products. The FDA inspects drug manufacturers and storage facilities to determine compliance with its Good Manufacturing Practice regulations, non-compliance with which can result in fines, recall and seizure of products, total or partial suspension of production, refusal to approve new drug applications and criminal prosecution. The FDA also has the authority to revoke approval of drug products.
With certain exceptions, FDA approval is required before any drug can be manufactured and marketed. New drugs require the filing of an NDA, including clinical studies demonstrating the safety and efficacy of the drug. Generic drugs, which are equivalents of existing brand name drugs, require the filing of an ANDA, which waives the requirement of conducting clinical studies of safety and efficacy. Ordinarily, the filing of an ANDA for generic drugs which contain the same ingredients as drugs already approved for use in the United States requires data showing that the generic formulation is equivalent to the brand name drug and that the product is stable in its formulation. The Company has no control over the time required for the FDA to approve NDA or ANDA filings.
The Company also manufactures and distributes several controlled-drug substances, the distribution and handling of which are regulated by the DEA. Failure to comply with DEA regulations can result in fines or
seizure of product. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations--Factors That May Effect Future Results--Government Regulation".
The Company does not anticipate any material effect from compliance with federal, state and local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment.
ITEM 1A.
ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth the executive officers of the Company as of March 15, 2000. Each officer serves as such at the pleasure of the Board of Directors.
ITEM 2.
ITEM 2. DESCRIPTION OF PROPERTY
Since August 1998, the Company's headquarters and certain administrative offices, as well as a finished goods warehouse, have been located in approximately 24,000 square feet of leased space at 2500 Millbrook Drive, Buffalo Grove, Illinois. From May 1997 to August 1998, the Company's headquarters and ophthalmic division offices were located in approximately 11,000 square feet of leased space in Lincolnshire, Illinois. The Company sub-lets the Lincolnshire space to several tenants. The Company's former headquarters, consisting of approximately 30,000 square feet located on ten acres of land in Abita Springs, Louisiana, was sold in February 1999.
The Company 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 in Decatur, Illinois. The Company leases approximately 7,000 square feet of office and warehousing space in San Clemente, California. The Company's Akorn (New Jersey) subsidiary also leases approximately 40,000 square feet of space in Somerset, New Jersey. This space is used for manufacturing, research and development and administrative activities. The combined space is considered adequate to accommodate growth for the foreseeable future.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is a party in legal proceedings and potential claims arising in the ordinary course of its business. The amount, if any, of ultimate liability with respect to such matters cannot be determined. Despite the inherent uncertainties of litigation, management of the Company at this time does not believe that such proceedings will have a material adverse impact on the financial condition or results of operations or cash flows of the Company.
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, 1999.
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 March 10, 2000, the Company estimated that the number of holders of its Common Stock was approximately 3,200, including record holders and individual participants in security position listings.
High and low bid prices per Nasdaq for the periods indicated were:
As of March 15, 2000, there were approximately 600 holders of record of the Company's Common Stock. Closing price at March 15, 2000 was $9.00 per share as reported by the Nasdaq National Market.
The Company did not pay cash dividends in 1999, 1998 or 1997, and is prohibited by its revolving credit agreement with The Northern Trust Company from doing so.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
In October 1996, the Board of Directors of the Company voted to change the Company's fiscal year from the year ending June 30 to a calendar year. The following table sets forth selected consolidated financial information for the Company for the years ended December 31, 1999, 1998 and 1997, the six month transition period ended December 31, 1996 and the years ended June 30, 1996 and 1995:
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(1) Dividends paid pertain to Subchapter S distributions made to former PRL shareholders for pre-acquisition earnings.
All of the information shown in the table above for the two year period ended June 30, 1996 has been restated to reflect the combined operations of Akorn and Pasadena Research Laboratories, Inc. (PRL).
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 consolidated financial statements.
RESULTS OF OPERATIONS
The Company's revenues are derived from sales of diagnostic and therapeutic pharmaceuticals by the ophthalmic and injectable segments, from sales of surgical instruments and related products by the ophthalmic segment and from sales of contract manufacturing services by the injectable segment. The following table sets forth the percentage relationships that certain items from the Company's Consolidated Statements of Income bear to revenues for the years ended December 31, 1999, 1998 and 1997.
COMPARISON OF TWELVE MONTHS ENDED DECEMBER 31, 1999 AND 1998
Net sales increased 14.1% for the year ended December 31, 1999 compared to the prior year. Ophthalmic segment sales increased 11.2%, primarily due to previously acquired products and product licensing agreements entered into in 1999. Injectable segment sales increased 17.1%, primarily due to strong sales of anesthesia products.
Consolidated gross profit increased 15.2% for the year, with gross margins increasing from 51.3% to 51.8%. The increase in gross margins was caused by branded products acquired in 1998 being included in the full year results for 1999 and the resultant shift in sales mix to higher margin products. 1999 cost of sales includes $1.4 million in unfavorable manufacturing variances resulting from under-utilization of manufacturing capacity at the Somerset, New Jersey facility. Management expects the unfavorable manufacturing variances to continue until additional product approvals are obtained at the Somerset facility.
Selling, general and administrative expenses (SG&A) increased 25.9% from 1998, resulting from new hires in 1999 and the associated salary and salary related expenses being included in the full year results for 1999 (28.9%) as well as one time consulting fees (55.5%) and warehouse related expenses (69.5%). Management expects the growth rate for SG&A expenses to significantly decrease in 2000.
Amortization of intangibles decreased 18.9% for the year, reflecting the expiration of a patent in May 1999.
Research and development expenses ("R&D") decreased 31.6%, primarily reflecting the conclusion of clinical studies on TP-1000, a migraine product, in December 1998. Since obtaining favorable preliminary clinical data, the Company has been seeking a partner to continue development of this product. The Company did not conduct clinical studies in 1999 until late in the third quarter, when a third Piroxicam trial began. Management expects R&D expenses to increase to approximately $4,000,000 in 2000, as three additional NDA projects begin to move through the pipeline. See "Item 1. Description of Business--Research and Development".
