ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis of the Company's financial condition and
results of operations should be read in conjunction with the consolidated
financial statements, the related notes to consolidated financial statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in the Company's annual report on Form 10-K/A and the
unaudited interim condensed consolidated financial statements included in Item 1
of this Quarterly Report on Form 10-Q.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2002
Net sales. Net sales increased 49.2% to $149.5 million for the six months ended
June 30, 2003 from $100.2 million in the comparable period in 2002. The
majority of the increase was attributable to products introduced in late June
2002 or thereafter. These products include Lisinopril, USP, Lisinopril/HCTZ,
Tizanidine HCl, Tramadol HCL, Nizatidine, USP and a Dextroamphetamine and
Amphetamine Mixed Salt Product. An increase in unit volume of several existing
products also contributed to higher sales for the six months ended June 30,
2003.
Gross profit. Gross profit as a percentage of net sales increased to 53.5% for
the six months ended June 30, 2003 compared to 51.4% in the comparable period in
2002. The increase was primarily due to increased utilization of manufacturing
capacity, including a significant increase in production at the Company's North
Carolina facility. Additionally, in 2002 there was a $1.6 million write down of
a raw material that will not be utilized in production. The Company's gross
profit margins are dependent on several factors, including product sales mix,
cost, volumes and competitive activity.
Amortization of other intangible assets. Amortization of other intangible
assets was $1.9 million for the six months ended June 30, 2003 and for the
comparable period in 2002.
Other selling, general and administrative expenses. Other selling, general and
administrative expenses increased $0.8 million to $14.1 million for the six
months ended June 30, 2003 from $13.2 million for the comparable period in
2002. Expenses for the six months ended June 30, 2003 were reduced by a $3.5
million recovery of legal fees related to Nabumetone litigation. Excluding the
recovery of legal fees, other selling, general and administrative expenses were
$17.6 million for the six months ended June 30, 2003, representing an increase
of $4.3 million compared to the prior year. However, other selling, general and
administrative expenses, excluding the recovery of legal fees in 2003, decreased
as percentage of net sales to 11.7% compared to 13.2% for the 2002 period. The
increase in other selling, general and administrative expenses was principally
due to higher insurance premiums, an increase in distribution costs due to
increased sales volume and increased costs related to personnel.
Research and development expenses. Research and development expenses increased
$3.1 million to $9.3 million for the six months ended June 30, 2003 compared to
$6.3 million for the comparable period in 2002. The increase was attributable
to an increase in generic product development costs of $3.6 million, offset by a
decrease of $0.5 million related to certain basic
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research contracts unrelated to the Company's business that were transferred in
March 2002 to an unrelated entity. The increase in generic product development
costs was primarily attributable to increases in costs related to bio-studies
and materials.
Operating income. Operating income increased $24.6 million to $54.8 million for
the six months ended June 30, 2003 from $30.1 million for the comparable period
in 2002. The increase in operating income was the result of increased sales and
gross profit, offset by increases in other selling, general and administrative
expenses and research and development costs.
Interest income (expense). Net interest income for the six months ended June
30, 2003 was $0.4 million compared to net interest expense of $3.3 million in
the comparable period in 2002. A decrease in outstanding debt, including the
elimination of $92.1 million of intercompany debt, decreased interest expense by
$3.1 million. Interest income increased by $0.5 million, the result of higher
investment balances.
Taxes on income. Taxes on income increased $11.1 million to $22.1 million
during the six months ended June 30, 2003 from $11.0 million for the comparable
period in 2002. The increase was the result of higher pre-tax income for 2003.
The effective tax rate decreased to 40.0% from 41.0% due principally to lower
state and local taxes in 2003.
Net income. Net income increased $17.3 million to $33.1 million for the six
months ended June 30, 2003 from $15.9 million in the comparable period in 2002
for the reasons described above.
THREE MONTHS ENDED JUNE 30, 2003 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2002
Net sales. Net sales increased 51.3% to $78.7 million for the three months
ended June 30, 2003 from $52.0 million for the comparable period in 2002. The
majority of the increase was attributable to products introduced in late June
2002 or thereafter. These products include Lisinopril, USP, Lisinopril/HCTZ,
Tizanidine HCl, Tramadol HCL and Nizatidine, USP, and a Dextroamphetamine and
Amphetamine Mixed Salt Product. An increase in unit volume of several existing
products also contributed to higher sales for the quarter ended June 30, 2003.
Gross profit. Gross profit as a percentage of net sales decreased to 52.9% for
the three months ended June 30, 2003 compared to 54.4% in the comparable period
in 2002. The decrease was primarily due to a change in product mix, partially
offset by the increased utilization of manufacturing capacity, particularly at
the Company's North Carolina facility. The Company's gross profit margins are
dependent on several factors, including product sales mix, cost, volumes and
competitive activity.
