BRADLEY PHARMACEUTICALS INC - BDY Quarterly Report (10-Q) Item 2. Management's Discussion and Analysis of Financial ...

The following is an excerpt from a 10-Q SEC Filing, filed by BRADLEY PHARMACEUTICALS INC on 8/9/2004.

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with the financial statements and notes thereto included elsewhere in this Form 10-Q and the financial statements and notes included in our Form 10-K for the year ended December 31, 2003. The following discussion and analysis contains forward-looking statements regarding our future performance. All forward-looking information is inherently uncertain and actual results may differ materially from the assumptions, estimates or expectations reflected or contained in the forward-looking statements. See "Forward-Looking Statements" and "Risk Factors" included in our Form 10-K for the year ended December 31, 2003.

Forward-Looking Statements

Some of the statements under the captions "Risk Factors" included in our Form 10-K for the year ended December 31, 2003, "Management's Discussion and Analysis of Financial Condition and Results of Operations" or contained or incorporated by reference in this Form 10-Q constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include statements that address activities, events or developments that we expect, believe or anticipate will or may occur in the future, including:

• our plans to execute our Acquire, Enhance, Grow strategy;

• market acceptance of our products;

• our plans to launch new and enhanced products;

• our plans to increase our sales;

• our ability to obtain new distributors and market approvals in new countries;

• our plans to pursue patents;

• our ability to successfully compete in the marketplace;

• our plans to increase the size of our sales force;

• our earnings estimates and future financial condition and results of operations;

• our plans to effect a rescission offer relating to our 401(k) plan and its expected impact on our financial condition;

• the adequacy of our cash, cash equivalents and cash generated from operations to meet our working capital requirements for the next twelve months; and

• the impact of the changes in the accounting rules discussed in this Form 10-Q.

In some cases, you can also identify forward-looking statements by terminology such as "may," "should," "could," "would," "predicts," "potential," "continue," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates" and similar

expressions. All forward-looking statements are based on assumptions that we have made based on our experience and perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate. These statements are subject to numerous risks and uncertainties, many of which are beyond our control, including the statements set forth under "Risk Factors" included in our Form 10-K for the year ended December 31, 2003.

No forward-looking statement can be guaranteed, and actual results may differ materially from those projected. We undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future events or otherwise.

Overview

We are a specialty pharmaceutical company that acquires, develops and markets prescription and over-the-counter products within the dermatologic, podiatric and gastrointestinal markets. We have experienced substantial growth in Net Sales and net income through increased sales of existing products and new product sales, recognizing Net Sales for the six months ended June 30, 2004 of $48,022,000 representing an increase of $16,756,000, or approximately 54% from $31,266,000 for the six months ended June 30, 2003.

Our CARMOL®40 product line accounted for approximately 29% of our sales for the six months ended June 30, 2004 and has faced increasing competition. To lessen our dependence on this product line, we have sought to grow our other product lines both in terms of dollar volume and percentage of revenues. During 2004, we have launched ZODERM® LOTION, GEL and CREAM and KERALAC™ LOTION and GEL.

ZODERM® products are internally developed urea-based topical prescription products that treat acne. KERALAC™ is a prescription urea-based topical therapy that removes the surface layer of dead cells and improves skin moisture. KERALAC™ was launched as a second-generation product line to CARMOL®40.

We market and sell our products in the highly competitive pharmaceutical industry primarily through our full-time sales personnel and wholesalers. We seek to expand our market reach through promotion of our products in new geographic regions and for wider application in existing regions, and will continue expansion of our field sales force as product growth, geographic reach or product acquisitions warrant.

On June 9, 2004, we entered into an agreement to purchase the assets of Bioglan Pharmaceuticals Company, a wholly-owned subsidiary of Quintiles Transnational Corp. As part of the transaction, which we anticipate closing shortly, we will acquire certain intellectual property, regulatory filings, and other assets relating to Solaraze® (diclofenac sodium), a topical treatment indicated for the treatment of actinic keratosis, Adoxa® (doxycycline monohydrate), an oral antibiotic indicated for the treatment of acne, Zonalon™ (doxepin hydrochloride), a topical treatment indicated for pruritus, Tx

Systems®, a line of advanced topical treatments used during in-office procedures, and certain other dermatologic products. The total consideration estimated to be paid by us at closing is approximately $185 million, subject to adjustment based upon Bioglan's working capital on the closing date and net sales for 2004 prior to the closing.