During 1998, the Company recorded $350,000 in charges related to a cancelled public equity offering.
Interest expense increased 32.4%, reflecting higher average outstanding debt balances related to prior year product acquisitions and 1999 capital spending.
Net income for 1999 was $6,670,000 or $0.36 per diluted share compared to $4,647,000 or $0.25 per diluted share for the prior year. The increase in earnings resulted from the above mentioned items.
COMPARISON OF TWELVE MONTHS ENDED DECEMBER 31, 1998 AND 1997
Net sales increased 33.9% for the year ended December 31, 1998 compared to the prior year. Ophthalmic segment sales increased 17.3%, primarily due to strong sales of acquired products. Injectable segment sales increased 57.6%, primarily due to acquired anesthesia products. Injectable segment sales also benefited from a continuing shortage of certain distributed products.
Consolidated gross profit increased 54.8% for the year, with gross margins increasing from 44% to 51%. The increase in gross margins was caused by branded product acquisitions and a shift in sales mix to higher margin products.
Selling, general and administrative expenses (SG&A) increased 11.2%, reflecting increased provisions for employee performance bonuses and expenses associated with the new corporate office facility in Buffalo Grove, Illinois.
Amortization of intangibles increased 584.9% for the year, reflecting significant product acquisitions in 1998.
R&D expenses increased 114.1%, primarily reflecting accelerated development of TP-1000, a migraine product.
During 1998, the Company recorded $350,000 in charges related to a cancelled public equity offering. During 1997, the Company recorded $1,451,000 in charges related to the relocation of the ophthalmic division and executive offices from Abita Springs, Louisiana to the Chicago area. The charges primarily relate to severance $494,000, and retention bonus payments, $151,000, as well as a write-down of the Abita Springs facility and equipment to net realizable value, $378,000 and moving relocations costs, $144,000.
Interest expense increased 192.0%, reflecting higher average outstanding debt balances related to product acquisitions. Interest income declined 97.6% due to the liquidation of cash balances to finance acquisition activities.
Net income for 1998 was $4,647,000 or $0.25 per diluted share compared to $1,792,000 or $0.11 per diluted share for the prior year. The increase in earnings resulted from the above mentioned items.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedge activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The statement, as amended, is effective for the fiscal quarters of the Company's fiscal year ending December 31, 2001. The Company is in the process of evaluating the effect of this Statement on its financial statements.
FINANCIAL CONDITION AND LIQUIDITY
As of December 31, 1999, the Company had cash and cash equivalents of $25,000. Working capital at that date was $26,158,000 versus $11,040,000 at December 31, 1998 resulting primarily from the refinancing of $11,000,000 of current liabilities with long term debt under the Company's new $45 million credit facility and an increase in receivables and inventory of $11,999,000. The Company manages its cash balances to minimize interest expense on its line of credit borrowing. At December 31, 1999, the Company had $16.8 million available under its revolving credit facility.
During the year ended December 31, 1999, the Company generated $131,000 in cash from operations after financing its working capital requirements, primarily an increase in accounts receivable and inventories
related to increased sales volume, including acquired products. Management anticipates additional investment in working capital to finance continued sales growth, but has active working capital management initiatives in place to reduce receivables and inventory levels. Investing activities, which include the purchase of product-related intangible assets as well as equipment required $6,233,000 in cash. Purchases of equipment for the manufacture of lyophilized (freeze-dried) pharmaceuticals accounted for $2,507,000 of the $6,233,000 cash used in investing activities and the Company expects to incur an additional $5,187,000 for such purchases during 2000. Financing activities provided $5,391,000 in cash primarily through a net $4,216,000 increase in long-term debt and $1,337,000 from stock option exercises. The Company's repayment of capital lease obligations used $162,000 in cash.
Capital expenditures for equipment in 1999 and 1998 principally relate to the Company's lyophilization project as discussed in Note F to the Consolidated Financial Statements.
In 1997 the Company entered into a $15 million revolving credit arrangement, increased to $25 million in 1998, and subsequently increased to $45 million in 1999, subject to certain financial covenants. See Note H to Consolidated Financial Statement for a description of this indebtedness and other indebtedness of the Company. Management believes that cash flow from operations, in conjunction with borrowing availability under its credit facility, will be sufficient to meet the cash needs of the business for the foreseeable future, but additional long-term financing may be needed to finance product development or acquisitions. There are no guarantees that such financing will be available or available at an acceptable cost.
YEAR 2000 ISSUES
The Company established a process to identify and resolve the business issues associated with Year 2000 and expended resources to ensure that its critical processes were Year 2000 compliant. The Company did not experience any business disruptions associated with Year 2000. The Company will continue to monitor its computer applications throughout Year 2000 to ensure that any latent Year 2000 matters are addressed promptly.
SELECTED QUARTERLY DATA (UNAUDITED) In Thousands, Except Per Share Amounts
FACTORS THAT MAY EFFECT FUTURE RESULTS
Government Regulation
Virtually all aspects of the Company's business are regulated by federal and state statutes and government agencies. The development, testing, manufacturing, processing, quality, safety, efficacy, packaging, labeling, record-keeping, distribution, storage and advertising of the Company's products, and disposal of waste products arising from such activities, are subject to regulation by one or more federal agencies, including the Food and Drug Administration ("FDA"), the Drug Enforcement Agency ("DEA"), the Federal Trade Commission ("FTC"), the Consumer Product Safety Commission, the Occupational Safety and Health Administration ("OSHA") and the U.S. Environmental Protection Agency ("EPA"). These activities are also regulated by similar state and local agencies. Failure to comply with applicable statutes and government regulations could have a material adverse effect on the Company's business, financial condition and results of operations.