Amortization of other intangible assets. Amortization of other intangible
assets was $0.9 million for the three months ended June 30, 2003 and for the
comparable period in 2002.
Other selling, general and administrative expenses. Other selling, general and
administrative expenses decreased $1.8 million to $5.3 million for the three
months ended June 30, 2003 from $7.1 million for the comparable period in 2002.
Expenses for the three months ended June 30, 2003 were reduced by a $3.5 million
recovery of legal fees related to Nabumetone litigation. Excluding the recovery
of legal fees, other selling, general and administrative expenses were $8.8
million for the three months ended June 30, 2003, representing an increase of
$1.7 million compared to the prior year. However, other selling, general and
administrative expenses, excluding the recovery of legal fees in 2003, decreased
as percentage of net sales to 11.2% from 13.6% for the 2002 period. The
increase in other selling, general and administrative expenses was principally
due to higher insurance premiums, and an increase in distribution costs.
Insurance expense increased by $1.0 million, primarily the result of higher
product liability and directors and officers insurance premiums. Higher sales
volume increased distribution expenses by $0.4 million.
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Research and development expenses. Research and development expenses increased
$2.7 million to $5.7 million for the three months ended June 30, 2003 compared
to $3.0 million for the comparable period in 2002. The increase was
attributable to an increase in generic product development costs of $2.7
million. The increase in generic product development costs was primarily
attributable to increases in costs related to bio-studies and materials.
Operating income. Operating income increased $12.4 million to $29.7 million for
the three months ended June 30, 2003 from $17.3 million for the comparable
period in 2002. The increase in operating income was the result of increased
sales and gross profit and the recovery of legal fees, offset by increases in
research and development costs.
Interest income (expense). Net interest income for the three months ended June
30, 2003 was $0.3 million compared to net interest expense of $1.2 million in
the comparable period in 2002. A decrease in outstanding debt, including the
elimination of $92.1 million of intercompany debt, reduced interest expense by
$1.3 million. Interest income increased by $0.2 million, the result of higher
investment balances.
Taxes on income. Taxes on income increased $5.4 million to $12.0 million during
the three months ended June 30, 2003 from $6.6 million in the comparable period
in 2002. The increase was the result of higher pre-tax income for 2003. The
effective tax rate decreased to 40.0% from 41.0% due principally to lower state
and local taxes in 2003.
Net income. Net income increased $8.5 million to $18.0 million for the three
months ended June 30, 2003 from $9.5 million in the comparable period in 2002
for the reasons described above.
LIQUIDITY AND CAPITAL RESOURCES
Cash and investments increased $25.6 million to $112.9 million at June 30, 2003
from $87.2 million at December 31, 2002. Cash and cash equivalents were $38.6
million at June 30, 2003 compared to $62.3 million at December 31, 2002. The
$23.7 million decrease in cash and cash equivalents was more than offset by a
$49.3 million increase in investments.
The Company also has a three-year $25 million credit facility which expires on
February 8, 2005. Under this facility, the Company can borrow at LIBOR plus
1.5%, the bank's prime rate or a fixed rate. The credit facility, which is for
working capital purposes, had no outstanding borrowings against it at June 30,
2003.
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Stockholders' equity increased to $293.2 million at June 30, 2003 from $258.2
million at December 31, 2002. Stockholders' equity increased by $1.7 million
(including tax benefits) from the exercise of employee stock options, net
earnings of $33.1 million for the six months ended June 30, 2003 and $0.2
million for the amortization of deferred stock-based compensation costs.
During the six months ended June 30, 2003, the Company consumed net cash of
$23.7 million. Operations generated $35.8 million of cash, comprised of net
earnings of $33.1 million and non-cash items totaling $49.0 million, offset by
an increase in working capital of $46.4 million. The increase in working
capital resulted from a decrease in accounts payable of $0.5 million and
increases in accounts receivable, inventory and prepaid expenses and other
current assets of $40.9 million, $8.5 million and $2.2 million, respectively. A
decrease in other assets of $0.8 million and an increase in accrued liabilities
of $5.0 million partially offset the other working capital increases. The
increases in accounts receivable, inventory, and accrued liabilities are
associated with higher sales and production levels. Prepaid expenses were
higher due to prepaid taxes.
Investing activities consumed $55.1 million of cash during the six months ended
June 30, 2003. Approximately $49.3 million was used to purchase short-term
investment grade debt instruments with the balance of $5.8 million used for
capital expenditures. The capital expenditures relate primarily to equipment
required to support increased production volume in the Company's North Carolina
facility.
Financing activities consumed $4.4 million of cash during the six months ended
June 30, 2003, with $4.8 million used to pay the remaining balance of the EHI
acquisition note. Additional sources of cash during this period included $0.05
million related to an increase in advances from an affiliate and $0.3 million of
proceeds from the exercise of stock options.