Results of Operations

The following table sets forth certain data as a percentage of net revenues for the periods indicated:

Three Months Ended Six Months Ended June 30, June 30,
2004 2003 2004 2003
Net sales 100% 100% 100% 100% Gross profit 91.2% 91.4% 91.4% 91.3% Operating expenses 59.9% 57.5% 55.3% 58.9% Operating income 31.3% 33.9% 36.1% 32.4% Interest income 3.5% 0.6% 3.2% 0.7% Interest expense 2.3% 0.6% 2.2% 0.3% Income tax expense 12.9% 13.2% 14.7% 12.8% Net income 19.6% 20.7% 22.4% 20.0%

NET SALES for the three months ended June 30, 2004 were $22,955,000, representing an increase of $6,605,000, or approximately 40%, from $16,350,000 for the three months ended June 30, 2003.

For the three months ended June 30, 2004, Doak Dermatologics' Net Sales were $17,353,000, representing an increase of $4,693,000, or approximately 37%, from $12,660,000 for the three months ended June 30, 2003. The increase in Net Sales was led by new product sales from ROSULA® AQUEOUS CLEANSER, launched in Third Quarter 2003, of $1,133,000; LIDAMANTLE® LOTION, launched in the Fourth Quarter 2003, of $159,000; LIDAMANTLE®HC LOTION, launched in the Fourth Quarter 2003, of $267,000; ZODERM® GEL 4.5%, launched in the First Quarter 2004, of $32,000; ZODERM® GEL 8.5%, launched in the First Quarter 2004, of $8,000; ZODERM® Cream 4.5%, launched in the First Quarter 2004, of $122,000; ZODERM® Cream 8.5%, launched in the First Quarter 2004, of $17,000; ZODERM® CLEANSER 4.5%, launched in the First Quarter 2004, of $369,000; ZODERM® CLEANSER 8.5%, launched in the First Quarter 2004, of $90,000; KERALAC™ LOTION 7oz, launched in the Second Quarter 2004, of $888,000; KERALAC™ LOTION 11oz, launched in the Second Quarter 2004, of $1,466,000; and KERALAC™ GEL, launched in the Second Quarter 2004, of $1,950,000. In addition, Doak benefited from product sales growth from CARMOL®40 GEL of $373,000 and CARMOL® SCALP products of $354,000, which were offset by declines in CARMOL®40 CREAM of $1,785,000 and CARMOL®40 LOTION of $798,000. The total Net Sales for CARMOL®40 CREAM, LOTION and GEL for the three months ended June 30, 2004 were $6,746,000.

For the three months ended June 30, 2004, Kenwood Therapeutics' Net Sales were $5,602,000, representing an increase of $1,912,000, or approximately 52%, from $3,690,000 for the three months ended June 30, 2003. The increase in Net Sales were led by new product sales of FLORA-Q™, launched in First Quarter 2004, of $395,000 and PAMINE® FORTE, launched in Third Quarter 2003, of $674,000 and product sales growth from ANAMANTLE®HC of $2,224,000. The increases in Net Sales were offset by a decrease in PAMINE® 2.5mg of $442,000 and respiratory products of $857,000.

Net Sales for the six months ended June 30, 2004 were $48,022,000, representing an increase of $16,756,000, or approximately 54%, from $31,266,000 for the six months ended June 30, 2003.