All pharmaceutical manufacturers, including the Company, are subject to regulation by the FDA under the authority of the Federal Food, Drug, and Cosmetic Act ("FDC Act"). Under the FDC Act, the federal government has extensive administrative and judicial enforcement powers over the activities of pharmaceutical manufacturers to ensure compliance with FDA regulations. Those powers include, but are not limited to, the authority to initiate court action to seize unapproved or non-complying products, to enjoin non-complying activities, to halt manufacturing operations that are not in compliance with current good manufacturing practices ("cGMP"), to recall products which present a health risk, and to seek civil monetary and criminal penalties. Other enforcement activities include refusal to approve product applications or the withdrawal of previously approved applications. Any such enforcement activities, including the restriction or prohibition on sales of products marketed by the Company or the halting of manufacturing operations of the Company, could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, product recalls may be issued at the discretion of the Company, the FDA or other government agencies having regulatory authority for pharmaceutical product sales. Recalls may occur due to disputed labeling claims, manufacturing issues, quality defects or other reasons. No assurance can be given that recalls of the Company's pharmaceutical products will not occur in the future. Any product recall could have a material adverse effect on the Company's business, financial condition and results of operations.
All "new drugs" must be the subject of an FDA-approved new drug application ("NDA") before they may be marketed in the United States. Certain prescription drugs are not currently required to be the subject of an approved NDA but, rather, may be marketed pursuant to an FDA regulatory enforcement policy permitting continued marketing of those drugs until the FDA determines whether they are safe and effective. All generic equivalents to previously approved drugs or new dosage forms of existing drugs must be the subject of an FDA-approved abbreviated new drug application ("ANDA") before they may be marketed in the United States. The FDA has the authority to withdraw existing NDA and ANDA approvals and to review the regulatory status of products marketed under the enforcement policy. The FDA may require an approved NDA or ANDA for any drug product marketed under the enforcement policy if new information reveals questions about the drug's safety or effectiveness. All drugs must be manufactured in conformity with cGMP and drugs subject to an approved NDA or ANDA must be manufactured, processed, packaged, held, and labeled in accordance with information contained in the NDA or ANDA.
The Company and its third-party manufacturers are subject to periodic inspection by the FDA to assure such compliance. The FDA imposes additional stringent requirements on the manufacture of sterile pharmaceutical products to ensure the sterilization processes and related control procedures consistently produce a sterile product. Additional sterile manufacturing requirements include the submission for expert review of detailed documentation for sterilization process validation in drug applications beyond those required for general manufacturing process validation. Various sterilization process requirements are the subject of detailed FDA guidelines, including requirements for the maintenance of microbiological control and quality stability. Pharmaceutical products must be distributed, sampled and promoted in accordance with FDA requirements. The FDA also regulates drug labeling and the advertising of prescription drugs. The Company believes its operating facilities and practices are in compliance with applicable federal and state law. However,
a finding by a governmental agency or court that the Company is not in compliance could have a material adverse effect on the Company's business, financial condition and results of operations.
While the Company believes that all of its current pharmaceuticals are lawfully marketed in the United States under current FDA enforcement policies or have received the requisite agency approvals for manufacture and sale, such marketing authority is subject to withdrawal by the FDA. In addition, modifications or enhancements of approved products are in many circumstances subject to additional FDA approvals which may or may not be granted and which may be subject to a lengthy application process. Any change in the FDA's enforcement policy or any decision by the FDA to require an approved NDA or ANDA for a Company product not currently subject to the approved NDA or ANDA requirements or any delay in the FDA approving an NDA or ANDA for a Company product could have a material adverse effect on the Company's business, financial condition and results of operations.
A number of products marketed by the Company are "grandfathered" drugs which are permitted to be manufactured and marketed without FDA-issued ANDAs or NDAs on the basis of their having been marketed prior to enactment of relevant sections of the FDC Act. The regulatory status of these products is subject to change and/or challenge by the FDA, which could establish new standards and limitations for manufacturing and marketing such products, or challenge the evidence of prior manufacturing and marketing upon which grandfathering status is based. The Company is not aware of any current efforts by the FDA to change the status of any of its "grandfathered" products, but there can be no assurance that such initiatives will not occur in the future. Any such change in the status of the Company's "grandfathered" products could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company also manufactures and sells drugs which are "controlled substances" as defined in the federal Controlled Substances Act and similar state laws, which establishes, among other things, certain licensing, security and record keeping requirements administered by the DEA and similar state agencies, as well as quotas for the manufacture, purchase and sale of controlled substances. The DEA could limit or reduce the amount of controlled substances which the Company is permitted to manufacture and market. The Company has not experienced sanctions or fines for non-compliance with the foregoing regulations, but no assurance can be given that any such sanctions or fines would not have a material adverse effect on the Company's business, financial condition and results of operations.
The Company cannot determine what effect changes in regulations or statutes or legal interpretation, when and if promulgated or enacted, may have on its business in the future. Changes could, among other things, require changes to manufacturing methods, expanded or different labeling, the recall, replacement or discontinuation of certain products, additional record keeping and expanded documentation of the properties of certain products and scientific substantiation. Such changes or new legislation could have a material adverse effect on the Company's business, financial condition and results of operations.
Dependence on Development of Pharmaceutical Products and Manufacturing Capabilities
The Company's strategy for growth is dependent upon its ability to develop products that can be promoted through existing marketing and distribution channels and, when appropriate, the enhancement of such marketing and distribution channels. The Company currently has 42 ANDAs in various stages of development and anticipates filing four NDAs. See "Item 1. Description of Business - Research and Development." The Company may not meet its anticipated time schedule for the filing of ANDAs and NDAs or may decide not to pursue ANDAs or NDAs that it has submitted or anticipates submitting. The internal development of new pharmaceutical products by the Company is dependent upon the research and development capabilities of the Company's personnel and its infrastructure. There can be no assurance that the Company will successfully develop new pharmaceutical products or, if developed, successfully integrate new products into its existing product lines. In addition, there can be no assurance that the Company will receive all necessary approvals from the FDA or that such approvals will not involve delays which adversely affect the marketing and sale of the Company's products. The Company's failure to develop new products or receive FDA approval of ANDAs or NDAs, could have a material adverse effect on the Company's business, financial condition and results of operations. Another part of the Company's growth strategy is to develop the
capability to manufacture lyophilized (freeze-dried) pharmaceutical products. While the Company has devoted resources to developing these capabilities, it may not be successful in developing these capabilities, or the Company may not realize the anticipated benefits from developing these capabilities.