The Company is involved in various litigation matters in which the potential
liabilities and/or related expenses are not covered by insurance. In addition,
an adverse outcome in patent litigation with Novartis and Apotex involving
cyclosporine capsules could result in the Company being unable to market this
product which would materially harm its profits and cash flows and could result
in the Company paying damages, cost, expenses, and fees that could have a
material adverse impact on its financial performance. In December 2002, the
United States District for the District of Delaware granted the Company's motion
in the Novartis case for summary judgment of non-infringement of the patent.
Novartis appealed the judgment and the appeal is currently pending.
The Company does not currently have or anticipate any short-term funding
requirements outside of the ordinary course of its business, and the Company
does not have or anticipate any liquidity concerns. The Company's principal
future cash requirements are associated with increased working capital to
support future growth, capital expenditures and legal defense costs. The
Company anticipates that its operating cash flows, together with its available
borrowings under its credit facility and current cash balances, will be
sufficient to meet all of its working capital and capital expenditures
requirements for both the short-term and foreseeable future.
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CRITICAL ACCOUNTING POLICIES
The Company's critical accounting policies are those policies that are important
to the portrayal of its financial condition and results of operations and
require management's subjective judgments. As a result, these judgments are
subject to an inherent degree of uncertainty. The Company bases its judgments
on its experience and various other assumptions that the Company believes to be
reasonable under the circumstances. On an ongoing basis, the Company evaluates
its estimates, including those related to revenues, returns, inventories, income
taxes and litigation. The Company's actual results could differ from these
estimates under different assumptions or conditions. The Company believes the
following accounting policies to be critical:
Sales are recognized when the products are received by the customer, which
represents the point when the risks and rewards of ownership are transferred to
the customer. Sales are shown net of discounts, rebates, contract pricing
adjustments and returns, which are estimated based on the Company's experience.
Discounts, rebates and contract pricing adjustments are recorded as a reduction
of sales based on agreed upon terms with the Company's customers at the time of
sale. The Company calculates a reserve for discounts and rebates based upon
actual sales under such arrangements. Reserves for contract pricing adjustments
represent the difference between the prices wholesalers are billed by the
Company and the prices billed to their customers to whom the Company has given
contract prices. In determining a reserve for contract pricing adjustments, the
Company takes into account an estimate of the percentage of product sales
subject to such pricing adjustments based on historical trends. Historical
trends are adjusted for new product introductions and changes in wholesaler or
contract prices.
Shelf stock adjustments are provided following a reduction in the prices of any
of the Company's products due to the competitive environment. Such adjustments
are credited to the Company's customers based on their on-hand inventory
quantities. Reserves are generally established when the Company reduces its
prices.
Estimates for returns, which are recorded at the time of sale, relate primarily
to returns of expiring products. The Company utilizes historical trends to
estimate the amount of products to be returned due to product expiration.
In determining whether liabilities should be recorded for pending litigation
claims, the Company must assess the allegations made and the likelihood that it
will successfully defend itself. When the Company believes it is probable that
it will not prevail in a particular matter, it will then make an estimate of the
amount of liability based in part on advice of outside legal counsel.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2002, the FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation-Transition and Disclosure" that amends FASB Statement No. 123
"Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based employee compensation. SFAS No. 148 amends the
disclosure requirements of APB Opinion No. 28, "Interim Financial Reporting" and
Statement No. 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reporting results. SFAS No.
148 is effective for fiscal years ending after December 15, 2002. The adoption
of SFAS No. 148, except for the disclosure requirements, had no impact on the
consolidated financial statements. The additional required disclosure is
included as part of note 4 in the Notes to the Condensed Consolidated Financial
Statements on Form 10-Q.
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In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150
requires that certain financial instruments, which under previous guidance were
accounted for as equity, must now be accounted for as liabilities. The
financial instruments affected include mandatory redeemable stock, certain
financial instruments that require or may require the issuer to buy back some of
its shares in exchange for cash or other assets and certain obligations that can
be settled with shares of stock. SFAS No. 150 is effective for all financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. The initial adoption of SFAS No. 150 on July 1, 2003 is not expected to
have any impact on the Company's consolidated financial statements.
The FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others - an Interpretation of FASB Statements No. 5, 57, and 107 and Rescission
of FASB Interpretation No. 34." This interpretation expands on the existing
accounting guidance and disclosure requirements for most guarantees, including
indemnifications. It requires that at the time a company issues a guarantee,
the company must recognize an initial liability for the fair value of the
obligations it assumes under that guarantee if that amount is reasonably
estimable, and must disclose that information in its interim and annual
financial statements. The provisions for initial recognition and measurement of
the liability are to be applied on a prospective basis to guarantees issued or
modified on or after January 1, 2003. The Company's initial adoption of this
statement on January 1, 2003, did not have an impact on its results of
operations, financial position, or cash flows. Guarantees issued or modified
after January 1, 2003, will be recognized at their fair value in the Company's
financial statements. The Company has not issued any guarantees as of June 30,
2003.