For the six months ended June 30, 2004, Doak Dermatologics' Net Sales were $34,855,000, representing an increase of $11,319,000, or approximately 48%, from $23,536,000 for the six months ended June 30, 2003. The increase in Net Sales was led by new product sales from ROSULA® AQUEOUS CLEANSER, launched in Third Quarter 2003, of $1,633,000; LIDAMANTLE® LOTION, launched in the Fourth Quarter 2003, of $733,000; LIDAMANTLE®HC LOTION, launched in the Fourth Quarter 2003, of $1,083,000; ZODERM® GEL 4.5%, launched in the First Quarter 2004, of $604,000; ZODERM® GEL 8.5%, launched in the First Quarter 2004, of $885,000; ZODERM® Cream 4.5%, launched in the First Quarter 2004, of $775,000; ZODERM® Cream 8.5%, launched in the First Quarter 2004, of $1,016,000; ZODERM® CLEANSER 4.5%, launched in the First Quarter 2004, of $1,005,000; ZODERM® CLEANSER 8.5%, launched in the First Quarter 2004, of $1,092,000; KERALAC™ LOTION 7oz, launched in the Second Quarter 2004, of $888,000; KERALAC™ LOTION 11oz, launched in the Second Quarter 2004, of $1,466,000; and KERALAC™ GEL, launched in the Second Quarter 2004, of $1,950,000. In addition, Doak benefited from product sales growth from CARMOL®40 GEL of $1,628,000, which was offset by declines in CARMOL®40 CREAM of $2,363,000 and CARMOL®40 LOTION of $1,149,000. The total Net Sales for CARMOL®40 CREAM, LOTION and GEL for the six months ended June 30, 2004 were $14,112,000.

For the six months ended June 30, 2004, Kenwood Therapeutics' Net Sales were $13,167,000, representing an increase of $5,437,000, or approximately 70%, from $7,730,000 for the six months ended June 30, 2003. The increase in Net Sales were led by new product sales of FLORA-Q™, launched in First Quarter 2004, of $444,000 and PAMINE® FORTE, launched in Third Quarter 2003, of $823,000 and product sales growth from ANAMANTLE®HC of $4,095,000 and PAMINE® 2.5mg of $645,000.

The overall increases in the sales of our existing products, in particular, CARMOL® 40 GEL and ANAMANTLE® HC, and new product sales, excluding sales as a result of initial stocking relating to ZODERM® products and KERALAC™ products, during the three and six months ended June 30, 2004 were primarily due to promotional efforts, including an increase in number of sales representatives detailing those products to physicians and customers who we believe will generate higher sales. In addition, initial stocking sales from ZODERM® products in the First Quarter 2004 and KERALAC™

LOTION and GEL in the Second Quarter 2004 significantly contributed to the increased sales in comparison to the same periods in the prior year. As a result of the ZODERM® products sales being initial stocking by our customers during the First Quarter 2004, ZODERM® sales during Second Quarter 2004 were significantly less than the previous quarter. Further, as a result of the KERALAC™ LOTION and GEL sales being initial stocking by our customers during the Second Quarter 2004, KERALAC™ LOTION and GEL sales during Third Quarter 2004 will most likely be significantly less than the Second Quarter 2004.

During the Second Quarter 2003, a competitor launched a competing product with the same active ingredient as CARMOL® 40 CREAM. During the Fourth Quarter 2003, generic competitors introduced less expensive comparable products to CARMOL® 40 CREAM, CARMOL® 40 LOTION and CARMOL® 40 GEL, also with the same active ingredient. These introductions of competing products resulted in reduced demand for our CARMOL® 40 CREAM and LOTION products during the three and six months ended June 30, 2004 in comparison to the same periods in the prior year. In order to minimize a reduction in Net Sales related to increased competition related the CARMOL® 40 products, the Company has introduced new products, including KERALAC™ LOTION and GEL. If sales of the CARMOL®40 product line or any other material product line decreases, including ZODERM® products, KERALAC™ LOTION and GEL, ANAMANTLE®HC, PAMINE® or other Company products, as a result of increased competition, government regulations, wholesaler buying patterns, physicians prescribing habits or for any other reason and we fail to replace those sales, our revenues and profitability would decrease.

COST OF SALES for the three months ended June 30, 2004 were $2,001,000, representing an increase of $587,000, or approximately 42%, from $1,414,000 for the three months ended June 30, 2003. Cost of sales for the six months ended June 30, 2004 were $4,155,000, representing an increase of $1,447,000, or approximately 53%, from $2,708,000 for the six months ended June 30, 2003. The gross profit percentage for the three and six months ended June 30, 2004 and the same periods the prior year was 91%.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES for the three months ended June 30, 2004 were $13,442,000, representing an increase of $4,352,000, or 48%, compared to $9,090,000 for the three months ended June 30, 2003. Selling, general and administrative expenses for the six months ended June 30, 2004 were $25,939,000, representing an increase of $8,115,000, or 46%, compared to $17,824,000 for the six months ended June 30, 2003. The increase in selling, general and administrative expenses reflects increased spending on sales and marketing to implement our strategy of aggressively marketing our dermatology, podiatry and gastrointestinal brands. In particular, the following table sets forth certain data as an increase in expenditures for the periods indicated:

Change from the Change from the Three Months Ended Six Months Ended June 30, 2004 in June 30, 2004 in comparison comparison to June 30, 2003 to June 30, 2003
Sales Payroll $ 1,111,000 $2,131,000 Travel and Entertainment* $ 551,000 $1,208,000 ZODERM® Promotional Costs $ 807,000 $ 1,256,000 KERALAC™ Promotional Costs** $ 199,000 $ 199,000 ANAMANTLE®HC Promotional Costs $ 153,000 $ 327,000 Marketing, General and
Administrative Payroll $ 639,000 $ 1,422,000

* Increases in Travel and Entertainment primarily relate to increased number of sales representatives and travel associated with increased number of conventions attended by Company personnel.

** Includes expenses associated with national launch meeting for KERALAC™.

Selling, general and administrative expenses as a percentage of Net Sales were 59% for the three months ended June 30, 2004, representing an increase of 3% compared to 56% for the three months ended June 30, 2003. Selling, general and administrative expenses as a percentage of Net Sales were 54% for the six months ended June 30, 2004, representing a decrease of 3% compared to 57% for the six months ended June 30, 2003.

DEPRECIATION AND AMORTIZATION EXPENSES for the three months ended June 30, 2004 were $311,000, representing an increase of $6,000 from $305,000 in the three months ended June 30, 2003. Depreciation and amortization expenses for the six months ended June 30, 2004 were $642,000, representing an increase of $54,000 from $588,000 in the six months ended June 30, 2003.

GAIN ON INVESTMENT for the six months ended June 30, 2004 was $31,000, in comparison to zero in the same period of the prior year. There was no gain or loss on investment during three months ended June 30, 2004 and 2003.

INTEREST INCOME for the three months ended June 30, 2004 was $797,000, representing an increase of $698,000 from the three months ended June 30, 2003. Interest income for the six months ended June 30, 2004 was $1,536,000, representing an increase of $1,324,000 from the six months ended June 30, 2003. The increases were principally due to investment increases from proceeds from the issuance of $37 million of

4% senior subordinated convertible notes due 2013 in June and July 2003 and net proceeds of $96,205,000 from the issuance of 4.6 million shares of common stock in December 2003.

INTEREST EXPENSE for the three months ended June 30, 2004 was $536,000, representing an increase of $433,000 from the three months ended June 30, 2003. Interest expense for the six months ended June 30, 2004 was $1,046,000, representing an increase of $936,000 from the six months ended June 30, 2003. The increases were principally due to interest expense related to our convertible notes.

INCOME TAX EXPENSE for the three months ended June 30, 2004 was $2,954,000, representing an increase of $794,000 from $2,160,000 for the three months ended June 30, 2003. Income tax expense for the six months ended June 30, 2004 was $7,051,000, representing an increase of $3,054,000 from $3,997,000 for the six months ended June 30, 2003. The effective tax rate used to calculate the income tax expense for the three and six months ended June 30, 2004 was approximately 40%. The effective tax rate used to calculate the income tax expense for the three and six months ended June 30, 2003 was approximately 39%. The increase in the effective tax rate during the three and six months ended June 30, 2004 was principally due to a projected increase in the federal statutory rate, as our estimated pretax income for 2004 will result in a higher tax bracket.

NET INCOME for the three months ended June 30, 2004 was $4,508,000, representing an increase of $1,131,000, or 33%, from $3,377,000 for the three months ended June 30, 2003. Net income as a percentage of Net Sales for the three months ended June 30, 2004 was 20%, representing a decrease of 1% compared to 21% for the three months ended June 30, 2003. Net income for the six months ended June 30, 2004 was $10,756,000 representing an increase of $4,505,000, or 72%, from $6,251,000 for the six months ended June 30, 2003. Net income as a percentage of Net Sales for the six months ended June 30, 2004 was 22%, representing an increase of 2% compared to 20% for the six months ended June 30, 2003. The improvement in net income in the aggregate for the three and six months ended June 30, 2004 was principally due to an increase in Net Sales and interest income, partially offset by an increase in selling, general and administrative expenses and interest expense.