Generic Substitution
The Company's branded pharmaceutical products are subject to competition from generic equivalents and alternative therapies. Generic pharmaceuticals are the chemical and therapeutic equivalents of brand-name pharmaceuticals and represent an increasing proportion of pharmaceuticals dispensed in the United States. There is no proprietary protection for most of the branded pharmaceutical products sold by the Company and generic and other substitutes for most of its branded pharmaceutical products are sold by other pharmaceutical companies. In addition, governmental and cost-containment pressures regarding the dispensing of generic equivalents will likely result in generic substitution and competition generally for the Company's branded pharmaceutical products. Although the Company attempts to mitigate the effect of this substitution through, among other things, creation of strong brand-name recognition and product-line extensions for its branded pharmaceutical products, there can be no assurance that the Company will be successful in these efforts. Increased competition in the sale of generic pharmaceutical products could have a material adverse effect on the Company's business, financial condition and results of operations. Generic substitution is regulated by the federal and state governments, as is reimbursement for generic drug dispensing. There can be no assurance that substitution will be permitted for newly-approved generic drugs or that such products will be subject to government reimbursement.
Dependence on Generic and Off-Patent Pharmaceutical Products
The success of the Company depends, in part, on its ability to anticipate which branded pharmaceuticals are about to come off patent and thus permit the Company to develop, manufacture and market equivalent generic pharmaceutical products. Generic pharmaceuticals must meet the same quality standards as branded pharmaceuticals, even though these equivalent pharmaceuticals are sold at prices which are significantly lower than that of branded pharmaceuticals. In addition, generic products that third parties develop may render the Company's generic products noncompetitive or obsolete. Although the Company has successfully brought generic pharmaceutical products to market in a timely manner in the past, there can be no assurance that the Company will be able to consistently bring these products to market quickly and efficiently in the future. An increase in competition in the sale of generic pharmaceutical products or the Company's failure to bring such products to market before its competitors could have a material adverse effect on the Company's business, financial condition and results of operations.
Competition; Uncertainty of Technological Change
The Company competes with other pharmaceutical companies, including major pharmaceutical companies with financial resources substantially greater than those of the Company, in developing, acquiring, manufacturing and marketing pharmaceutical products. The selling prices of pharmaceutical products typically decline as competition increases. Further, other products now in use, under development or acquired by other pharmaceutical companies, may be more effective or offered at lower prices than the Company's current or future products. The industry is characterized by rapid technological change which may render the Company's products obsolete, and competitors may develop their products more rapidly than the Company. Competitors may also be able to complete the regulatory process sooner, and therefore, may begin to market their products in advance of the Company's products. The Company believes that competition in sales of its products is based primarily on price, service, availability and product efficacy. There can be no assurance that: (i) the Company will be able to develop or acquire commercially attractive pharmaceutical products; (ii) additional competitors will not enter the market; or (iii) competition from other pharmaceutical companies will not have a material adverse effect on the Company's business, financial condition and results of operations.
Dependence on Supply of Raw Materials and Components
The Company requires a supply of quality raw materials and components to manufacture and package pharmaceutical products for itself and for third parties with which it has contracted. The principal components
of the Company's products are active and inactive pharmaceutical ingredients and certain packaging materials. Many of these components are available from only a single source and, in many of the Company's ANDAs and NDAs, only one supplier of raw materials has been identified. Because FDA approval of drugs requires manufacturers to specify their proposed suppliers of active ingredients and certain packaging materials in their applications, FDA approval of any new supplier would be required if active ingredients or such packaging materials were no longer available from the specified supplier. The qualification of a new supplier could delay the Company's development and marketing efforts. If for any reason the Company is unable to obtain sufficient quantities of any of the raw materials or components required to produce and package its products, it may not be able to manufacture its products as planned, which could have a material adverse effect on the Company's business, financial condition and results of operations.
Dependence on Third-Party Manufacturers
The Company derives a significant portion of its net sales from the sale of products manufactured by third parties, including its competitors in some instances. There can be no assurance that the Company's dependence on third parties for the manufacture of such products will not adversely affect the Company's profit margins or its ability to develop and deliver its products on a timely and competitive basis. If for any reason the Company is unable to obtain or retain third-party manufacturers on commercially acceptable terms, it may not be able to distribute certain of its products as planned. No assurance can be made that the manufacturers utilized by the Company will be able to provide the Company with sufficient quantities of its products or that the products supplied to the Company will meet the Company's specifications. Any delays or difficulties with third-party manufacturers could adversely affect the marketing and distribution of certain of the Company's products, which could have a material adverse effect on the Company's business, financial condition and results of operations.
Product Liability
The Company faces exposure to product liability claims in the event that the use of its technologies or products or those it licenses from third parties is alleged to have resulted in adverse effects in users thereof. Receipt of regulatory approval for commercial sale of such products does not mitigate such product liability risks. While the Company has taken, and will continue to take, what it believes are appropriate precautions, there can be no assurance that it will avoid significant product liability exposure. In addition, future product labeling may include disclosure of additional adverse effects, precautions and contraindications, which may adversely impact sales of such products. The Company currently has product liability insurance in the amount of $10.0 million for aggregate annual claims with a $25,000 deductible per incident and a $150,000 aggregate annual deductible. However, there can be no assurance that its insurance coverage will be sufficient to cover fully potential claims. Additionally, there can be no assurance that adequate insurance coverage will be available in the future at acceptable costs, if at all, or that a product liability claim would not have a material adverse effect on the Company's business, financial condition and results of operations.