Recent Accounting Pronouncements

In December 2003, the FASB issued FASB Interpretation No. 46(R), "Consolidation of Variable Interest Entities" ("FIN 46(R)"). FIN 46(R) clarifies the application of Accounting Research Bulletin 51, "Consolidated Financial Statements," for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest ("variable interest entities"). Variable interest entities within the scope of FIN 46(R) will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both. FIN 46(R) applies

immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies to us in the first fiscal year or interim period ending after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. We adopted FIN 46(R) in December 2003. Adoption of FIN 46(R) did not have a material effect on our financial position or results of operations.

In March 2004, the EITF reached a consensus opinion on EITF 03-6, "Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share." The EITF reached several consensuses on the definition of a participating security and when and how to apply the two-class method when an entity has any type of participating security. EITF 03-6 is effective in periods beginning after March 31, 2004. Adoption of EITF 03-6 did not have an effect.

In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." This consensus clarifies the meaning of other-than-temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity under SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and investments accounted for under the cost method or the equity method. The application of this guidance should be used to determine when an investment is considered impaired, whether an impairment is other than temporary, and the measurement of an impairment loss. The guidance also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance for evaluating whether an investment is other-than-temporarily impaired is effective for evaluations made in reporting periods beginning after June 15, 2004. We do not believe that the application of this consensus will have a material impact on our results of operations or financial position.

In March 2004 the FASB issued a proposed standard entitled "Share-Based Payment - An Amendment of FAS Nos. 123 and 95." The proposed rules will eliminate the disclosure-only election under FAS 123 and require the recognition of compensation expense for stock options and other forms of equity compensation based on the fair value of the instruments on the date of grant. The FASB currently expects to issue a final standard in late 2004, which is slated to be effective for the first quarter 2005 for the Company. See Note B for the quarterly disclosures of the pro forma dilutive impact on net income and earnings per share of expensing stock options based on the Black-Scholes model. The FASB's proposal advocates using a binomial (lattice-based) option pricing model rather than the Black-Scholes model we currently use to determine grant date fair value. We have not yet determined what, if any, impact using the recommended binomial model will have on our estimated net income and earnings per share dilution compared to the Black-Scholes model.

On July 1, 2004, the Emerging Issues Task Force (the "EITF") of the FASB reached a tentative conclusion that would require all shares that are contingently issuable

under outstanding convertible notes to be considered outstanding for its diluted earnings per share computations, if dilutive, using the "if converted" method of accounting from the date of issuance. Currently these shares are only included in the diluted earnings per share computation if the common stock price has reached certain conversion trigger prices. If approved, this EITF statement ("EITF 04-8") would also require retroactively restate prior periods diluted earnings per share. It is believed likely that EITF 04-8 will be effective for periods ending after mid-October 2004. If adopted, we believe EITF 04-8 will not have a material impact on our diluted earnings per share.

Liquidity and Capital Resources

Our cash and cash equivalents and short-term investments were $175,933,000 at June 30, 2004 and $182,503,000 at December 31, 2003. Cash used in operating activities for the six months ended June 30, 2004 were $1,355,000. The sources of cash primarily resulted from net income of $10,756,000 plus non-cash charges for depreciation and amortization of $642,000; non-cash charges for amortization of deferred financing costs of $170,000; non-cash compensation for services of $125,000; tax benefit from exercise of non-qualified stock options and warrants of $267,000; and a decrease in deferred income tax assets of $73,000. The sources of cash were offset by a gain on investment of $31,000 from sales of short-term investments; an increase in accounts receivable of $7,242,000, primarily due to the initial sales of the newly launched products being recorded during the Second Quarter 2004; an increase in inventories of $799,000, primarily due to initial purchases of finished goods of our newly launched products; an increase in prepaid expenses and other of $1,614,000, principally due to prepayment of our annual insurance premiums; a decrease in accounts payable of $311,000 primarily due to increased payments during the period; a decrease in accrued expenses of $1,252,000, principally due to payment of annual bonuses accrued during 2003; and a decrease in income taxes payable of $2,138,000, primarily due to increased tax payments.