Dependence on Acquisition and Licensing of Pharmaceutical Products
As part of its growth strategy, the Company plans to purchase or license pharmaceutical product lines of other pharmaceutical or biotechnology companies. Other companies, including those with substantially greater financial, marketing and other resources, compete with the Company for the right to acquire or license such products. The Company's success in executing this strategy depends, in part, on its ability to identify potential products that meet the Company's criteria, including possessing a recognizable brand name or being complementary to the Company's existing product lines. There can be no assurance that the Company will have success in identifying potential product acquisitions or licensing opportunities or that, if identified, it will complete such product acquisitions or obtain such licenses on acceptable terms or that it will successfully integrate any acquired or licensed products into its existing product lines. The inability to complete acquisitions of, or obtain licenses for, pharmaceutical products could have a material adverse effect on the Company's business, financial condition and results of operations. Furthermore, there can be no assurance that the Company, once it has obtained rights to a pharmaceutical product and committed to payment terms, will be able to generate sales sufficient to create a profit or otherwise avoid a loss. Any inability to generate such
sufficient sales or any subsequent reduction of sales could have a material adverse effect on the Company's business, financial condition and result of operations.
Patents and Proprietary Rights
The patent position of competitors in the pharmaceutical industry generally is highly uncertain, involves complex legal and factual questions, and is the subject of much litigation. There can be no assurance that any patent applications relating to the Company's potential products or processes will result in patents being issued, or that the resulting patents, if any, will provide protection against competitors who: (i) successfully challenge the Company's patents; (ii) obtain patents that may have an adverse effect on the Company's ability to conduct business; or (iii) are able to circumvent the Company's patent position. It is possible that other parties have conducted or are conducting research and could make discoveries of pharmaceutical formulations or processes that would precede any discoveries made by the Company, which could prevent the Company from obtaining patent protection for these discoveries or marketing products developed therefrom. Consequently, there can be no assurance that others will not independently develop pharmaceutical products similar to or obsoleting those that the Company is planning to develop, or duplicate any of the Company's products. The inability of the Company to obtain patents for its products and processes or the ability of competitors to circumvent or obsolete the Company's patents could have a material adverse effect on the Company's business, financial condition and results of operations.
Need to Attract and Retain Key Personnel in Highly Competitive Marketplace
The Company's performance depends, to a large extent, on the continued service of its key research and development personnel, other technical employees, managers and sales personnel and its ability to continue to attract and retain such personnel. Competition for such personnel is intense, particularly for highly motivated and experienced research and development and other technical personnel. The Company is facing increasing competition from companies with greater financial resources for such personnel. There can be no assurance that the Company will be able to attract and retain sufficient numbers of highly-skilled personnel in the future, and the inability to do so could have a material adverse effect on the Company's business, operating results and financial condition.
Dependence on Key Executive Officers
The Company's success will depend, in part, on its ability to retain its key executive officers. The loss of one or more of the Company's key executive officers could have a material adverse effect on the Company's business, financial condition and results of operations.
Quarterly Fluctuation of Results; Possible Volatility of Stock Price
The Company's results of operations may vary from quarter to quarter due to a variety of factors including the timing of the development and marketing of new pharmaceutical products, the failure to develop such products, delays in obtaining government approvals, including FDA approval of NDAs or ANDAs for Company products, expenditures incurred to acquire and promote pharmaceutical products, changes in the Company's customer base, a customer's termination of a substantial account, the availability and cost of raw materials, interruptions in supply by third-party manufacturers, the introduction of new products or technological innovations by the Company's competitors, loss of key personnel, changes in the mix of products sold by the Company, changes in sales and marketing expenditures and competitive pricing pressures. There can be no assurance that the Company will be successful in maintaining or improving its profitability or avoiding losses in any future period. Such fluctuations may result in volatility in the price of the Company's Common Stock.
Relationships With Other Entities; Conflicts of Interest
Mr. John N. Kapoor, Ph.D., the Company's Chairman of the Board is affiliated with EJ Financial Enterprises, Inc., a health care investment firm ("EJ Financial"). EJ Financial is involved in the management of health care companies in various fields, and Dr. Kapoor is involved in various capacities with the management and operation of these companies. The John N. Kapoor Trust, the beneficiary of which is Dr. Kapoor, is a principal shareholder of each of these companies. As a result, Dr. Kapoor devotes limited time to the business of the Company. Although such companies do not currently compete directly with the
Company, certain companies with which EJ Financial is involved are in the pharmaceutical business. Discoveries made by one or more of these companies could render the Company's products less competitive or obsolete. Potential conflicts of interest could have a material adverse effect on the Company's business, financial condition and results of operations.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedge activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The statement, as amended, is effective for the fiscal quarters of the Company's fiscal year ending December 31, 2001. The Company is in the process of evaluating the effect of this Statement on its financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to market risk associated with changes in interest rates. The Company's interest rate exposure is limited to interest rate changes on its revolving credit agreement. The revolving credit agreement bears interest at rates which fluctuate at the federal funds rate or LIBOR plus an applicable percentage, depending upon certain financial ratios. All of the Company's remaining long-term debt is at fixed interest rates. The Company believes that reasonable possibly near-term changes in interest rates would not have a material effect on the Company's financial position, results of operations and cash flows.
The Company's financial instruments consist mainly of cash, accounts receivable, accounts payable and debt. The carrying amount of these instruments, except debt, approximate fair value due to their short-term nature. The estimated fair value of the Company's debt instruments is based upon rates currently available to the Company for debt with similar terms and remaining maturities.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are included in Part II, Item 8 of this Form 10-K.
REPORT OF 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, 1999 and 1998, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. 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 respects, the financial position of Akorn, Inc. and subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
Chicago, Illinois February 25, 2000
AKORN, INC.
CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)
See notes to consolidated financial statements.
AKORN, INC.
CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA)
COMPUTATION OF NET INCOME PER SHARE (IN THOUSANDS, EXCEPT PER SHARE DATA)
See notes to consolidated financial statements.
AKORN, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
See notes to consolidated financial statements.
AKORN, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)
See notes to consolidated financial statements.
AKORN, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation: The accompanying consolidated financial statements include the accounts of Akorn, Inc. and its wholly owned subsidiaries (the Company), Compass Vision, Inc. (Compass), Spectrum Scientific Pharmaceuticals, Inc. (Spectrum), Walnut Pharmaceuticals, Inc. (Walnut) and Akorn (New Jersey), Inc. Balances and activities of Compass, Spectrum and Walnut are immaterial. Intercompany transactions and balances have been eliminated in consolidation.