Cash used in investing activities for the six months ended June 30, 2004 was $39,539,000, resulting from net purchases of short-term investments of $34,042,000; purchase of intangible assets of $2,600,000 for an international distribution agreement from Dermik Laboratories; payment of acquisition costs associated with the purchase of the assets of Bioglan Pharmaceuticals, Inc. of $926,000; a refundable escrow payment of $1,500,000 for a potential product acquisition that did not come to fruition; and purchases of property and equipment of $472,000.

Cash provided by financing activities for the six months ended June 30, 2004 was $767,000, which was the result of proceeds from exercise of stock options and warrants of $750,000 and distribution of treasury shares valued at $109,000 to fund our 401(k) plan, partially offset by payments of registration costs associated with the sale of our common stock during December 2003 of $77,000; and payments of notes payable of $16,000.

We have a loan agreement with Wachovia Bank with respect to a $5 million revolving asset-based credit facility and a $10 million acquisition facility for future product acquisitions. Advances available under the revolving asset-based credit facility are calculated using a formula, which is based upon our eligible accounts receivable and inventory levels. As of June 30, 2004, we are eligible to borrow $5,000,000 under the $5 million revolving asset-based credit facility. Advances under the $10 million acquisition facility are subject to our finding a potential acquisition, satisfying financial covenants and, depending upon the size of the acquisition, Wachovia's approval. This loan agreement has an initial term of two years, expiring on October 31, 2004. Interest accrues on amounts outstanding at a rate equal to LIBOR plus 1.85% and the commitment fee accrues on the unused portion of the asset-based credit facility and the acquisition facility at a rate equal to .05% per annum. Our obligations under this loan agreement are secured by our grant to Wachovia of a lien upon substantially all of our assets. As of the date of this Form 10-Q, we have not borrowed any funds from the revolving asset-based credit facility or the acquisition facility.

Concurrently with the expected closing on the assets of Bioglan Pharmaceuticals Company as described earlier, we anticipate entering into a loan agreement with Wachovia Bank with respect to a $50 million revolving bridge credit facility, which will replace our existing loan agreement mentioned above. Thereafter, we anticipate entering a new $100 million credit facility with a syndicate of lenders led by Wachovia, which would replace the bridge credit facility.

As of June 30, 2004, we had the following contractual obligations and commitments:

Convertible Minimum Operating Capital Notes due Inventory Period Leases Leases(a) 2013(b) Other Purchases(c)
July 1,
2004 to
December $ $ $ $ $ 31, 2004 556,650 18,029 - 61,478 917,500 Fiscal 2005 1,122,641 30,209 - 120,000 1,175,000 Fiscal 2006 1,137,598 22,748 - 120,000 1,275,000 Fiscal 2007 1,018,434 - - 120,000 1,000,000 Fiscal 2008 241,381 - - 120,000 1,100,000 Thereafter - - 37,000,000 120,000 - $ $ $ $ 4,076,704 70,986 $37,000,000 661,478 5,467,500

(a) Lease amounts include interest and minimum lease payments.

(b) On June 15, 2008, holders of the notes may require us to purchase all or a portion of their notes for cash at a purchase price equal to 100% of the principal amount of notes to be purchased, plus any accrued and unpaid interest.

(c) For more information on minimum inventory purchases, see "Contract Manufacturing Agreement" in Note J.6 of the notes to our consolidated financial statements included in our Form 10-K for the year ended 2003 and Note N of the notes to our consolidated financial statements included herewith.

We believe that our cash and cash equivalents and cash generated from operations will be adequate to fund our current working capital requirements for at least the next twelve months. However, if we make or anticipate significant acquisitions, we may need to raise additional funds through additional borrowings or the issuance of debt or equity securities during that period. If needed, following our expected acquisition of the assets of the Bioglan business, we may be unable to raise funds through a public offering of our securities for a period of time due to the unavailability of certain historical financial statements of that business prior to its acquisition by Quintiles in March 2002 which would be required by the Securities and Exchange Commission, and we would instead need to pursue additional borrowings or a private placement.