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. Significant estimates and assumptions relate to the reserve for wholesaler chargebacks, the reserve for slow-moving and obsolete inventory and the carrying value of intangible assets.
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.
Inventory: Inventory is stated at the lower of cost (average cost method) or market (see Note E). Provision is made for slow-moving, unsalable or obsolete items.
Stock Compensation Plans: The Company has an Incentive Compensation Plan under which any officer or key employee is eligible to receive options as designated by the Company's Board of Directors. The Company also has a Stock Option Plan for directors under which directors are granted nonqualified options.
Intangibles: Intangibles consist primarily of product licensing and other such costs which are capitalized and amortized on the straight line method over the lives of the related license periods or the estimated life of the acquired product, which range from 17 months to 18 years. Accumulated amortization at December 31, 1999 and 1998 was $4,523,000 and $2,976,000, respectively.
The Company annually assesses the impairment of intangibles based on several factors, including probable fair market value and anticipated cash flows.
Property, Plant and Equipment: Property, plant and equipment is stated at cost, less accumulated depreciation. Depreciation is provided using the straight-line method in amounts considered sufficient to amortize the cost of the assets to operations over their estimated service lives. The average estimated service lives of buildings and leasehold improvements, furniture and equipment and automobiles are approximately 30, 8 and 5 years, respectively.
Accrual for Chargebacks: The Company accrues an estimate of the difference between the gross sales price of certain products sold to wholesalers and expected resale prices of such products under contractual arrangements with third parties such as hospitals and group purchasing organizations at the time of sale. As part of the Company's sales terms to wholesale customers, it agrees to reimburse wholesalers for such differentials between wholesale prices and contract prices. Because this accrual relates to amounts not yet collected from the wholesalers, this accrual is recorded as a reduction of accounts receivable.
Income Taxes: The Company files a consolidated federal income tax return with all of its subsidiaries. Deferred income taxes are provided in the financial statements to account for the tax effects of temporary differences resulting from reporting revenues and expenses for income tax purposes in periods different from those used for financial reporting purposes.
Fair Value of Financial Instruments: The Company's financial instruments include cash, accounts receivable, accounts payable and term debt. The fair values of cash, accounts receivable and accounts payable approximate fair value because of the short maturity of these instruments. The carrying amounts of the
NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) Company's bank borrowings under its credit facility approximate fair value because the interest rates are reset periodically to reflect current market rates.
Net Income Per Common Share: Basic net income per common share is based upon weighted average common shares outstanding. Diluted net income per common share is based upon the weighted average number of common shares outstanding, including the dilutive effect of stock options and warrants using the treasury stock method.
NOTE B -- NONCASH TRANSACTIONS
On August 26, 1999, a former employee exercised options for 23,352 shares of the Company's common stock. The individual tendered approximately 8,800 shares of the Company's outstanding stock as consideration for the option exercise, which was recorded as treasury stock. The net effect of this transaction was to increase common stock and paid in capital by $35,028 and increase treasury stock by $35,028.
In July 1998, the Company financed the acquisition of four product licenses with long-term debt in the amount of $3.332 million.
On June 5, 1998, a former employee exercised options for 105,000 shares of the Company's common stock. The individual tendered approximately 22,000 shares of the Company's outstanding stock as consideration for the option exercise and approximately 33,000 shares to satisfy the personal income tax withholding requirements of the transaction, all of which was recorded as treasury stock. The net effect of this transaction was to increase accrued liabilities by $280,000, increase common stock and paid in capital by $185,000, and increase treasury stock by $465,000.
On March 31, 1998, the Company financed the acquisition of two product licenses with long-term debt in the amount of $3.905 million.
NOTE C -- PRODUCT AND OTHER ACQUISITIONS
In March 1999, the Company purchased Paredrine from Pharmics for $62,500 in cash. The acquisition cost has been allocated to intangibles and will be amortized over 15 years.
On February 1, 1999, the Company paid $400,000 in cash to Eastman Kodak to license IC Green raw material manufacturing processes. The acquisition cost has been allocated to intangibles and will be amortized over 15 years.
On August 1, 1998, the Company entered into an agreement to purchase three ophthalmic products, Fluress, Ful-Glo and Rose Bengal, from Allergan, Inc. The total purchase price was $4,650,000 with $2,000,000 paid in cash upon closing and two additional payments of $1,500,000 and $1,150,000 payable on the next two anniversaries of the closing date. The Company is imputing interest on these payments with a 7.5 percent interest rate. The acquisition cost has been allocated to intangibles and will be amortized over 15 years.
In July 1998, the Company acquired certain assets of Advanced Remedies, Inc. (ARI) for approximately $3,750,000. The purchase price included, in addition to capital equipment, all Abbreviated New Drug Applications (ANDAs) for any product previously approved for ARI or under review by the FDA. The purchase price also included regulatory files for products under development by ARI but not yet filed with the FDA. The total purchase price was allocated to ANDAs, $3,000,000 with amortization over 15 years, and tangible assets, $750,000 with asset depreciation up to ten years.
On January 21, 1998, the Company announced the purchase of the New Drug Application (NDA), trademark and U.S. trade name rights to Paremyd, a topical mydriatic combination product, from Allergan. Paremyd had been off the market for all of 1997 due to a raw material shortage. The Company is awaiting FDA approval to manufacture the product. The total purchase price was $700,000, with $500,000 paid in cash upon closing and $200,000 payable upon receipt of an approved supplement from the FDA or twelve months
NOTE C -- PRODUCT AND OTHER ACQUISITIONS -- (CONTINUED) from closing, whichever is sooner. The acquisition cost has been allocated to intangibles and will be amortized over 15 years.
On January 13, 1998, the Company announced the purchase of two branded injectable products, Sufenta and Alfenta, from Janssen Pharmaceutica, Inc. The products are injectable opioid analgesics indicated for use in the induction and maintenance of general anesthesia. Both were NDA products, and Alfenta remains covered under patent. The total purchase price was $6,600,000, with $2,200,000 paid in cash upon closing and two additional payments of $2,200,000 payable on the next anniversary of the closing date and on December 29, 1999, respectively. The second two payments were secured by irrevocable bank letters of credit, which were issued under the revolving credit facility (see Note H). The acquisition cost has been allocated to intangibles and will be amortized for 17 months (patent) and 15 years.
NOTE D -- ALLOWANCE FOR UNCOLLECTIBLES
The activity in the allowance for uncollectibles for the periods indicated is as follows (in thousands):
NOTE E -- INVENTORY
The components of inventory are as follows (in thousands):
Inventory at December 31, 1999 and 1998 is reported net of reserves for slow-moving, unsalable and obsolete items of $134,000 and $572,000, respectively.
NOTE F -- PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following (in thousands):
Construction in progress represents capital expenditures principally related to the Company's lyophilization project which will enable the Company to perform processes in-house which are currently being performed by a sub-contractor. The Company is committed to $1.4 million in additional construction costs.
NOTE G -- PRE-FUNDED DEVELOPMENT COSTS
As part of a cross-licensing agreement with Pfizer, Inc. (Pfizer), the Company was paid an advance of $1 million to be used to fund the costs of developing a non-steroidal anti-inflammatory drug for ophthalmic indications. During the twelve months ended December 31, 1997, the Company incurred development costs of $534,696 which were charged against the pre-funded balance.
NOTE H -- FINANCING ARRANGEMENTS
The Company's long-term debt consists of (in thousands):
Maturities of debt are as follows (in thousands):
In December 1997, the Company entered into a $15,000,000 revolving credit agreement with The Northern Trust Company, which was increased to $25,000,000 on June 30, 1998 and to $45,000,000 on December 28, 1999, of which there were outstanding borrowings of $28,200,000 and letters of credit of $35,000 at December 31, 1999. The total outstanding principal balance is payable in full on December 28, 2001. Outstanding borrowings under this facility currently bear interest at the federal funds rate or LIBOR plus an applicable percentage, depending on certain financial ratios, which interest rate was 5.365% at December 31, 1999.
The agreement provides that an annual commitment fee be paid by the Company based on 0.25% of the average daily unused amount of the facility. The agreement also requires the Company to maintain certain financial covenants including, but not limited to: minimum net income, minimum net worth, minimum cash flow coverage and maximum funded debt to EBITDA. The agreement prohibits the Company from declaring any cash dividends on its common stock. The revolving credit facility is secured by substantially all of the assets of the Company and its subsidiaries, excluding real property located in Decatur, Illinois.
On June 1, 1998, the Company entered into a $3,000,000 mortgage agreement with Standard Mortgage Investors, LLC of which there were outstanding borrowings of $2,678,000 at December 31, 1999. The principal balance is amortized over 10 years, with the final payment due in June 2007. The mortgage note bears an interest rate of 7.375% and is secured by the real property located in Decatur, Illinois.
On August 1, 1998, the Company entered into an agreement to purchase three ophthalmic products from Allergan, Inc. The total purchase price was $4,650,000 with $2,000,000 paid in cash upon closing and two additional payments of $1,500,000 and $1,150,000 payable on the next two anniversaries of the closing date. The Company is imputing interest on these payments with a 7.5% interest rate.
NOTE I -- 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 (in thousands):
Depreciation expense provided on these assets was $157,034, for each of the years ended December 31, 1999, 1998 and 1997.
The following is a schedule, by year, of future minimum lease payments under these capital leases together with the present value of the net minimum lease payments (in thousands):
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 $906,167, $570,288, and $289,276 for the years ended December 31, 1999, 1998 and 1997, respectively.
The following is a schedule, by year, of future minimum rental payments required under these non-cancelable operating leases (in thousands):
NOTE I -- LEASING ARRANGEMENTS -- (CONTINUED)
The Company currently sub-lets portions of its leased space. Rental income under these sub-leases was $211,043 in 1999 and $41,160 in 1998.
NOTE J -- STOCK OPTIONS AND EMPLOYEE STOCK PURCHASE PLAN
Under the 1988 Incentive Compensation Program (the "Incentive Program") any officer or key employee of the Company is eligible to receive options as designated by the Company's Board of Directors. As of December 31, 1999, 4,500,000 shares of the Company's Common Stock are reserved to be issued under the Incentive Program. The exercise price of the options granted under the Incentive Program may not be less than 50 percent of the fair market value of the shares subject to the option on the date of grant, as determined by the Board of Directors. All options granted under the Incentive Program during the years ended December 31, 1999, 1998 and 1997 have exercise prices equivalent to the market value of the Company's Common Stock on the date of grant. Options granted under the Incentive Program generally vest over a period of three years and expire within a period of five years.
Under the 1991 Stock Option Plan for Directors (the "Directors' Plan") persons elected as directors of the Company are granted nonqualified options at the fair market value of the shares subject to option on the date of the grant. As of December 31, 1999, 500,000 shares of the Company's Common Stock are reserved to be issued under the Directors' Plan. Options granted under the Directors' Plan vest immediately and expire five years from the date of grant.
A summary of the status of the Company's stock options as of December 31, 1999, 1998 and 1997 and changes during the years ended December 31, 1999, 1998 and 1997 is presented below (shares in thousands):
The fair value of each option granted during the year ended December 31, 1999 is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: (i) dividend yield of 0%, (ii) expected volatility of 51%, (iii) risk-free interest rate of 6.5% and (iv) expected life of 5 years.
NOTE J -- STOCK OPTIONS AND EMPLOYEE STOCK PURCHASE PLAN -- (CONTINUED) The fair value of each option granted during the year ended December 31, 1998 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 55%, (iii) risk-free interest rate of 5.75% and (iv) expected life of 5 years.
The fair value of each option granted during the year ended December 31, 1997 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 39%, (iii) risk-free interest rate of 5.75% and (iv) expected life of 5 years.
The following table summarizes information about stock options outstanding at December 31, 1999 (shares in thousands):
The Company applies Accounting Principles Board (APB) Opinion No. 25 and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock option plans.