Critical Accounting Policies

In preparing financial statements in conformity with accounting principles generally accepted in the U.S., we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses for the relevant reporting period. Actual results could differ from those estimates. We believe that the following critical accounting policies affect our more significant estimates used in the preparation of financial statements. Management has discussed the development and selection of the critical accounting estimates discussed below with our audit committee, and our audit committee has reviewed our disclosures relating to these estimates.

Revenue recognition. Revenue from product sales, net of estimated provisions, is recognized when the merchandise is shipped to an unrelated third party, as provided in Staff Accounting: Bulletin No. 104, "Revenue Recognition in Financial Statements." Accordingly, revenue is recognized when all four of the following criteria are met:

• persuasive evidence that an arrangement exists;

• delivery of the products has occurred;

• the selling price is both fixed and determinable; and

• collectibility is reasonably probable.

Our customers consist primarily of large pharmaceutical wholesalers who sell directly into the retail channel. Provisions for sales discounts, and estimates for chargebacks, rebates, damaged product returns and exchanges for expired products, are established as a reduction of product sales revenues at the time revenues are recognized, based on historical experience adjusted to reflect known changes in the factors that impact these reserves. These revenue reductions are generally reflected either as a direct reduction to accounts receivable through an allowance, or as an addition to accrued expenses if the payment is due to a party other than the wholesale or retail customer.

We typically do not provide any form of price protection to our wholesale customers and we typically permit product returns only if the product is damaged or if it is returned within six to twelve months of expiration and twelve months after expiration.

Chargebacks and rebates are based on the difference between the prices at which we sell our products to wholesalers and the sales price ultimately paid under fixed price contracts by third party payers, who are often governmental agencies and managed care buying groups. We record an estimate of the amount either to be charged back to us, or rebated to the end user, at the time of sale to the wholesaler. We have recorded reserves for chargebacks, returns and rebates based upon various factors, including current contract prices, historical trends and our future expectations. The amount of actual chargebacks, returns and rebates claimed could be either higher or lower than the amounts we accrued. Changes in our estimates would be recorded in the income statement in the period of the change.

Product returns. In the pharmaceutical industry, customers are normally granted the right to return product for a refund if the product has not been used prior to its expiration date, which is typically two to three years from the date of manufacture. Our return policy typically allows product returns for products within an eighteen-month window from six months prior to the expiration date and up to twelve months after the expiration date. Our return policy conforms to industry standard practices. We believe that we have sufficient data to estimate future returns at the time of sale. Management is required to estimate the level of sales, which will ultimately be returned pursuant to our return policy, and record a related reserve at the time of sale. These amounts are deducted from our gross sales to determine our net revenues. Our estimates take into consideration historical returns of a given product, product specific information provided by our customers and information obtained regarding the levels of inventory being held by our customers, as well as overall purchasing patterns by our customers. Management periodically reviews the reserves established for returns and adjusts them based on actual experience. If we over or under estimate the level of sales, which will ultimately be returned, there may be a material impact to our financial statements.

Intangible assets. We have made acquisitions of products and businesses that include goodwill, license agreements, product rights and other identifiable intangible assets. We assess the impairment of identifiable intangibles, including goodwill prior to January 1, 2002, when events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important which could trigger an impairment review include:

• significant underperformance compared to expected historical or projected future operating results;

• significant changes in our use of the acquired assets or the strategy for our overall business; and

• significant negative industry or economic trends.

When we determine that the carrying value of intangible assets may not be recoverable based upon the existence of one or more of these factors, we first perform an assessment of the asset's recoverability based on expected undiscounted future net cash flow, and if the amount is less than the asset's value, we measure any impairment based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model.

As of January 1, 2002, we adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," which eliminated the amortization of purchased goodwill. Adoption of this standard did not have a material effect on our financial statements. Upon adoption of SFAS No. 142, we performed an impairment test of our goodwill, which amounted to $289,328 at January 1, 2002, and determined that no impairment of the recorded goodwill existed. The fair value of our Doak Dermatologics subsidiary that we acquired in January 1995 was calculated on the basis of discounted estimated future cash flows and compared to the related book value. Under SFAS No. 142, goodwill will be tested, for impairment at least annually, and more frequently if an event occurs that indicates the goodwill may be impaired. We performed the test at December 31, 2003, and noted that no impairment existed.

As of January 1, 2002, we also adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets," which supersedes SFAS No. 121, "Accounting for the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed of." The adoption of SFAS No. 144 had no effect on our financial statements.

Deferred income taxes are provided for the future tax consequences attributable to the differences between the carrying amounts of assets and liabilities and then respective tax base. Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion of the deferred tax assets will not be realized. As of March 31, 2004 and December 31, 2003, we determined that no deferred tax asset valuation allowance was necessary, and we eliminated our previously established valuation allowance. We believe that our projections of future taxable income makes it more likely than not that these deferred tax assets will be realized. If our projections of future taxable income changes in the future, we may be required to reduce deferred tax assets by a valuation allowance.

Certain Risk Factors Affecting Our Business and Prospects

There are many factors that may affect our business and the results of our operations, some of which are beyond our control. These factors include:

• We derive a majority of our net sales from our core branded products, and any factor that hurts our sales of these products could reduce our revenues and profitability.

• Failure to maintain CARMOL®40 net sales would reduce our revenues and profitability.

• Our operating results and financial condition may fluctuate which could negatively affect the price of our stock.

• We have outstanding indebtedness, which could adversely affect our financial condition.

• Because we rely on independent manufacturers for our products, any regulatory or production problems could affect our product supply.

• Our reliance on third party manufacturers and suppliers can be disruptive to our inventory supply.

• Our inability to accurately predict customer demand for our products could result in shortages or excess inventory.

• If we cannot purchase or integrate new products or companies, our business may suffer.

• We may need additional financing to implement our business strategy, which may not be available on terms acceptable to us.

• Our earnings may be reduced in the future due to the potential impairment of our acquired intangible assets.

• Our research and development efforts may require us to incur substantial expenses, some of which we may not recoup.

• We do not have proprietary protection for most of our branded pharmaceutical products, and our sales could suffer from competition by generic or comparable products.

• Our intellectual property rights might not afford us with meaningful protection.

• We could be sued regarding the intellectual and proprietary rights of others, which could seriously harm our business and cost us a significant amount of time and money.

• We depend on a limited number of customers, and if we lose any of them, our business could be harmed.

• Consolidation of wholesalers of pharmaceutical products can negatively affect our distribution terms and sales of our products.

• If we become subject to a product liability claim, we may not have adequate insurance coverage and our reputation could suffer.

• We are subject to chargebacks and rebates when our products are resold to governmental agencies and managed care buying groups, which may reduce our future profit margins.

• We selectively outsource some of our non-sales and non-marketing services, and cannot assure you that we will be able to obtain adequate supplies of such services on acceptable terms.

• The loss of our key personnel could limit our ability to operate our business successfully.

• We face significant competition within our industry.

• Failure to comply with government regulations could affect our ability to operate our business.

• Changes in the reimbursement policies of managed care organizations and other third party payors may reduce our gross margins.

• We may need to change our business practices to comply with changes to, or may be subject to charges under, the fraud and abuse laws.

• We may become subject to federal false claims or other similar litigation brought by private individuals and the government.

• Our Class B common stock has the right, as a class, to elect a majority of our board of directors and has disparate voting rights with respect to all other matters on which our stockholders vote, your voting rights will be limited and the market price of our common stock may be affected adversely.

• Our founder and Chairman of the Board, President and Chief Executive Officer exercises substantial control over our affairs.

• We have potential liability arising from securities transferred to accounts of 401(k) plan participants in violation of applicable securities laws.

• Our certificate of incorporation and Delaware law may delay or prevent our change of control, even if beneficial to investors.

• Our stock price has fluctuated considerably and may decline.

• We are at risk of securities class action litigation due to our stock price volatility.

• The exercise of outstanding warrants and options, the conversion of outstanding notes, or the issuance of other shares could reduce the market price of our stock.

• We may sell equity securities in the future, which would cause dilution.

For a discussion of these and other factors affecting our business and prospects, see "Item 1. Business-Risk Factors That May Affect Future Results" in our Annual Report on Form 10-K for the year ended December 31, 2003.