Had compensation cost for the Company's stock-based compensation plans been determined based on Statement of Financial Accounting Standards ("SFAS") No. 123, the Company's net income and net income per share for the years ended December 31, 1999, 1998 and 1997 would have been the pro forma amounts indicated below (in thousands, except per share amounts):
The Akorn, Inc. Employee Stock Purchase Plan permits eligible employees to acquire shares of the Company's common stock through payroll deductions not exceeding 15% of base wages, at a 15% discount from market price. A maximum of 1,000,000 shares of the Company's common stock may be acquired under the terms of the Plan. Purchases of shares issued from treasury stock approximated 7,000, 8,000 and 9,000 shares, respectively, during the years ended December 31, 1999, 1998 and 1997. New shares issued under the plan approximated 26,000 in 1999, 8,000 in 1998 and 11,000 in 1997.
NOTE K -- INCOME TAXES
The income tax provision (benefit) consisted of the following (in thousands):
NOTE K -- INCOME TAXES -- (CONTINUED)
Income tax expense differs from the "expected" tax expense computed by applying the U.S. Federal corporate income tax rate of 34% to income before income taxes as follows (in thousands):
Deferred tax assets (liabilities) at December 31, 1999 and 1998 include (in thousands):
The deferred taxes are classified in the accompanying balance sheets as follows (in thousands):
NOTE L -- CHANGES IN ACCOUNTING ESTIMATES
The Company accrues an estimate of the difference between the gross sales price of certain products sold to wholesalers and expected resale prices of such products under contractual arrangements with third parties such as hospitals and group purchasing organizations at the time of sale. This reserve is carried as a reduction
NOTE L -- CHANGES IN ACCOUNTING ESTIMATES -- (CONTINUED) of accounts receivable. The Company evaluates the reserve balance against actual chargebacks processed by wholesalers. Actual chargebacks processed can vary substantially from period to period. The acquisition of two injectable anesthesia products from Janssen Pharmaceutica in the third quarter of 1996 resulted in a substantial increase in chargeback activity. Initial receipt of actual chargeback requests from wholesalers was sporadic during 1996. By year-end 1997, management felt that chargeback activity for these products had stabilized and that sufficient data had been obtained to validate adjustments to chargeback accrual assumptions. During the fourth quarter of the year ended December 31, 1997, the Company revised its assumptions underlying the reserve for chargebacks, resulting in an increase in net sales of $1,300,000.
The Company records a reserve for slow-moving and obsolete inventory based upon evaluation of product dating and unit sales forecasts. In 1999, the Company incurred $328,000 in charges for unsalable product. Throughout 1999, the Company evaluated its estimate for unsalable product resulting in an estimate decrease of approximately $206,000. This reduction in the reserve balance reflects more timely destruction of obsolete product. During 1998, the Company evaluated its estimate for unsalable product resulting in an estimate increase of approximately $665,000.
During the quarter ended December 31, 1997, the Company increased its estimate for management bonuses by approximately $300,000.
NOTE M -- RETIREMENT PLAN
All employees who have attained the age of 21 with six months of service are eligible for participation in the Company's 401(k) Plan. The plan-related expense recognized for the years ended December 31, 1999, 1998 and 1997 totaled $220,203, $89,020 and $65,704, respectively. The employer's matching contribution is a percentage of the amount contributed by each employee and is funded on a current basis.
NOTE N -- INDUSTRY SEGMENT INFORMATION
The Company classifies its operations into two business segments, ophthalmic and injectable. The ophthalmic segment manufactures, markets and distributes diagnostic and therapeutic pharmaceuticals and surgical instruments and related supplies. The injectable segment manufactures, markets and distributes
NOTE N -- INDUSTRY SEGMENT INFORMATION -- (CONTINUED) injectable pharmaceuticals, primarily in niche markets. Selected financial information by industry segment is presented below (in thousands):
For the year ended December 31, 1997, operating income for the ophthalmic segment includes non-recurring charges of $1,451,000 related to the relocation of the division from Abita Springs, Louisiana to the Chicago area. The charges primarily relate to severance, $494,000, and retention bonus payments, $151,000 as well as a write-down of the Abita Springs facility and equipment to net realizable value, $378,000 and moving relocation costs, $144,000. For the same period, operating income for the injectable segment includes non-recurring charges of $213,000 related to a change in an estimate of the timing of absorption of manufacturing overhead.
The Company records sales between the segments at fully absorbed cost.
NOTE O -- COMMITMENTS AND CONTINGENCIES
The Company is a party in legal proceedings and potential claims arising in the ordinary course of its business. Despite the inherent uncertainties of litigation, management of the Company at this time does not believe that such proceedings will have a material adverse impact on the consolidated financial position, results of operations, or cash flows of the Company.
NOTE P -- SUPPLEMENTAL CASH FLOW INFORMATION (IN THOUSANDS)
NOTE Q -- RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedge activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The statement, as amended, is effective for the fiscal quarters of the Company's fiscal year ending December 31, 2001. The Company is in the process of evaluating the effect of this Statement on its financial statements.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
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 and compliance with Section 16(a) of the Exchange Act is incorporated by reference to the Company's Definitive Proxy Statement for its 2000 Annual Meeting of Shareholders. Information concerning the Company's executive officers is included in Item 1A of Part I hereof.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item as to executive compensation is hereby incorporated by reference from the information appearing under the caption "Executive Compensation" in the Company's definitive Proxy Statement which is to be filed with the Securities and Exchange Commission (the "Commission") within 120 days of the Company's fiscal year ended December 31, 1999.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item as to the ownership of management and others of securities of the Company is hereby incorporated by reference from the information appearing under the caption "Security Ownership" in the Company's definitive Proxy Statement which is to be filed with the Commission within 120 days of the Company's fiscal year ended December 31, 1999.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item as to certain business relationships and transactions with management and other related parties of the Company is hereby incorporated by reference from the information appearing under the caption "Transactions with Shareholders and Directors" in the Company's definitive Proxy Statement which is to be filed with the Commission within 120 days of the Company's fiscal year ended December 31, 1999.
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.
(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/ FLOYD BENJAMIN ------------------------------------ Floyd Benjamin Chief Executive Officer
Date: March 28, 2000
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.